What is a “Security” Under California Law?
Many people are aware that the offer and sale of securities are governed by federal and California law. The applicable California law is the Corporate Securities Law of 1968 (“CSL”). See Cal. Corp. Code, §§ 25000-25707.
In general, § 25110 of the CSL states that: “It is unlawful for any person to offer or sell in this state any security in an issuer transaction … unless such sale has been qualified … or unless such security or transaction is exempted or not subject to qualification….”
Violation of the CSL will subject the offender to civil and criminal prosecution. The CSL and case law have provided definitions of all the relevant words. What is a sale? What is an offer? What is “in this state?” Today’s article provides some information on the definition of “security.”
What is a Security in California?
Probably the most commonly recognized type of “security” is stock certificates for a corporation. In addition, § 25019 of the CSL defines dozens of other financial and corporate instruments as “securities,” including, without limitation:
- Promissory note
- Membership in an incorporated or unincorporated association
- Evidence of indebtedness
- Certificate of interest or participation in any profit-sharing agreement
- Transferable share
- Investment contract
- Certificate of interest or participation in an oil, gas or mining title or lease or in payments out of production under that title or lease
In general, the key definition and concept is “investment contracts.” If you are offering or selling any sort of investment contract, most likely, you are offering and selling security. The main features of an investment contract are:
- An investment of money that is “at risk”
- In a common enterprise
- With an expectation of profit
- To be realized primarily through efforts of others
The final fourth component is often the critical inquiry; passive investment. Sometimes the focus is on the “at risk” part of the first component (the so-called “risk capital” test). See S.E.C. v. Howey Co., 328 U.S. 293 (US Supreme Court 1946); Silver Hills Country Club v. Sobieski (1961) 55 Cal.2d 811, 13 Cal.Rptr. 186, 361 P.2d 906 (Cal. Supreme Court 1961).
Definition of Securities in California from Recent Court Cases
California courts do not apply the definition of “securities” by rote. What constitutes a security is a question of fact to be decided on a case-by-case basis.
The case of Moreland v. Department of Corporations, 194 Cal. App. 3d 506 (Cal. App. 5th Dist. 1987), is instructive. At issue in Moreland were contracts for sale and refining of gold ore located in Kern County, California. The gold ore was contained in dirt and rock that was offered for sale at $37.50 per ton. The buyers could remove the rock and dirt at their own cost and have it refined by whom they chose. The seller of the ore also offered to removal and refinery services via a separate contract.
The court held these sales and refining contracts to NOT be securities. Essentially, there was no passive investment. The buyers were in complete control. They could leave their tons of rock and dirt in place, could remove them or whatever else. The court also rejected the “risk capital” test because the buyers could take immediate possession of the ore. There was no collaterialization or other contingency factor.
In recent years, the courts have found the following to be investment contracts:
- Management, service or replacement contracts coupled with the sale of something like payphones, ATM machines, kiosks, vending machines, etc. — the combination has been held to be an “investment contract”
- Prime bank money pooling investments
- Promissory note investments
- Life insurance investment schemes
- Oil and gas investment offerings
Contact San Diego Corporate Law
For further information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to private securities offerings/sales, the sale/purchase of a business and for mergers and acquisitions. Mr. Leonard can be reached at (858) 483-9200 or via email. We look forward to helping your business succeed.
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