Boston College Law School

From the SelectedWorks of Scott T. FitzGibbon

1980

What is a Security? -- A Redefinition Based on

Eligibility to Participate in the Financial Markets
Scott T. FitzGibbon, Boston College Law School

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Citation: 64 Minn. L. Rev. 893 1979-1980

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What Is a Security?-A Redefinition Based
on Eligibility to Participate
in the Financial Markets

Scott FitzGibbon*

I. INTRODUCTION

People generally believed in the 1930s, as they do today,

that the Great Depression was caused by a malfunctioning of
the securities markets.' It was under the impetus of this belief
that President Roosevelt proposed and Congress passed the
early New Deal securities laws-the Securities Act of 1933 (the
Securities Act),2 and the Securities Exchange Act of 1934 (the
Exchange Act).3 "Whatever may be the full catalogue of the
forces that brought to pass the present depression," stated the
House Report on the Securities Act, "not [the] least among
these has been [the] wanton misdirection of the capital re-
sources of the Nation" through the flotation of vast quantities
of worthless securities. 4 As one result, the Senate Report
* Assistant Professor of Law, Boston College Law School. It was be-
cause I was in the midst of producing this Article that I was unable to contrib-
ute to the Minnesota Law Review's memorial issue for Professor J. Morris
Clark, which was published in March. I therefore dedicate this Article to his
memory.
For their help on this Article, I would like to thank Professor Robert
Charles Clark of the Harvard Law School, Professor James Gordley of the Uni-
versity of California School of Law (Boalt Hall), Professors Cynthia Lichten-
stein and Thomas Abram of Boston College Law School, and the following
students at Boston College Law Schooh Elizabeth Blendell, John Curran, Con-
stance Hutner, Robert Mendelson, Anne Sweeney, and John Volk.
1. See text accompanying notes 80-94 infra.
2. Ch. 38, tit. I, 48 Stat. 74 (current version at 15 U.S.C. §§ 77a-77aa (1976 &
Supp. II 1978)). The legislative history of the principal securities acts, and the
bills and enactments themselves, are collected in LEGISLATIVE HISTORY OF THE
SEcuRrrms ACT OF 1933 AND SEcuarriEs EXCHANGE ACT OF 1934 (J. Ellenberger
& E. Mahar eds. 1973) [hereinafter cited as LEGIsLATIVE HISTORY]. The Securi-
ties Act as first adopted is reprinted in 1 id., Item 1.
3. Ch. 404, tit. I, 48 Stat. 881 (current version at 15 U.S.C. §§ 78a-78kk (1976
& Supp. I 1978)), reprinted in 4 LEGISLATIVE HISTORY, supra note 2, Item 1.
4. H.R. REP. No. 85, 73d Cong., 1st Sess. 2-3 (1933), reprinted in 2 LEGIsLA-
TwE HISTORY, supra note 2, Item 18, at 2-3.
 MINNESOTA LAW REVIEW [Vol. 64:893

noted,5
capital, or some of it, grew "timid to the point of hoard-
ing."
The Securities Act, the Exchange Act, and (to a lesser ex-
tent) subsequent securities laws 6 are largely revisions of the
law of contracts. 7 They attempt to handle with special strict-
ness and specificity, in the area of securities transactions, tradi-
tional contract law problems such as defective disclosure,
unequal access to information, and abuse of relationships of
8
trust and dependence.
The development of contract law into branches identified
according to either the nature of the items or services trans-
ferred or the nature of the relationships established was famil-

5. S. REP. No. 47, 73d Cong., 1st Sess. 1 (1933), reprinted in 2 LEGISLATIVE
HISTORY, supra note 2, Item 17, at 1. For a statement that the securities laws
were enacted because of the belief that the Crash had caused the Great De-
pression, see R. POSNER, ECONOMIC ANALYSIS OF LAw 331 (2d ed. 1977).
6. The other major securities laws are the Investment Company Act of
1940, 15 U.S.C. §§ 80a-1 to 80a-52 (1976 & Supp. I 1978), the Investment Advisers
Act of 1940, 15 U.S.C. §§ 80b-1 to 80b-21 (1976 & Supp. 11 1978), and the Trust In-
denture Act of 1939, 15 U.S.C. §§ 77aaa-77bbbb (1976 & Supp. H 1978). See also
Public Utility Holding Company Act of 1935, 15 U.S.C. §§ 79 to 79z-6 (1976 &
Supp. II 1978).
7. President Roosevelt, in his 1933 message to Congress proposing securi-
ties legislation, stated: "This proposal adds to the ancient rule of caveat
emptor, the further doctrine 'let the seller also beware."' H.R. Doc. No. 12, 73d
Cong., 1st Sess. 1 (1933), reprinted in 2 LEGISLATIVE HISTORY, supra note 2,
Item 15, at 1.
8. For example, the contract law prohibition of false statements by one
party to the other is reproduced and extended to certain parties not in privity,
and the contract law regarding nondisclosure is made stricter, by the many pro-
visions that prohibit various parties from making "an untrue statement of a ma-
terial fact or [omitting] to state a material fact necessary to make the
statements ... made not misleading." This prohibition or one much like it ap-
pears, among other places, in sections 11(a) and 12(2) of the Securities Act, 15
U.S.C. §§ 77k(a), 771(2) (1976), and in rule lob-5 (promulgated under the Ex-
change Act), 17 C.F.R. § 240.10b-5(b) (1979), reprinted in 3 FED. SEC. L. REP.
(CCH) 26,744 (1978). Detailed rules setting forth what affirmative disclosures
certain parties must make, and how and when they must make them, are the
focus of the Securities Act, especially of its registration and prospectus provi-
sions. Similar concerns figure prominently in the Exchange Act and the Invest-
ment Company Act.
The common law principles that fall under the heading of "fiduciary du-
ties" are supplemented in securities law by several different types of provi-
sions: provisions that prohibit market institutions and corporate insiders from
engaging in certain transactions that might tempt them to harm customers or
the public, see, e.g., 17 C.F.R. § 240.10b-6 (1979) (rule lOb-6 promulgated under
the Exchange Act), reprintedin 3 FED. SEC. L. REP. (CCH) 26,745 (1978); pro-
visions that require the insider or institution to give a preference to members
of the public, see, e.g., 17 C.F.R. § 240.llal-l(T) (1979) (rule llal-l(T) promul-
gated under the Exchange Act), reprinted in 3 FED. SEC. L. REP. (CCH) 26,756
(1978); and provisions that impose special disclosure obligations when adver-
sity of interest may exist, see, e.g., 17 C.F.R. § 240.10b-10 (1979) (rule lOb-10
promulgated under the Exchange Act), reprintedin 3 FED. SEC. L REP. (CCH)
26,749 (1978).
1980] DEFINITION OF SECURITY

iar to the common law, so that it would have been natural in

the early nineteenth century for a common lawyer to classify a
case as, for example, involving a loan, a partnership, or a guar-
anty, or as relating to real property or personal service.9 But
this type of particularism was certainly not tle spirit of the le-
gal world of the 1930s, nor is it the spirit today. This is perhaps
part of the reason why the question of what is a "security" (the
question, really, of within what parameters most of the special
doctrines apply) has remained muddy in an area otherwise dis-
tinguished for its maturity and precision-muddy to the point
that courts and other authorities frequently refer to the lack of
clear standards,10 and many financial arrangements that are ba-
sic to commerce and industry remain in the zone of doubt." In

9. See, e.g., J. CHrrrY, A PRAcTIcAL TREATISE ON THE LAW OF CONTRACTS

(1st ed. 1842); Story, Metcalf, Greenleaf, Forbes & Cushing, Codification of the
Common Law, in THE MISCELIANEOUS WRITINGS OF JOSEPH STORY 698, 730-31
(W. Story ed. 1852). For a strong view of the particularistic nature of the com-
mon law relating to contracts, see G. GILMORE, THE DEATH OF CONTRACT (1974).
Tension between general theory and particularization appears to have been a
feature of the law relating to contracts during many periods. See J. Cm'rry,
supra; 1 S. WLLSTON, THE LAW OF CONTRACTS vii (3d ed. W. Jaeger 1957)
('"The law of contracts .... after starting with some degree of unity now tends
from its very size to fall apart."); Gordley, Book Review, 89 HARv. I REV. 452
(1975) (reviewing G. GmTORE, supra).
10. For example, it has been said that the most widely adopted test for de-
termining when notes are securities--"notes" being one of the most common
and important categories likely to give rise to serious disagreement under the
language of the statute---"does not provide a predictive standard" and that it
"can only result in an arbitrary application of the securities acts in many
cases." Pollock, Notes Issued in Syndicated Loans-A New Test to Define Se-
curities, 32 Bus. LAW. 537, 541-42 (1977).
11. During the first six months of 1979, for example, decisions of federal
courts reflected continuing controversy over whether the following arrange-
ments involved securities: a mortgage loan from a savings and loan association
to a real estate developer, e.g., First Fed. Sav. & Loan Ass'n v. Mortgage Corp.,
467 F. Supp. 943 (N.D. Ala. 1979); interests in various sorts of employee retire-
ment plans, e.g., International Bhd. of Teamsters v. Daniel, 439 U.S. 551 (1979);
Black v. Payne, 591 F.2d 83 (9th Cir.), cert. denied, 100 S. Ct. 139 (1979); Tanuggi
v. Grolier Inc., 471 F. Supp. 1209 (S.D.N.Y. 1979); a lease of premises for a retail
shop in a shopping center, e.g., Cordas v. Specialty Restaurants, Inc., 470 F.
Supp. 780 (D. Or. 1979); loans to a business evidenced by its promissory notes,
e.g., Ross v. Popper, [1979 Transfer Binder] FED. SEC. L. REP. (CCH) 96,888
(S.D.N.Y. 1979); certificates of deposit, passbooks, and similar instruments is-
sued by banks, e.g., Hamblett v. Board of Say. & Loan Assoc., 472 F. Supp. 158
(N.D. Miss. 1979); Hendrickson v. Buchbinder, 465 F. Supp. 1250 (S.D. Fla. 1979);
a discretionary trading account in commodity futures, e.g., Berman v. Bache,
Halsey, Stuart, Shields, Inc., 467 F. Supp. 311 (S.D. Ohio 1979); an arrangement
for participation in a mail advertising venture, e.g., SEC v. Paro, 468 F. Supp.
635 (N.D.N.Y. 1979); a bank participation in a trust company loan to a business,
e.g., Provident Nat'l Bank v. Franlkford Trust Co., 468 F. Supp. 448 (E.D. Pa.
1979); notes deposited in connection with a franchise arrangement, e.g.,
Principe v. McDonald's Corp., 463 F. Supp. 1149 (E.D. Va. 1979); a sale of stock
in connection with an agreement under which the purchaser was to become ex-
 MINNESOTA LAW REVIEW [Vol. 64:893

an area of law where obscurity and vagueness can disrupt fun-

damental business relationships, this is an expensive anomaly.
This Article is devoted to the development of a clear defini-
tion of the term "security" as it is used in the Securities Act
2
and the Exchange Act.'
I1. THE DEVELOPMENT AND CURRENT STATE OF THE
DEFINITION OF "SECURITY"
A. THE CASE LAW

The definitions of "security" in the principal securities

laws13 and in the proposed Federal Securities Code14 are simi-

ecutive vice president of the issuer, e.g., Coffin v. Polishing Machs., Inc., 596
F.2d 1202 (4th Cir.), cert. denied, 100 S. Ct. 142 (1979); and limited partnership
interests in an intended tax shelter, e.g., Bartels v. Algonquin Properties, Ltd.,
471 F. Supp. 1132 (D. Vt. 1979). In a clear majority of these cases, it would have
been difficult for anyone to predict the result, and in none was a decision ar-
ticulated that is likely to afford much predictability. In all of the cases, consid-
erable ranges of neighboring questions remain unresolved.
This condition of federal confusion affects state securities law adjudication,
since state statutory definitions of "security" are generally interpreted by refer-
ence to federal cases. See, e.g., Anderson v. Grand Bahama Dev. Co., 67 IlL
App. 3d 687, 384 N.E.2d 981 (1978), cert. denied, 100 S. Ct. 272 (1979); Long, Intro-
duction to Student Symposium: Interpretingthe Statutory Definition of a Se-
curity: Pragmatic Considerations, 6 ST. MAR.Y'S LJ. 96, 104 (1974). The
definition in the Uniform Securities Act, which has been adopted or substan-
tially adopted in 36 states, see 1 BLUE SKY L. REP. (CCH) 4901, at 701-02
(1980), is virtually identical to that in the Securities Act. Compare UNIFoRM SE-
CURITIES ACT § 401(1), reprinted in 1 BLUE SKY L. REP. (CCH) 4931, at 727
(1971) with Securities Act § 2(1), 15 U.S.C. § 77b(1) (1976).
12. Courts have repeatedly attempted to develop principles for defining
"security" that are common to these two acts. See, e.g., Tcherepnin v. Knight,
389 U.S. 332, 335-36 (1967); Grenader v. Spitz, 537 F.2d 612, 616 (2d Cir.), cert. de-
nied, 429 U.S. 1009 (1976). This is appropriate because the two acts contain,
and were perceived by the lawmakers to contain, similar definitions of the
term. See S. REP. No. 792, 73d Cong., 2d Sess. 14 (1934) (the definitions of "is-
suer" and "security" in the Exchange Act "are substantially the same as those
in the Securities Act of 1933"), reprintedin 5 LEGISLATIVE HISTORY, supra note
2, Item 17, at 14. Furthermore, the two acts have overlapping purposes and his-
tories. In fact, Congress, when it passed the Exchange Act, amended the Se-
curities Act definition in a way that made the Securities Act definition closer to
the new Exchange Act definition. See Act of June 6, 1934, ch. 404, tit. II,
§ 201(a), 48 Stat. 905 (codified at 15 U.S.C. § 77b(1) (1976)). Compare Exchange
Act § 3(a) (10), 15 U.S.C. § 78c(a) (10) (1976) with Securities Act § 2(1), 15 U.S.C.
§ 77b(1) (1976).
13. "Security" is defined in the Securities Act as follows:
When used in this title, unless the context otherwise requires-
(1) The term "security" means any note, stock, treasury stock,
bond, debenture, evidence of indebtedness, certificate of interest or
participation in any profit-sharing agreement, collateral-trust certifi-
cate, preorganization certificate or subscription, transferable share, in-
vestment contract, voting-trust certificate, certificate of deposit for a
security, fractional undivided interest in oil, gas, or other mineral
rights, or in general, any interest or instrument commonly known as a
1980] DEFINITION OF SECURITY 897

lar to one another, and consist of categories of securities such

"security", or any certificate of interest or participation in, temporary
or interim certificate for, receipt for, guarantee of, or warrant or right to
subscribe to or purchase, any of the foregoing.
Securities Act § 2, 15 U.S.C. § 77b (1976). The term is defined in the Exchange
Act as follows:
When used in this chapter, unless the context otherwise requires-

(10) The term "security" means any note, stock, treasury stock,
bond, debenture, certificate of interest or participation in any profit-
sharing agreement or in any oil, gas, or other mineral royalty or lease,
any collateral-trust certificate, preorganization certificate or subscrip-
tion, transferable share, investment contract, voting-trust certificate,
certificate of deposit, for a security, or in general, any instrument com-
monly known as a "security"; or any certificate of interest or participa-
tion in, temporary or interim certificate for, receipt for, or warrant or
right to subscribe to or purchase, any of the foregoing; but shall not in-
clude currency or any note, draft, bill of exchange, or banker's accept-
ance which has a maturity at the time of issuance of not exceeding
nine months, exclusive of days of grace, or any renewal thereof the ma-
turity of which is likewise limited.
Exchange Act § 3(a), 15 U.S.C. § 78c(a) (1976).
The Investment Company Act and the Advisers Act contain definitions
identical to that in the Securities Act. See Investment Company Act of 1940,
§ 2(a) (36), 15 U.S.C. § 80a-2(a) (36) (1976); Investment Advisers Act of 1940,
§ 80b-2(a) (18), 15 U.S.C. § 80b-2(a) (18) (1976). The Trust Indenture Act adopts
by reference the Securities Act definition. Trust Indenture Act of 1939, § 303(1),
15 U.S.C. § 77ccc(1) (1976). The Public Utility Holding Company Act of 1935
contains a definition similar to those in the Securities Act and the Exchange
Act. See Public Utility Holding Company Act of 1935, § 2(a) (16), 15 U.S.C.
§ 79b(a) (16) (1976).
14. "Security" is defined in the proposed code as follows:
(a) [General] "Security" means a bond, debenture, note, evidence
of indebtedness, share in a company (whether or not transferable or
denominated 'stock'), preorganization certificate or subscription, in-
vestment contract, certificate of interest or participation in a profit-
sharing agreement, collateral trust certificate, equipment trust certifi-
cate (including a conditional sale contract or similar interest or instru-
ment serving the same purpose), voting trust certificate, certificate of
deposit for a security, or fractional undivided interest in oil, gas, or
other mineral rights, or, in general, an interest or instrument com-
monly considered to be a "security," or a certificate of interest or par-
ticipation in, temporary or interim certificate for, receipt for, guarantee
of, or warrant or right to subscribe to or buy or sell, any of the forego-
ing.
(b) [Exclusions] Notwithstanding section 299.53(a), "security"
does not include (1) currency, (2) a check (whether or not certified),
draft, bill of exchange, or bank letter of credit, (3) a note or evidence of
indebtedness issued in a primarily mercantile or consumer, rather than
investment, transaction not involving a distribution. .. , (4) an inter-
est in a deposit account with a bank (but not a participation in such
interests), (5) ... a bank certificate of deposit that ranks on a parity
with an interest in a deposit account with the bank, (6) an insurance
policy (including an endowment policy) issued by an insurance com-
pany, (7) an annuity contract (including an optional annuity contract)
under which the insurance company promises to pay one or more sums
of money that are fixed or vary in accordance with a cost-of-living in-
dex or on any other basis specified by rule, (8) a commodity contract
(whether for present or future delivery) or warrant or right to buy or
 MINNESOTA LAW REVIEW [Vol. 64:893

as "debentures," "notes," and "shares in a company," joined

with elastic clauses such as "unless the context otherwise re-
quires" and "any instrument or interest commonly known as a
'security."' The extreme flexibility of these provisions, and the
absence of any apparent efforts on the part of the draftsmen to
express common concepts or principles in the definitions,' 5 pro-
vide an invitation to courts to develop a set of coherent guide-
lines.
The leading Supreme Court effort to develop such guide-
lines is SEC v. W.J. Howey Co.,16 in which the Court deter-
mined that sales contracts for plots of orchard land and
contracts to service the fruit trees constituted securities for
purposes of the Securities Act. The defendants were two sister
corporations, one of which owned large tracts of citrus groves
in Florida, and the other of which cultivated the groves and ser-
viced them in various ways. To obtain financing, the company
that owned the land offered plots of trees to the public, espe-
cially to guests at a nearby resort hotel owned by one of the de-
fendants. These guests were primarily business and
professional people from out of state. They and others were of-
fered small plots arranged in long, narrow strips so that an
acre, for example, consisted of a row of forty-eight trees. Offer-
ees were encouraged to enter into a ten-year contract with the
service company under which the service company took a
leasehold interest in the land and assumed full discretion and
authority for cultivating, harvesting, and marketing the crops.
The purchasing "owner," after entering into the contract, had
no right to any specific fruit; his right was limited to a portion
of the profits determined on the basis of the amount of fruit
harvested from his plot.17
The Court held that the arrangements involved securities
sell such a contract, or (9) the interest of a mini-account client under
advisement if section 914(c) is effective.
ALI FED. SECURITIES CODE § 299.53 (Proposed Official Draft, Mar. 15, 1978).
Subsections (c) and (d) provide further exclusions relevant to the broker-
dealer insolvency and trust indenture provisions. Like current law, the pro-
posed code introduces the definition with the proviso that it applies "unless the
context requires otherwise." Id. § 201(a).
15. The proposed codification is an exception in that reference is made to a
distinction between instruments issued in "mercantile or consumer" transac-
tions and instruments issued in "investment" transactions. See note 14 supra.
For a discussion of the similar "commercial-investment" distinction, see text
accompanying notes 147-169 infra.
16. 328 U.S. 293 (1946).
17. See SEC v. W.J. Howey Co., 151 F.2d 714, 717 (5th Cir. 1945), rev'd, 328
U.S. 293 (1946).
 1980] DEFINITION OF SECURITY

for purposes of the registration and disclosure provisions of the

Securities Act. Writing against the background of the expan-
sive interpretation given the term "investment contract" under
state securities laws,18 Justice Murphy observed that the term
"security" was defined by the statute to include an "investment
contract," which meant "a contract, transaction or scheme
whereby a person invests his money in a common enterprise
and is led to expect profits solely from the efforts of the pro-
moter or a third party."19 This formulation, still generally con-
sidered to be the classic definition, 20 was held to encompass the

18. The principal state case on which Justice Murphy relied was State v.
Gopher Tire &Rubber Co., 146 Minn. 52, 177 N.W. 937 (1920), in which the court
broadly stated that "investment" for purposes of the definition of "investment
contract" in the state securities laws included "[t] he placing of capital or laying
out of money in a way intended to secure income or profit from its employ-
ment." Id. at 56, 177 N.W. at 938. See SEC v. W.J. Howey Co., 328 U.S. at 298.
State securities laws had been enacted under the impetus of the progressive
movement and in aid of business interests in the enacting states. See generally
M. PAauusii SEcURrTEs REGULATION AND THE NEw DEAL (1970). Their purposes
were understood by courts to be very broad, and not particularly connected
with the protection of a market in securities. The court in Gopher, for example,
said that "[t]he purpose of the statute is to protect the public against imposi-
tion." 146 Minn. at 55, 177 N.W. at 938. The court in Vercellini v. U.S.I. Realty
Co., 158 Minn. 72, 74, 196 N.W. 672, 672 (1924), stated that "Blue Sky Laws are
intended to protect one class of individuals from the imposition of another
class." The term "investment contract" made its way into state securities laws
(and from them into the federal laws) as part of an effort to regulate purported
sales of out-of-state land. Note, Pension Plans as "Investment Contracts," 96 U.
PA. L REv. 549, 553 (1948).
19. 328 U.S. at 298-99.
20. For the twenty years following Howey, the Supreme Court was almost
silent as to the definition of the term "security." But see SEC v. Variable Annu-
ity Life Ins. Co., 359 U.S. 65 (1959) (holding, without discussion, that variable
annuity contracts constituted securities). When the Court broke its silence in
SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967), it applied the "character
in commerce" language of SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344
(1943), and, in an opinion by Mr. Justice Harlan, did not even mention Howey.
The Howey test became unpopular among the commentators. See, e.g., Long,
An Attempt to Return "Investment Contracts" to the Mainstream of Securities
Regulation, 24 OKLA. L. REV. 135, 177 (1971) (describing Howey as "tragic");
Tew & Freedman, In Support of SEC v. W.J. Howey Co.: A CriticalAnalysis of
the Parametersof the Economic Relationship between an Issuer of Securities
and the Securties Purchaser,27 U. MAMV L. REv. 407, 448 (1973) (remarking
with regret that "criticism of Howey is a mark of progressive thought"). Never-
theless, the case was very widely followed in the lower courts, and the
Supreme Court in United Hous. Foundation, Inc. v. Forman, 421 U.S. 837, 852
(1975), stated that the Howey test "embodies the essential attributes that run
through all of the Court's decisions defining a security."
It should be noted that the Howey Court was not defining "security" in
general, but rather "investment contract," which is a portion of the statutory
definition of "security." Thus, it would be consistent with a very restrictive
reading of Howey for a court to hold that an instrument which had failed the
Howey test was a security under some other portion of the definition, or to
hold that an instrument which had passed the Howey test was nevertheless not
 MINNESOTA LAW REVIEW [Vol. 64:893

fruit grove arrangements because such arrangements really in-

volved "an opportunity to contribute money and to share in the
profits of a large citrus fruit enterprise managed and partly
owned by respondents."2 1 The offerees "have no desire to oc-
cupy the land or to develop it themselves; they are attracted
solely by the prospects of a return on their investment." 22 The
Court concluded that in view of these facts,
all the elements of a profit-seeking business venture are present here.
The investors provide the capital and share in the earnings and profits;
the promoters manage, control and operate the enterprise. It follows
that the arrangements whereby the investors' interests are made mani-
fest involve investment contracts .... 23

As with many leading cases, the Court's opinion in Howey

has undergone a type of common law codification, or has been
regarded by some lower courts as codified. The definition of an
"investment contract" has become known as the "three-prong
test" of Howey: An "investment contract" is (1) an investment
of money (2) in a common enterprise from which one is led to
expect (or does expect) profits (3) solely from the efforts of
others. A literal application of the test, however, would lead to
unacceptable results. The test seems to produce the result that
whenever one puts funds in the hands of others in the hope of
gain, one is purchasing a security, at least so long as one does
not assist in the efforts of the recipients to use the funds pro-
ductively. (Indeed, it is widely accepted today that some such
assistance will not disqualify the instrument. 24 ) The test pro-

a security because of the introductory phrase in the definition--"unless the

context otherwise requires." See, e.g., Daniel v. International Bhd. of Team-
sters, 561 F.2d 1223, 1265 (7th Cir. 1977) (describing the Howey test as the 'Tirst
hurdle"), rev'd, 439 U.S. 531 (1979). In most instances, however, the Howey test
has been determinative. For a close analysis of the extent to which the Howey
test applies to other than "investment contracts," see Braniff Airways, Inc. v.
LTV Corp., 479 F. Supp. 1279, 1283-86 (N.D. Tex. 1979) (concluding that the test
is "at least relevant" there).
21. 328 U.S. at 299.
22. Id. at 300.
23. Id.
24. See, e.g., SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 (5th Cir.
1974) (holding that pyramid marketing scheme, in which "investor's" profits
were partly a product of his own selling efforts, involved a security because
"the critical inquiry is 'whether the efforts made by those other than the inves-
tor are the undeniably significant ones, those essential managerial efforts
which affect the failure or success of the enterprise' ") (quoting SEC v. Glenn
W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir.), cert. denied, 414 U.S. 821
(1973)); Securities Act Release No. 5347, 38 Fed. Reg. 1735 (1973), reprinted in
[1972-1973 Transfer Binder] FED. SEC. L. REP. (CCH) 79,163 (stating that con-
dominiums offered in conjunction with servicing arrangements can constitute
securities because, inter alia, "an investment contract may be present in situa-
tions where an investor is not wholly inactive"). The Supreme Court in For-
 1980] DEFINITION OF SECURITY

vides no way to avoid the conclusion that virtually all loans in-
volve securities, including commercial loans from banks,
secured revolving credit loans from credit companies, and con-
sumer loans to individuals.25 Similarly, the Howey rubric
might require the conclusion that a dealer has purchased a se-
curity by making advance payments under a contract for the
supply of goods. The goods represent a benefit to the dealer
arising from the efforts of the supplier; the dealer expects a
"profit" in that the benefit of the goods will be greater than
their cost. Moreover, how are we to avoid the conclusion that
the result in Howey would have been the same if the leaseback
and servicing arrangements had not related to adjacent strips
of fruit trees but instead covered entire farms, and, indeed, that
it would have been the same if there had been no servicing ar-
rangement but instead merely a sale and leaseback?
Considerations such as these have led to many efforts to
modify and reinterpret the three-prong test, the most important
of which are the Supreme Court decisions in United Housing
Foundation,Inc. v. Forman26 and InternationalBrotherhood of
Teamsters v. Daniel.27 In Forman,prospective tenants of Co-op
City, a publicly financed low-income housing project that was
organized as a cooperative, were required, as a condition of oc-
cupancy, to purchase shares of "stock" in the nonprofit corpora-
tion that owned and operated the land and buildings. A
prospective tenant had to purchase eighteen shares per room
at $25 per share, for a total of $1,800 for a four-room apartment.
The nature of this stock was described by the Court as follows:
The sole purpose of acquiring these shares is to enable the purchaser
to occupy an apartment in Co-op City; in effect, their purchase is a re-
coverable deposit on an apartment. The shares are explicitly tied to
the apartment: they cannot be transferred to a nontenant; nor can they
be pledged or encumbered; and they descend, along with the apart-
ment, only to a surviving spouse. No voting rights attach to the shares
as such: participation in the affairs of the cooperative appertains to the
apartment, with the residents of each apartment being entitled to one
vote irrespective of the number of shares owned.
Any tenant who wants to terminate his occupancy, or who is forced
to move out, must offer his stock to Riverbay at its initial selling price
of $25 per share. In the extremely unlikely event that Riverbay de-
clines to repurchase the stock, the tenant cannot sell it for more than
the initial purchase price plus a fraction of the portion of the mortgage

man expressly refused to state whether the Turner court was correct on this
point. United Hous. Foundation, Inc. v. Forman, 421 U.S. 837, 852 n.16 (1975).
25. For a discussion of debt instruments, see text accompanying notes 144-
182 infra.
26. 421 U.S. 837 (1975).
27. 439 U.S. 551 (1979).
 MINNESOTA LAW REVIEW [Vol. 64:893

that he has paid off, and then only to a prospective

28
tenant satisfying
the statutory income eligibility requirements.
Some of the tenants sued the nonprofit corporation and the
state, alleging violations of rule 10b-5 and other antifraud provi-
sions of the securities laws arising from misstatements of
financial arrangements relevant to the likelihood and amount of
rent increases. The Court held that, despite the fact that the
instruments in question were called "stock," they should be
tested by reference to "economic realities" and that under such
an approach, they were not securities. 29 The Court discovered
two major aspects of the Co-op City arrangements that caused
them to fail the Howey test. First, the return sought by the
supposed investors was in the form of a right to occupy apart-
ment space. "What distinguishes a security transaction-and
what is absent here-is an investment where one parts with his
money in the hope of receiving profits from the efforts of
others, and not where he purchases a commodity for personal
consumption or living quarters for personal use." 30 The right to
occupy apartment space was not, the Court indicated, a 'Tman-
cial return." 31 In addition, the Court analyzed the manner in
which the issuing corporation hoped to earn returns that could
be passed along to the tenants as rent reductions. After re-
marking that "[bly profits, the Court has meant either capital
appreciation resulting from the development of the initial in-
vestment.., or a participation in earnings resulting from the
use of investors' funds," 32 the Court stated:
The Court of Appeals also found support for its concept of profits in
the fact that Co-op City offered space at a cost substantially below the
going rental charges for comparable housing. Again, this is an inappro-
priate theory of "profits" that we cannot accept. The low rent derives
from the substantial financial subsidies provided by the State of New
York. This benefit cannot be liquidated into cash; nor does it result
from the managerial efforts of others. In a real sense, it no more em-
bodies the attributes of income or profits than do welfare benefits, food
stamps, or other government subsidies.
The final source of profit relied on by the Court of Appeals was the
possibility of net income derived from the leasing by Co-op City of
commercial facilities, professional offices and parking spaces .... The
income, if any, from these conveniences ... is to be used to reduce
tenant rental costs. [But] this income ... is far too speculative and in-
33
substantial to bring the entire transaction within the Securities Acts.
As a result, the expectation-of-profits prong of the Howey test

28. 421 U.S. at 842-43 (1975) (footnotes omitted).

29. Id. at 848-52, 858.
30. Id. at 858.
31. Id. at 853.
32. Id. at 852.
33. Id. at 855-56.
 1980] DEFINITION OF SECURITY

was not satisfied; this prong was interpreted by the Court to re-
quire that the profits hoped for by the supposed investor be
"derived from the entrepreneurial or managerial efforts of
34
others."
Although the Court's opinion in Forman never explicitly
departed from Howey, it might be viewed as adding two new
requirements: first, that the return be "financial" in form or at
least not be something to be consumed; and second, that the
activities engaged in by the issuer-the activities which put it
in a position to furnish the return-be predominantly "en-
trepreneurial and managerial."
Daniel, the second major Supreme Court case interpreting
Howey, dealt with the issue of whether an interest in the
Teamsters' Union Pension Fund was a security. The fund was
established out of contributions made by employers of Team-
sters; collective bargaining agreements required these employ-
ers to make payments to the fund in proportion to the number
of Teamsters that they employed. The plan did not permit em-
ployees to opt out, nor did it in general contemplate their mak-
ing contributions on their own behalves. 35 Upon retirement, an
eligible employee received a pension in a fixed amount deter-
mined according to a formula that took into account anticipated
employer contributions, anticipated performance of the invest-
37
ments made, 36 and the anticipated amount of other pensions.
The Supreme Court held that "the Securities Acts do not apply
to a noncontributory, compulsory pension plan,"3 8 and that con-
sequently the employee did not have a cause of action under
the antifraud provision of the securities laws. 39
The Court first reasoned that the "investment of money"
requirement of Howey was not satisfied. The plaintiff argued

34. Id. at 852 (emphasis added).

35. The Supreme Court prominently described the plan as "noncontribu-
tory." 439 U.S. at 553. For a further discussion of employee benefit plans, see
text accompanying notes 183-191 in/ra.
36. The fund was administered by trustees who invested the assets. 439
U.S. at 561.
37. For a description of the Teamster plan and the various types of tax-
qualified employee benefit plans, see Kelly, Securities Regulationof Retirement
PlansAfter Daniel, 10 Loy. CHL LJ.631, 635-40 (1979). See also note 184 infra.
38. 439 U.S. at 570.
39. This result was consistent with recent case law. See Robinson v.
United Mine Workers Health & Retirement Funds, 435 F. Supp. 245 (D.D.C.
1977); Wiens v. International Bhd. of Teamsters, [1977-1978 Transfer Binder]
FED. SEC. L. REP. (CCH) 96,005 (C.D. Cal. 1977); Hum v. Retirement Fund
Trust of the Plumbing, Heating & Piping Indus., 424 F. Supp. 80 (C.D. Cal. 1976).
The Court unaccountably failed to mention any of these cases.
 MINNESOTA LAW REVIEW [Vol. 64:893

that although the employee normally made no direct payment

of any kind into the fund, the requirement was satisfied be-
cause the employer contributed money, and the employee in-
duced him to do so by working. The Court did not explicitly
reject this argument; it did not state that indirect payments or
payments in services rather than in cash could never satisfy
the requirement. Rather, it appeared to rest its conclusion on
the impossibility of distinguishing, in either the consideration
furnished by the employee to the employer or the payment by
the employer to the fund, a separable element constituting con-
sideration for the supposed security. The Court's reasoning in
this regard suggests that it was applying a different test, such
as one of motive:
In every decision of this Court recognizing the presence of a "security"
under the Securities Acts, the person found to have been an investor
chose to give up specific consideration in return for separable financial
interest ....
In a pension plan such as this one, by contrast, the purported in-
vestment is a relatively insignificant part of an employee's total and in-
divisible compensation package.... His decision to accept and retain
covered employment may have only an attenuated relationship, if any,
to perceived investment possibilities of a future pension. 4°
A second basis for the decision was the lack of expectation
of profits from the efforts of others. The Court focused not on
the presence or absence of profits but on their source:
It is true that the Fund... depends to some extent on earnings from
its assets. In the case of a pension fund, however, a far larger portion
of its income comes from employer contributions, a source in no way
dependent on the efforts of the Fund's managers....
[In addition,] the principal barrier to an individual employee's re-
alization of pension benefits is not the financial health of the Fund.
Rather, it is his own ability to meet the Fund's eligibility requirements.
Thus, even if it were proper to describe the benefits as a "profit" re-
turned on some hypothetical investment by the employee, this profit
would depend primarily on the employee's efforts to meet the vesting
requirements, rather than the fund's investment success 4 1

40. 436 U.S. at 559-60.

41. Id. at 561-62 (footnote omitted). It is clear that the Court, in stating
that the hoped-for gain related largely to employer contributions, was not mak-
ing the fallacious argument that the plan did not involve a security because em-
ployer contributions with respect to the employee in question accounted for a
large part of his return. That would be similar to arguing that a corporate bond
is not a security because a large portion of the anticipated payments are to be
the repayment of principal at maturity. Rather, the Court probably had in
mind the point made in Judge Cummings' opinion in the court below: one's
hope of gain depended in part on employer contributions made with respect to
other employees who later, for one reason or another, became disqualified and
forfeited their pensions. When that happened the payments made on behalf of
disqualified employees remained in the fund and were taken into consideration
in determining the amount of benefits to those who did not forfeit. See Daniel
1980] DEFINITION OF SECURITY

Two points can be made about the state of the law after
Forman and Daniel. The first is that a great deal remains un-
42
resolved. The current status of the three-pronged Howey test,
including the doubts, questions, and modifications suggested
by Forman, Daniel, and other recent cases can be depicted as
follows:
A "security" (by means of the term "investment contract"
in the statutory definition), is a contract, transaction or
scheme-
1. "Whereby a person invests his money." Despite its
evident hostility to the view that a security was present,
the Daniel Court did not insist that a direct money contri-
bution be made by the supposed investor, and indeed it
would be difficult to insist that a standard equity share, for
example, was not a security even if it was obtained for real
or personal property.4 3 After Daniel, however, serious
doubts about the presence of a security must arise when,
under the circumstances of the purchase, it is impossible to
find a divisible portion of the consideration that is attribu-
table to the acquisition of the instrument. 44 But does it
make sense to hold that a standard equity share acquired
for a week's work is a security whereas the same share ac-
quired together with $200, indivisibly in consideration for
two weeks' work, is not? Can this problem be solved by
reference to the motives of the worker, as the Court at one
45
point seems to imply?
2. "In a common enterprise and is led to expect prof-
its." Is a common enterprise present when there is only"
one investor in the business? 46 As to profits, after Forman
one might be inclined to say that they must be 'mancial"
or that one must expect them in some form other than that
of a "commodity for personal consumption." 47 Why?
Would it matter that one did not use up the consumable re-
turn but sold it for cash, perhaps in advance of receiving it?

v. International Bhd. of Teamsters, 561 F.2d 1223, 1234 (7th Cir. 1977), rev'd, 436
U.S. 551 (1979).
42. See text accompanying note 19 supra.
43. See also Long, supra note 11, at 114.
44. It is also worth noting that the Daniel Court mentioned that the form
of consideration-work-was not "tangible." International Bhd. of Teamsters v.
Daniel, 439 U.S. 551, 560 (1979).
45. See text accompanying note 40 supra.
46. For a description of the conflicting authorities on this point, see Troyer
v. Karcagi, 476 F. Supp. 1142 (1979).
47. United Hous. Foundation, Inc. v. Forman, 421 U.S. at 858.
 MINNESOTA LAW REVIEW [Vol. 64:893

How would this apply to a commodity future? After For-

man, it may also be true that the return, even if in cash or
some other clearly acceptable form, will not qualify as a
"profit" unless it is paid out of "earnings" or "capital appre-
ciation" resultingfrom the use of investors' funds. Must
courts actually conduct an inquiry into causation, and thus
trace the invested funds or apply some test like the "but
for" test?
3. "Solely from the efforts of[others]." After Forman,
and after taking into account the judicial retreat from the
"solely" requirement, 48 this prong must be amended to
read: largely from the entrepreneurial or managerial ef-
forts of others. 49 How much is "largely" and against what
is it measured? What is meant to be ruled out by the im-
posing phrase "entrepreneurial and managerial efforts?"5 0
All undertakings involve the exercise of management func-
tions, but nearly all involve additional work at
nonmanagerial levels. Daniel suggests that forfeitures of
pension rights by other employees do not count as the
products of managerial or entrepreneurial efforts.51 The
Court in Forman stated that government subsidies are also
ineligible.5 2 This clearly raises difficult questions in an
economy in which tax incentives and disincentives are
prominent considerations in every important business deci-
sion.
The second point about the current state of the law is that
even what has been resolved may not have been articulated in
a way that fully reflects the courts' reasoning or that provides a
reliable guide to their future holdings. Two recent district
court opinions demonstrate this point. In Cordas v. Specialty
Restaurants,Inc.,5 3 the plaintiff claimed that her lease of busi-
ness premises in a shopping center involved the sale of a secur-
ity, thus affording a basis for a fraud claim when the shopping-
center did poorly. After considerable discussion, which was in-
duced in part by the fact that the plaintiff had given a substan-

48. See note 24 supra and accompanying text.

49. See 421 U.S. at 852.
50. For a theory under which this and other elements of the Howey test
would be interpreted by reference to the amount of control the investor may
exercise, see Newton, What Is a SecurityZ" A Critical Analysis, 48 Miss. I.J.
167, 190 (1977) ("If the efforts... produce an actual right of control, the exist-
ence of a security is precluded.").
51. See 439 U.S. at 561-62.
52. 421 U.S. at 855.
53. 470 F. Supp. 780 (D. Or. 1979).
 1980] DEFINITION OF SECURITY

tial security deposit, the court held that no security was

involved.54 The result is sensible, and one naturally looks to
Forman for authority. But it will be noted that neither of the
major disqualifying features mentioned in Forman was present
in Cordas: the return-a commercial leasehold-was not for
"personal consumption," and the profit-generating activities of
the lessor could not be dismissed as relating to government
benefits but rather were of a thoroughly managerial and en-
trepreneurial nature. 55 In Tanuggi v. Grolier Inc.,5 6 an em-
ployee claimed that a security was involved in a voluntary
employee pension plan to which the employee made contribu-
tions. The court rejected that contention even though one of
the major disqualifying features in Daniel was absent-there
was clearly a "separable contribution" attributable to the em-
ployee-and even though the other major disqualifying feature
was of diminished importance-the court did not indicate that
forfeitures by other employees constituted a major source of
the profits. If the Cordas and Tanuggi results seem intuitively
correct, that must be because of factors not fully articulated in
the leading cases.
The ambiguity of the Howey test, even in its revised form,
suggests that the door is still open to the development of basic
principles in this area, and the welcome mat is out. Intriguing
language, suggestive of a theory, appears in several cases. In
the early case of SEC v. C.M. JoinerLeasing Corp.,57 for exam-
ple, the Supreme Court stated that the test is "what character
the instrument is given in commerce"; 58 instruments would be

54. Id. at 790.

55. See id. at 785. The court rested its holding on its conclusion that the
"profits solely [or preponderantly] from the efforts of [others]" prong of
Howey was not satisfied, since plaintiff was to contribute efforts by managing
her shop. The opinion fails to distinguish clearly between (i) the benefit mea-
sured by the market value of the leasehold, which would be greater or less ac-
cording to the general success of the shopping center in attracting business,
and to which plaintiffs efforts would have contributed only slightly and (ii) the
benefits involved in owning and operating her store (that is, the store's profit-
ability), to which her efforts would have been far more important. Only the for-
mer benefit is relevant under Howey because only the former benefit is the
direct product of the investment at issue; the profitability of the store was a
product of many transactions, no others of which were stated to involve the les-
sor. It therefore is difficult to justify the court's result under Howey and For-
man. The test proposed in this Article justifies the result in the manner
explained in note 117 infra.
56. 471 F. Supp. 1209 (S.D.N.Y. 1979). Other cases since Daniel dealing
with pension plans are cited in note 185 infra. For a better approach to the
problem, see text accompanying notes 183-191 infra.
57. 320 U.S. 344 (1943).
58. Id. at 352-53.
 MINNESOTA LAW REVIEW [Vol. 64:893

securities if "they were widely offered or dealt in under terms

or courses of dealing which established their character in com-
merce as 'investment contracts.'-59 Lower court decisions in
the area of debt instruments have inquired whether the instru-
ment or the transaction in which it passes is of a "commercial"
nature, in which case no security is involved, or an "invest-
ment" nature, in which case a security is present.60 In its re-
cent opinions, the Supreme Court has frequently mentioned
the importance of looking to the "economic realities" in-
volved.61 We should accept these comments as indicating a di-
rection. Scholars can learn from the insights to which courts
aspire as well as those that they have actually achieved.

B. THE COMMENTATORS
Commentators offering general guidance as to the defini-
tion of "security" have more often than not followed the gen-
eral lines of an approach suggested by Professor Ronald Coffey.
Professor Coffey argued that a security is a "transaction whose
characteristics distinguish it from the generality of transactions
so as to create a need for the special fraud procedures, protec-
tions, and remedies provided by the securities laws." 62 This
need for special protection, he observed, is most likely to be
present when the buyer's investment is at risk, when the in-
vestment is in a "risk enterprise" with which the buyer is unfa-
miliar and over which he has no control, and when there is a
reasonable expectation of return in excess of value given. This
approach would afford the benefits that might be expected from
a broad application of the securities laws; it is supported by
language frequently found in the cases stating that the securi-
ties laws are to be construed broadly, and that the definition of
"security" in particular should be "capable of adaptation to
meet the countless and variable schemes devised by those who
seek the use of the money of others on the promise of prof-
its."63 It is also supported by cases, notably from the Court of
Appeals for the Ninth Circuit, applying a "risk capital" test,64

59. Id. at 351.

60. For an extensive discussion and critique of the commercial-investment
distinction, see text accompanying notes 144-169 infra.
61. See, e.g., United Hous. Foundation, Inc. v. Fornan, 421 U.S. 837, 858
(1975).
62. Coffey, The Economic Realities of a "Security's Is There a More Mean-
ingful Formula?, 18 W. REs. L. REV. 367, 373 (1967).
63. SEC v. W.J. Howey Co., 328 U.S. 293, 299 (1946).
64. See, e.g., United Cal. Bank v. THC Financial Corp., 557 F.2d 1351, 1358
(9th Cir. 1977). See also Amfac Mortgage Corp. v. Arizona Mall, Inc., 583 F.2d
 1980] DEFINITION OF SECURITY

and by cases applying a "commercial-investment" distinction to

debt instruments. 65 On the other hand, it would be difficult to
think of instruments that created a more desperate need for
special protection than those in Daniel, which were subject to
vesting requirements so obscure and difficult to meet that the
66
defendants admitted that they were shocking.
In its most extreme form-a form commonly found in the
literature-this "need for buyer and offeree protection" test
would be applied by taking into account all of the characteris-
tics of the transaction proposed to be subjected to the securi-
ties laws, rather than only the characteristics of the instrument
involved. For example, if an instrument were issued and sold
in a transaction in which the purchaser lacked information or
expertise, and at a time when the issuing company was in a
shaky condition, the instrument would be especially eligible for
characterization as a security.67 Presumably, if the instrument
were later resold to an expert business analyst at a time when
the issuing company was in excellent condition, it would lose
its standing as a security under the test. This approach would
produce anomalous results, such as causing the same instru-
ment to be a security at one time but not at another according
to the type of transaction involved, and causing some instru-
ments to be deemed securities and others of an identical issuer
and class not to be, according to their different trading patterns.
Neither common usage nor the syntax of the securities laws
countenances such results, which would make a hash of some
of the major provisions. Consider, for example, the difficulties
in determining the number of offerees for purposes of the Se-
curities Act nonpublic-offering exemption 6 8 when some of the

426 (9th Cir. 1978); Great W. Bank & Trust Co. v. Kotz, 532 F.2d 1252 (9th Cir.
1976); Silver Hills Country Club v. Sobieski, 55 Cal. 2d 811, 361 P.2d 906, 13 Cal.
Rptr. 189 (1961); note 169 infra. It has been argued that support for the risk
capital test is afforded by SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65
(1959), and by SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967). Hannan
& Thomas, The Importance of Economic Reality and Risk in Defining Federal
Securities,25 HASTINGS L.J. 219, 246 (1974).
65. See text accompanying notes 147-169 infra. For some support for the
"need for protection" analysis, see Boone v. GLS Livestock Management, Inc.,
[1980] FED. SEC. L, REP. (CCH) 1 97,174 (D. Utah 1976).
66. Daniel v. International Bhd. of Teamsters, 561 F.2d 1223, 1228 (7th Cir.
1977), rev'd, 439 U.S. 551 (1979).
67. The test proposed by Professor Coffey appears to be transaction-based,
in that it is formulated using the word "transaction" as the predicate: "A 'se-
curity' is [a] transaction in which .... " Coffey, supra note 62, at 377. This
contrasts with the statutory definitions in the principal securities laws, see note
13 supra, in which "instrument" or "interest" is occasionally used in that way.
68. Securities Act § 4(2), 15 U.S.C. § 77d(2) (1976). Numbers of offerees or
 MINNESOTA LAW REVIEW [Vol. 64:893

offerees are knowledgeable and hold controlling interests while

other offerees are ignorant outsiders. Consider the difficulties
in applying the test to provisions, such as the Exchange Act re-
gistration requirement, 69 that use the term "security" without
identifying any particular transaction.
These objections might be circumvented by a more cau-
tious form of the "need for protection" test under which one
would ignore factors peculiar to the transaction at issue; the de-
termination as to need for protection would be made wholly on
the basis of the nature of the instrument and of the issuer. An
instrument would be more likely a security, for example, if it
were issued by a risky company or a company raising start-up
capital, 70 and if it involved close participation in the risks. This
cautious form of the test avoids many of the defects of the ex-
treme form, 71 but at the price of leaving the less risky instru-
ments and issuers outside the securities laws-an unacceptable
price when one recalls that a seller may almost as readily use
fraud to overprice a safe instrument as a risky one.
Furthermore, both the bold and cautious forms of the test
are.vulnerable to the objection that the securities laws protect
73
sellers as well as purchasers: rule l0b572 and section 14(e) of
the Exchange Act are examples. Is the test to be inverted
when a seller sues, so that, in order to afford him more protec-
tion, the instrument will be held to be a security when it is rela-
tively risk-free and (applying the bold form of the test) when
the issuer is doing well and the purchaser is well informed and
canny?7 4 A test that reaches different results depending on

purchasers are no longer decisive in determining whether the exemption is

available as a purely statutory matter, but they are determinative under some
of the related "safe harbor" rules such as rule 146 and the new rule 242. See
Rule 146(g), 17 C.F.R. §230.146(g) (1979), reprinted in 1 FED. SEC. L. REP.
(CCH) 2709 (1978); Rule 242(e) (i), 17 C.F.R. § 230.242(e) (i) (1979), reprinted
in 1 FED. SEC. L. REP. (CCH) %2358F (1980).
69. Exchange Act § 12(g), 15 U.S.C. § 781(g) (1976).
70. Some authorities applying the "risk capital" analysis have implied that
it is only in the start-up phase that a business will be deemed to be obtaining
risk capital. However, a business with a long history could be just as risky, just
as strongly motivated by a need for new capital, and, indeed, just as involved in
new activities. This point is suggested and accompanied by relevant citations
in Hannan & Thomas, supra note 64, at 262-63.
71. Note, however, that so long as the riskiness of the issuer is a part of the
test, the characterization of identical instruments as securities may differ ac-
cording to whether the issuer is risky, or is raising start-up capital, at either the
time of issuance or the time of the transaction in question.
72. 17 C.F.R. § 240.10b-5 (1979), reprinted in 3 FED. SEC. L. REP. (CCH)
26,744 (1978).
73. 15 U.S.C. § 78n(e) (1976).
74. For a discussion of whether promissory notes are securities in the con-
1980] DEFINITION OF SECURITY

who brings the suit is certainly undesirable. Again, protection

is afforded not only to buyers and sellers but also to brokers by
section 17(a) of the Securities Act.75 Is an instrument to be
considered a security according to whether it can be traded
through a broker? Similar problems arise under those sections
of the securities laws that identify which exchanges and mar-
76
kets are subject to SEC marketplace regulation.
It can only be helpful, in view of the current state of the au-
thorities, to accept the commentators' suggestion and inquire
into the purposes behind the securities laws. Most of the con-

text of a lawsuit under rule lOb-5 brought by the issuer, see Bellah v. First Nat'l
Bank, 495 F.2d 1109 (5th Cir. 1974). In Bellah, the court implied that a different
standard would have applied to the question if the suit had been brought by
the purchaser; it distinguished decisions in lawsuits brought by purchasers by
observing that in the case at hand "the maker... seeks to invoke the Act's
prophylactic protection. While we do not disparage the conclusions reached in
[two cases involving lawsuits by purchasers], we do suggest that a maker can-
not bring the notes he executes within the Act merely by demonstrating his
own lack of fiscal integrity." Id. at 1112 n.3 (emphasis added).
75. 15 U.S.C. § 77q(a) (1976). In United States v. Naftalin, 441 U.S. 768
(1979), the Court held that wrongs against brokers may be the subject of crimi-
nal prosecutions under section 17(a) of the Securities Act.
76. In response to these objections, the "need for protection" test might be
framed differently according to the section of the securities laws at issue. The
term "security" when used in sections primarily designed for purchaser protec-
tion, like the remedial provision of the Securities Act, would be interpreted
under the "need for purchaser protection" test; when used in sections primarily
designed for seller or offeree protection, such as section 14(e) of the Exchange
Act, it would be interpreted under a test of need for seller protection. The
proposition that the term "security" may be defined differently for purposes of
different sections of the securities laws is supported, at least by implication, in
4 L. Loss, SEcunrris REGULATION 2485 (2d ed. Supp. 1969). See also SEC v. Na-
tional Sec., Inc., 393 U.S. 453, 465-66 (1969) (In interpreting the term "purchase
or sale," the Supreme Court acknowledged that "the same words may take on a
different coloration in different sections of the securities laws.") (emphasis ad-
ded). Revising the "need for protection" test in this way, however, would not
solve the problem as to those sections of the acts that protect both purchasers
and sellers. It would also fail to resolve another shortcoming of the test: it is
unsatisfactory when applied to cases in which the plaintiff, whether a pur-
chaser or seller, alleges fraud arising from statements relating not to the secur-
ity, but to the consideration for which it was exchanged. See, e.g., MacAndrews
& Forbes Co. v. American Barmag Corp., 339 F. Supp. 1401, 1406-07 (D.S.C. 1972)
(holding bills of exchange to be securities for purposes of an action brought
under section 17 of the Securities Act and under rule lob-5 by an issuer alleg-
ing misrepresentations about the machinery for which the bills were ex-
changed). A similar situation is presented by cases such as Superintendant of
Ins. v. Bankers Life & Cas. Co., 404 U.S. 6 (1971), in which the lob-5 plaintiff was
the corporate seller of securities, the defendants were not the purchasers but
rather persons and entities that assisted in the sale, and the alleged deception
related neither to the security nor to the consideration given for it, but to the
purported misappropriation of the assets. For an indication that rule lOb-5 con-
tinues to be available for use in attacks on fraud collateral to the security trans-
action, see Goldberg v. Meridor, 567 F.2d 209 (2d Cir. 1977).
 MINNESOTA LAW REVIEW [Vol. 64:893

fusion stems from the view, which many commentators adopt

without discussion, that those purposes were simply to protect
against fraud and other defects in disclosure. The following
discussion proposes a test based on a somewhat different view
of the legislative purpose, and leads to an instrument-based
rather than a transaction-based test.

III. A BETTER DEFINITION OF "SECURITY"

A. WHY HAVE DIFFERENT LAwS FOR SECURITIES?

It seems most unlikely that the lawmakers thought that

fraud, inadequate disclosure, market manipulation, or many of
the other things prohibited by the securities laws were wrong-
ful or undesirable only when securities were involved. Evi-
dently, they decided to legislate as to only some of the conduct
they believed wrongful-not an unusual procedure for
lawmakers with the common law as a backstop, especially
when they are federal lawmakers acting during a major crisis
in an area that is widely regulated at the state level. That ex-
plains why they did not undertake a general revision of the law
of contracts or corporations. But why did they focus on securi-
ties?
Lawmakers often legislate in an area merely because na-
tional experience has painted them a vivid picture of it. In the
early part of this century, national experience, or its interpret-
ers, did paint such a picture: that of the American public
purchasing unsound stocks and bonds at inflated prices under
the influence of misleading statements and the high-pressure
tactics of corporate insiders, broker-dealers, and investment
bankers; that of the "humble, honest citizens" being "plun-
dered and despoiled of their small earnings... by the alluring
machinations of the deceptive, misleading, and fraudulent de-
vices which the unscrupulous, cunning, and deceitful 'Get-Rich-
Quick Wallingford's' of our day practice." 77 Sometimes
lawmakers see such a vivid picture and do nothing more ab-
stract than prohibit the activity depicted. This was the case in
those states that, hoping to prevent the revival of the saloon af-
ter the end of Prohibition, forbade establishments that served
liquor by the drink from having swinging doors and certain
other architectural features. 7 8 The image of shysters selling
worthless stocks and bonds to widows seems to have been a

77. The statement is that of the attorney general of Iowa, describing the
purpose of Iowa securities regulation, quoted in M. Pmsif, supra note 18, at 7.
78. See, e.g., Act of May 10, 1934, ch. 478, § 106(9), 1934 N.Y. Laws 1111.
 1980] DEFINITION OF SECURITY

major factor in the passage of the blue sky laws. 79 No doubt

80
the same is true of the federal securities laws.
By 1933, however, the picture had become more complex.
The financial markets and, indeed, the economy, had collapsed.
As a result, not only the purchasers of the unsound stock but
also ordinary workers and farmers were impoverished. The
lawmakers were presented with reasons to conclude that, while
fraud and the other prohibited activities are generally undesir-
able, these activities are especially undesirable when securities
are involved, because the result could be general economic col-
lapse.8 1
As with artists, when legislators search for causes, the re-
sults are likely to be symbolic and abstract. References to wid-
ows and con men in the legislative history of the securities acts
are crowded out by references to markets, supply, demand,
capital, and the depression. 82 By singling out "securities" as
the object of a set of laws, the New Deal was identifying a seg-
ment of the national economy, rather as it singled out banking
in other legislation. Defining "security" involves determining
what this segment is and why it was thought to merit special
protection.

79. "Blue sky" laws are state securities laws. Consider, for example, the
statement of an early advocate of state securities laws: "Funny how simple are
the solutions of these intricate problems. Just stop it. That's all." Kohr, The
Blue Sky Law, 17 TECH. WORLD MAGAZINE 36, 39 (1912). For an extensive
description of the populist, progressive, and reformist currents that influenced
antispeculation legislation, see C. COWING, POPULISTS, PLUNGERS, AND PROGRES-
sIVEs (1965). For a sketch of the development of statutory blue sky definitions
of "security," see Long, supra note 11, at 96-98.
80. The defrauded widow made her mournful appearance more than once
in the debates on the Securities Act as well. See 77 CONG. REC. 2925 (1933) (re-
marks of Rep. Bulwinkle); id. at 2935 (remarks of Rep. Chapman); id. at 2983
(remarks of Sen. Fletcher).
81. "National emergencies, which produce widespread unemployment and
the dislocation of trade, transportation, and industry ... are precipitated, in-
tensified, and prolonged by manipulation and ... by excessive speculation" on
securities exchanges and over-the-counter markets. Exchange Act § 2(4), 15
U.S.C. § 78b(4) (1976). For a description of what contemporaries thought were
the causes of the depression, which included (in addition to misconduct in the
securities markets) high tariffs, the economic troubles of the farmers, and the
failure of United States' allies to pay their war debts, see C. COWING, upra
note 79, at 196-98, 209-10.
82. See SENATE COMIITrEE ON BANKING AND CURRENCY, STOCK EXCHANGE
PRACTICES, S. REP. No. 1455, 73d Cong., 2d Sess. 81 (1934) ('"The purpose of the
[Exchange Act] is ... to purge the securities exchanges of those practices
which have prevented them from fulfilling their primary function of furnishing
open markets for securities where supply and demand may freely meet at
prices uninfluenced by manipulation or control."), reprinted in 5 LEGISLATIVE
HISTORY, supra note 2, Item 21, at 81.
 MINNESOTA LAW REVIEW [Vol. 64.893

It is helpful in making this determination to understand

how, in contemporary opinion, misconduct with respect to se-
curities could harm the general economy. President Roosevelt
expressed his belief in a chain of causation between such
wrongdoing and the Great Depression. "[M]uch of our trouble
today," he said in a fireside chat in 1934, "has been due to a lack
of understanding of the elementary principles of justice and
fairness by those in whom leadership in business and finance
was placed . 83 What analysis lies behind this attractive
*...
but cryptic synthesis of ethics and economics?
One portion of the picture may be of help. It prominently
features the public financial markets and the major financial
market participants: corporations seeking to obtain financing
and to use it in production, financial intermediaries and
financial service organizations such as banks and broker-deal-
ers, and members of the public who have saved and who wish
to obtain income by putting their savings at the disposal of
others. The instruments listed in the statutory definitions of
"security" are the primary vehicles of these markets-that is,
they are, or represent, bundles of financial claims and liabili-
ties. Financial markets serve as a channel through which sav-
ings 84 are allocated to investment, and they perform the closely
related function of pricing financial instruments, thereby assist-
ing in the allocation of savings to those economic units that can
use them most productively. 85 The widespread view in the
1930s was that these functions had miscarried. President
Roosevelt, members of Congress, and their contemporaries, in
surveying the situation before the Crash, perceived the
financial markets to have been plagued by "the overnight man-
ufacture of security issues [and] the flotation of issues without
adequate disclosure of facts," 86 both of which damaged honest
enterprises seeking capital 87 and led to wild speculation. 88 The

83. F.D. Roosevelt, Radio Address, June 28, 1934, reprintedin 3 THE PuBLIc
PAPERS AND ADDRESSES OF FRiN D. ROOSEVELT 313-14 (S. Rosenman ed.
1938).
84. The term "savings" is commonly defined as income not spent on con-
sumption. See, e.g., R. ROBINSON & D. WmoGHTsmA , FANCIAL MARKETS: THE
ACCUMULATION AND ALLOCATION OF WEALTH 437-38 (1974).
85. J. LIGHT & W. WHrrE, THE FINANCIAL SYSTEM 4 (1979).
86. F.D. Roosevelt, untitled note, in 2 THE PUBLIC PAPERS AND ADDRESSES
OF FRANKLIN D. ROOSEVELT, supra note 83, at 215. For an indication that con-
temporary Congressional and popular opinion also emphasized abuses such as
high-pressure salesmanship, see F. ALLEN, SINCE YESTERDAY 136 (1939).
87. See S. REP. No. 47, supra note 5, at 1 ('The aim is to prevent further
exploitation of the public by the sale of unsound, fraudulent, and worthless se-
curities through misrepresentation [and] to protect honest enterprise, seeking
1980] DEFINITION OF SECURITY

result, aggravated by manipulation of the securities markets 89

and excessive use of credit in financing market transactions, 90
was the swelling and eventual bursting of a speculative bub-
ble.91 This led to a loss of confidence-to that "fear itself'
which President Roosevelt said alone deserved to be feared-
and a consequent "hoarding," such that savers, especially those
who were outsiders, refrained from venturing into the financial
markets. 92 This in turn impaired the economy. Exaggerated
somewhat in detail and precision, the general view was that the
following causal chain existed: (i) fraud and similar miscon-
duct led to speculation, which, aggravated by market manipula-
tion, resulted in (ii) the Crash, which in turn caused (iii) loss
of confidence in the financial markets and hoarding by those
who otherwise would have invested, which caused in some way
(perhaps by starving business of capital) (iv) the initiation and
continuation of the economic collapse. The securities laws
were intended to prevent the recurrence of this process 9 3 or

capital by honest presentation, against the competition afforded by dishonest

securities ... "), reprintedin 2 LEGISLArIVE HISTORY, s'upra note 2, Item 17, at
1.
88. See, e.g., 77 CONG. REc. 2982-83 (1933) (remarks of Sen. Fletcher) ("Peo-
ple have been persuaded to invest their money in securities without any infor-
mation respecting them, except the advertisements put forth by the agents or
representatives of those issuing the securities, and such advertisements have
not given full information to the public. The result was that we had a saturna-
lia of speculation throughout the country.... ").
89. An extensive compendium of evidence of market manipulation, accom-
panied by the assertion that such manipulation caused wide fluctuations in se-
curities prices, is contained in S. REP. No. 1455, supra note 82, at 30-55, reprinted
in 5 LEGISLATIVE HISTORY, supra note 2, Item 21, at 30-55. This report was sub--
mitted shortly after the enactment of the Exchange Act. Another instance of
this view is 78 CONG. REc. 7689 (1934) (remarks of Rep. Sabath) (referring to "a
small group of men who... ruthlessly manipulated the markets and brought
about the conditions from which the Nation is now suffering"), reprinted in 4
LEGISLATIVE HISTORY, supra note 2, Item 8, at 7689.
90. See, e.g., 78 CONG. REc. 7863-64 (1934), reprinted in 4 LEGISLATrvE HIS-
TORY, supra note 2, Item 8, at 7863-64 (remarks of Rep. Wolverton).
91. The FinancialOutlookfor 1930, N.Y. Times, Jan. 1, 1930, § 1, at 33, col. 3
(reporting the opinion that "an orgy of reckless speculation" caused the
Crash); Letter from President Franklin D. Roosevelt to Senator Duncan V.
Fletcher and Congressman Sam Rayburn (Mar. 26, 1934) ("unregulated specu-
lation in securities and in commodities was one of the most important contrib-
uting factors in the artificial and unwarranted 'boom' which had so much to do
with the terrible conditions of the years following 1929"), reprinted in 3 THE
PuBUc PAPERS AND ADDRESSES OF FRANKLIN D. ROOSEVELT, supra note 83, at
170.
92. See text accompanying note 5 supra; 77 CONG. REc. 2983 (1933) (re-
marks of Sen. Fletcher).
93. See, e.g., 78 CONG. REc. 7693 (1934) (remarks of Rep. Cochran) ("Had
the Securities Act of 1933 and this bill [the Exchange Act] been a law 10 years
ago the crash of 1929 would never have happened. We do not want another dis-
 MINNESOTA LAW REVIEW [Vol. 64:893

even to reverse it-'o bring into productive channels of indus-

try and development capital which has grown timid to the point
of hoarding; and to aid in providing employment and restoring
94
buying and consuming power."
Were these views correct? Modern economists generally
agree on the presence of fraud and speculation, and that this
was one cause of the Crash, although another cause was a busi-
ness downturn earlier in 1929.95 There is good statistical evi-
dence that the Crash was closely followed by a general decline
in investment in financial assets, and especially a decline in in-
vestment in the riskier sorts of instruments, whether or not
there was "hoarding" in the more limited sense of "accumula-
tion of currency."9 6 There is support for the view that this

aster such as we experienced in 1929, and the way to prevent it is to pass this
bill."), reprinted in 4 LEGISLATIVE HISTORY, supra note 2, Item 8, at 7693. Ac-
cord, Lincoln Nat'l Bank v. Herber, 604 F.2d 1083 (7th Cir. 1979) (stating that
the market regulation provisions of the Exchange Act were intended "to pre-
vent recurrence of the excesses that were viewed as responsible for the stock
market crash of 1929").
94. S. REP. No. 47, supra note 5, at 1, reprinted in 2 LEGISLATIVE HISTORY,
supra note 2, Item 17, at 1. See also 77 CONG. REC. 2935 (1939) (remarks of Rep.
Chapman) ("We believe the enactment of this bill into law will bring money
from the hoarders' hiding places. It will be conducive to confidence on the part
of investors. It will stimulate industry; it will accelerate the wheels of com-
merce."). The interpretation of congressional intent suggested in the text is
supported by Justice Brennan's recent statement for the Court that "Congress'
primary contemplation [in adopting the Securities Act] was that regulation of
the securities markets might help set the economy on the road to recovery."
United States v. Naftalin, 441 U.S. 768, 775 (1979).
95. For the view that fraud or speculation helped to cause the Crash, see L
CHANDLER, AMERICA'S GREATEST DEPRESSION, 1929-1941, at 17-19 (1970); J. GAL-
BRArTH, THE GREAT CRASH: 1929, at 174 (3d ed. 1972); Kirkwood, The GreatDe-
pression: A Structuralist Analysis, 4 J. MONEY, CREDIT & BANKING 811, 822 n.12
(1972). But see Benston, The Effectiveness and Effects of the SEC's Accounting
Disclosure Requirements, in ECONOMIC POLICY AND THE REGULATION OF CoRPo-
RATE SECURITIES 23, 52-53 (H. Manne ed. 1969) ("A careful examination of the
Senate hearings that preceeded [sic] passage of the Securities Act of 1933 and
the voluminous Pecora Hearings that preceded the Securities Exchange Act of
1934 fails to turn up more than one citation of fraudulently prepared financial
statements.... Thus, the need for the financial disclosure requirements [ap-
pears] to have had [its] genesis in the general folklore and 'abuses' of turn-of-
the-century finance rather than in the events of the 1920s ... insofar as fraud
and misrepresentation are concerned.") (citations omitted).
96. There was a marked diminution in investment in financial assets dur-
ing 1930, 1931, and 1932, as compared to the three previous years, on the part of
nonagricultural individuals, nonfinancial corporations, and unincorporated
businesses. Moreover, there is some indication that the flight from stocks was
more marked than from government securities. See P. TEMN, Dm MONETARY
FORCES CAUSE THE GREAT DEPRESSION? 131-35 (1976) (presenting flow-of-funds
figures for those groups). Hoarding in a narrower sense is contraindicated by
the fact that money holdings decreased. Id. The monetarist view, contested by
Temin, is that this was caused by a drop in the money supply rather than by a
1980] DEFINITION OF SECURITY

caused the increase in the return that had to be paid on all but
short-term instruments. 97 It is more controversial to say that
the economic depression was the upshot, and it is at best in-
complete to attribute such a result solely to shortages of funds
for business. 98 In their lucid book FinancialMarkets: The Ac-
cumulation and Allocation of Wealth, Robinson and Wrights-
man offer the following more extended account:
There are at least three ways in which a turn in the stock market
might cause economic activity to change. One way is through a wealth
effect. A sharp fall of stock prices reduces the market value of inves-
tors' financial wealth. Feeling poorer, investors may feel compelled to
reduce their consumption expenditures ....
Another way is through a financing effect.... Selling stock when
prices are abnormally depressed can have an adverse dilution effect on
existing stockholders. To the extent that corporations rely on external
equity to finance capital expenditures, an unfavorable stock market can
lead to a postponement of business investment and initiate a downturn
in economic activity. The fact is, however, that most corporations raise
considerably more new capital through retained earnings and by bor-
rowing in credit markets than by selling new stock. Thus a stock mar-
ket decline cannot be said to make funds much less available for
business capital expenditures.
Still another way is through an expectations effect. A declining
stock market may cause businessmen to develop pessimistic expecta-
tions of future business conditions.... Business expects an economic
downturn, so it does not invest and a downturn materializes. The
Great Depression of the 1930s would have happened anyway, but it
probably would not have been as severe as it was had there not been a
99
shattering of business confidence following the Crash.
Explanations for the depression may be divided into two
classes. One, the monetarist explanation, emphasizes the col-
lapse of the banking system as a primary cause; the other, the
spending explanation, emphasizes a fall in spending, especially
spending on consumption. In each case, the stock market crash
is perceived as one of the causes of the primary cause;

drop in the demand for money. See M. FRIEDMAN & A. SC-WARTZ, A MONETARY
HISTORY OF THE UNITED STATES: 1867-1960, at 673 (1963).
97. P. TEim, supra note 96, at 169.
98. "Investment fell in 1930, as it falls in all recessions, but it did not fall
more than usual. The Depression was not caused by a dramatic collapse of in-
vestment." Id. at 172. Demand for funds by business also fell, according to
Temin. Id. at 134-35. For a tentative expression of doubt that the Crash was a
significant cause of the depression, see Green, The Economic Impact of the
Stock Market Boom and Crash of 1929, in FEDERAL RESERVE BANK OF BOSTON,
CONSUMER SPENDING AND MONETARY PoUcy: THE LINKAGES 189 (1971). For an
expression of doubt that the Crash caused a reduction in investment spending
by increasing yields, see id. at 199-201.
99. R. ROBINSON & D. WImrTSmAN, supra note 84, at 378-79. For a vigorous
criticism of the application of the "expectations effect" analysis to the depres-
sion, see P. Tsinm, supra note 96, at 75-83.
 MINNESOTA LAW REVIEW [Vol. 64.893

monetarists see the Crash as a cause of the banking crisis, 100

and spending theorists observe that it had an impact on spend-
ing.101 These alternative views thus do not involve a denial that
fraud and speculation caused the Crash or that the Crash
caused the depression; instead, they provide different links in
the chain of events between the Crash and the depression.
Such views might detract from one's respect for the conclusion
that the depression could have been cured by prohibiting fraud
on the financial markets; the introduction of such cataclysms as
the collapse of banks into the causal chain makes the chain ap-
pear less susceptible to a simple reversal. Those views, how-
ever, do not undercut the legislators' hope that such
prohibitions would help prevent future depressions.

B. WHAT IS A SECURITY?

"Security" should be defined so as to respect the intention

of the framers to focus the securities law on the financial mar-
kets. Perhaps the most obvious definition would be that any in-
strument is a security which is the subject of transactions in
the financial markets, or, perhaps, which has in the past been
the subject of such transactions. But it would be better to
adopt a broader definition that would include not only those in-
struments that have entered the market, but also those that are
"waiting in the wings." Although all the common stock of the
Boston Gas Company has been owned for over fifty years by
Eastern Gas and Fuel Associates, 102 it seems obvious that the
securities laws should cover it. The alternative approach-
making actual participation a requirement-would occasionally
cause some instruments of an issue and class to be called se-

100. See, e.g., M. FRIEDMAN & A. ScHwARTz, THE GREAT CONTRACTION: 1929-
1933, at 59 (1965) (stating that the bank failures were largely attributable to the
decline in the value of the banks' portfolios of securities). See also M. FriEn-
AN & A. SCHWARTZ, supra note 96, at 306-07 (stating that the Crash "helped to
deepen the contraction"). For a close critique of this view, see P. TEmI, supra
note 96. For a monetarist response, see Klein, Book Review, 50 J. Bus. 244
(1977). For another work in the area by Friedman and Schwartz, see Money
and Business Cycles, 45 REV. EcoN. & STATrsncs 32 (Supp. Feb. 1963).
101. Cf. P. TEMnw, supra note 96, at 170-72 (describing the Crash as having
contributed to the depression, as one of several factors, by reducing wealth in
the hands of consumers, which in turn contributed (in small part) to the reduc-
tion in consumption expenditures, and thus to the general economic decline).
It should be noted that Temin's acceptance of the spending hypothesis is a
qualified one.
102. See [1979] 1 MOODY'S INDusTRIAL MANuAL 593; Boston Gas Company,
Amendment No. 1 to Form S-7 RegistrationStatement Under the Securities Act
of 1933, at 4 (Reg. No. 2-52522, filed with the SEC on Jan. 10, 1975).
1980] DEFINITION OF SECURITY

curities while others of the same issue and class were not.103
The definition, therefore, should identify as securities not
only those instruments that have been or are the subject of
transactions in the financial markets, but also those instru-
ments that could be. Accordingly, the following definition is
suggested: A security is a financial instrument eligible to par-
ticipatein a public market. In other words, a security is an in-
strument that can be sold in a public market by an economic
unit to obtain funds for investment, and that can be purchased
in a public market by an economic unit which has accumulated
savings and which hopes, by making the purchase, to make a
profit related to the issuer's business.
Some of the components of the definition are broad ones.
The term "instrument," for example, is intended to be a nonre-
strictive term applicable to any candidate for inclusion as a "se-
curity" and should be taken to include almost any bundle of
rights and duties. 0 4 The more restrictive parts of the defini-
tion-the requirements that the instrument be a "financial" one
and that it be responsive to the markets in various ways-call
for a closer analysis.

1. The Requirement That the Instrument Be a FinancialOne

The term '"mancial instrument" is intended to mean an in-
strument that, when issued and sold, can operate to transfer
the savings of the purchaser to the investment uses of the is-
suer and can do so in accordance with judgments by the mar- 05
ket regarding the most productive allocation of those savings.1
What features must an instrument possess to enable it to
operate as a channel for a desirable allocation of savings to in-
vestment? Very little seems necessary to allow an instrument
to be used to take in "savings"; anything that can be purchased
can be purchased out of savings. "Investment," as the term is
used here, occurs when funds are employed in the production
of goods and services rather than in obtaining goods and serv-
ices for consumption.106 This suggests more stringent require-
ments.
103. See text accompanying notes 67-69 supra.
104. Perhaps a fuller sketch of an "instrument" would be as follows: it is a
set of rights and duties conferred (or purported to be conferred) by one party
upon another, under circumstances such that the rights and duties would nor-
mally be treated as a unit and would normally be transferred, if at all, as a unit.
The term "instrument" also includes the documents reflecting such rights and
duties.
105. The requirement that the instrument be an investment vehicle might
find some grounding in the "investment of money" prong of Howey.
106. "Investment," as defined in J. BowyEP, INvESTMENT ANALYsis AND
 MINNESOTA LAW REVIEW [Vol. 64:893

a. It Must Be Possible to Issue and Sell the Instrument for

the Purpose of Obtaining Funds for Investment
Just as anything that can be purchased can be purchased
out of savings, so it might seem that anything that can be is-
sued and sold can be issued and sold to raise funds for invest-
ment. But there are two instances in which this would not be
the case.
First, when the issuer 07 was not engaged in the production
of goods and services, the instrument would not be financial.
Intermediaries, however, are not excluded by this qualification.
Their business, like that of an investment company, is to rein-
vest; they are part of the process of producing goods and serv-
ices, and the instruments they issue may be financial ones.
Similarly, governments produce goods and services; thus, the
instruments they issue may be financial.108 Nor, of course, is
the qualification intended to rule out those issuers that contrib-
ute to the production of goods and services by functioning as
service or assistance operations rather than as primary produ-
cers: delivery companies and management consultant firms are
producers of goods and services, and so is the individual who,
although owning no business of his own, is an employee of a
productive business. Very little, then, is ruled out by this part
of the test.
One exclusion would be that of instruments issued by an
individual not worldng for any enterprise, such as someone

MANAGEMENT 9 (4th ed. 1972), is "the commitment of funds with the hope of
gain." See also BLACK'S LAW DITIONARY 960 (4th rev. ed. 1968) (defining "in-
vestment" as "[t]he placing of capital or laying out of money in a way intended
to secure income or profit from its employment").
107. The term "issuer" means the party that creates and is subject to obliga-
tions by the instrument. In the case of a note, for example, the issuer is the
borrower. It would be undesirable to permit a company to avoid the securities
laws by contracting out of or passing to an affiliate those functions, such as the
production of goods or services, which if conducted directly would make its in-
struments securities under the test proposed in this Article. The term "issuer"
for purposes of the test should therefore include such an affiliate or contracting
party. An analogous approach is used under current law-the "profits from the
efforts of others" requirement of Howey can be satisfied by the efforts of par-
ties other than (but associated with) the issuer. See R. JENNINGS & H. MARSH,
SECURITIES REGULATION: CASES AND MATERIALS 227-28 (4th ed. 1977) and cases
cited therein. The term "issuer" is defined in section 2(4) of the Securities Act,
15 U.S.C. § 77b(9) (1976), and in section 3(a)(8) of the Exchange Act, 15 U.S.C.
§ 78c(a) (8) (1976).
108. Robinson and Wrightsman, however, question whether governments
can be said to invest. See R. ROBINSON & D. WRIGn'TsMAN, supra note 84, at 24-
25.
1980] DEFINITION OF SECURITY

who is almost wholly a consumer. The requirements of the

Daniel and Forman cases that the hope of gain must arise
from the managerial or entrepreneurial efforts of others bear a
close relationship to this exclusion. Managerial efforts, how-
ever, are a part of every enterprise; perhaps it was not the ab-
sence of managerial efforts but rather the absence of
productive efforts that caused the Court to exclude enterprises
that thrive largely on government benefits or on forfeitures by
creditors. The issuers in Forman and Daniel, Co-op City and
the Teamsters' Fund, made money in productive as well as
nonproductive ways,109 so the results in those cases cannot be
fully explained by reference to the proposed requirement that
the issuer be engaged in the production of goods and services,
unless a test of preponderance is to be applied.11o
Second, the instrument would not be financial when the is-
suer, although engaged in the production of goods or services,
could not use the proceeds from the sale of the instrument for
production. This is the case, for example, with the typical
short-term consumer loan instrument; the consumer might pro-
duce goods on his job as a factory worker, but the proceeds of
his borrowing would be unlikely to facilitate this work. Proba-
bly few important cases will be resolved by this portion of the
test. Because money is fungible, no producer that uses money
in its production activities should be heard to say that the pro-
ceeds of its sale of some particular instrument were earmarked
for nonproductive activities. Even were such earmarking possi-
ble, economic enterprises that are legally required to act for the
economic benefit of their owners should not be heard to say
that they are raising funds for consumption."I

b. The Attractiveness of the Instrument Must Relate to the

Success of the Productive Activities of the Issuer

Not every instrument issued to obtain funds for production

can be a financial instrument. For example, unauthorized trad-

109. See text accompanying notes 26-41 supra.

110. Should engaging in a legal battle to become a beneficiary of an estate
be regarded as a productive activity for purposes of this test? See SEC v. Latta,
250 F. Supp. 170 (N.D. Cal.) (securities held to be involved in the sale of
1/21,000 interests in such proceeds as the seller might obtain in her legal battle
to cause a redistribution of an estate), affrd per curiam, 356 F.2d 103 (9th Cir.
1965), cert. denied, 384 U.S. 940 (1966).
111. For example, when a stipend is paid to the widow of the chief execu-
tive, courts should, as they do when the propriety of such an expenditure is at
issue, remember that the health and productivity of the enterprise is furthered
by decent treatment of those that work for it.
 MINNESOTA LAW REVIEW [Vol. 64.893

ing recently occurred on the floor of the New York Stock Ex-
change in coupons conferring upon the bearer the right to
travel half-fare on certain domestic airline flights.112 Nothing in
the tests developed so far would exclude these coupons from
the category of "securities." The issuers, American Airlines
and United Airlines, are certainly engaged in the production of
services, and sale of such coupons could certainly have been
arranged so as to raise funds to assist in such production. In
fact, the coupons had been given away by the airlines to their
passengers, but no part of the test makes that a disqualifica-
tion. A share of equity is no less a financial instrument for hav-
ing been given away by the issuer; the test asks whether the
instrument is capable of being sold for the specified purpose.
Nevertheless, the coupons should be excluded because, al-
though they can be used in the marketplace to take advantage
of one of the marketplace's great services-the channeling of
funds from savings to investment-they cannot be used to take
advantage of another service: the formation and execution of
market judgment as to where investment funds can best be em-
ployed. It should thus be an additional part of the definition of
"financial instrument" that the instrument be responsive to the
market's judgments of such matters-that it be an instrument
by which the issuer can obtain funds for investment by appeal-
ing to the market's view as to whether the issuer can use them
well. The market forms and executes these 'Judgments," of
course, wholly in response to the prospect of economic rewards
to market participants. This part of the definition can therefore
be revised as follows: an instrument is not a "financial" one un-
less it affords the holder prospects of gain that are preponder-
antly dependent on the success of the productive activities of
the issuer.
What types of instruments would be ruled out by this re-
quirement? First, no instrument could qualify as '"inancial"
which did not afford any hope of return; the market would have
no incentive to assess such an instrument. A non-interest-bear-
ing note issued at par, such as a check, is for this reason not a
financial instrument." 3 When the financial vice president of
General Motors issues a company check in order to obtain
cash, he is issuing an instrument that can be used to transfer
112. See Wall Street J., June 28, 1979, at 1, col. 4.
113. For a case holding checks to be securities when they are interest bear-
ing, see United States v. Attaway, 211 F. Supp. 682 (W.D. La. 1962).
1980] DEFINITION OF SECURITY

the recipient's savings to the company's productive efforts, but

he is not issuing a financial instrument.
Second, the requirement rules out instruments that offer
prospects of return that are mainly dependent on factors other
than the success of the productive activities of the issuer. The
half-fare coupons are thus excluded because, although one
might hope for a profit from buying one-hope, for example,
that air fares would go up-the fulfillment of this hope would in
no important way depend on the wisdom with which the air-
lines operated. Gambling contracts would be excluded for simi-
lar reasons.1 1 4 A ticket on a horse is not a financial instrument,
even though the proceeds of its sale may be used by the race-
track to continue producing what is arguably an entertainment
service, because the holder's prospects of gain depend on the
race rather than on the profitability of the racetrack. Commod-
ity futures, which have been described as "little more than...
wager[s] that the market price of a given commodity will
change,"115 are excluded for this reason,116 as are instruments

114. But cf. Birtch v. Hunter, 158 F.2d 134 (10th Cir. 1946) (holding, without
discussion, that a "statement of account" reflecting gambling winnings was a
security within the meaning of the National Stolen Property Act, which defined
"security" in language similar to that in the federal securities laws).
115. Berman v. Bache, Halsey, Stuart, Shields, Inc., 467 F. Supp. 311, 316
(S.D. Ohio 1979).
116. Commodity futures have been uniformly held not to be securities. See,
e.g., McCurnin v. Kohlmeyer & Co., 340 F. Supp. 1338, 1341-42 (E.D. La. 1972)
(cotton futures held not to be securities under the Securities Act because,
among other things, "[t]he expectation of profit arises solely from the specula-
tive hope that the market price of the underlying commodity will vary in [the
investor's] favor"); Sinva, Inc. v. Merrill, Lynch, Pierce, Fenner & Smith, -Inc.,
253 F. Supp. 359, 367 (S.D.N.Y. 1966) (sugar future held not a security under ei-
ther the Securities Act or the Exchange Act because, among other reasons,
"It]he mere presence of a speculative motive on the part of the purchaser or
seller does not evidence the existence of an 'investment contract' .... [T]he
expected return is not contingent upon the continuing efforts of another."). See
also Glen-Arden Commodities, Inc. v. Costantino, 493 F.2d 1027, 1033 (2d Cir.
1974) (dictum). For a discussion of options to purchase or sell securities, see
text accompanying notes 140-141 infra.
A different issue is whether an interest in a trading account in commodities
futures constitutes a security. For a discussion of the divergent authorities on
this question, see Curran v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 554
SEC. REG. & L. REP. (BNA) G-1 (6th Cir. May 12, 1980). An approach similar to
that suggested by this Article was taken in Brodt v. Bache & Co., 595 F.2d 459
(9th Cir. 1978), in which the court held that an interest in a discretionary com-
modities trading account did not constitute a security because the "common
enterprise" requirement of Howey was not satisfied. There was insufficient
commonality between the defendant enterprise and the investor, the court rea-
soned, because "the success or failure of Bache as a brokerage house does not
correlate with individual investor profit or loss. On the contrary, Bache could
reap large commissions for itself and be characterized as successful, while the
individual accounts could be wiped out." Id. at 461.
 MINNESOTA LAW REVIEW [Vol. 64.893

that reflect only advance payments for goods or security depos-

its for leaseholds. The general economic success of the "is-
suer" has some bearing on the value of these instruments; the
issuer's survival is likely to be a condition to the honoring of
the half-fare coupons or racetrack tickets or to the delivery of
goods or services. But the market will chiefly assess such in-
struments by reference to matters extraneous to the prospects
of the issuer, and consequently these instruments should not
be considered securities.1 17 This part of the definition is sup-

117. A related problem is raised by an instrument whose value will be as-

sessed in the market, not by reference to factors extraneous to the economic
position of the issuer, but rather by reference to some part of the issuer's busi-
ness. This might be the case, for example, with corporate instruments whose
return was tied to the performance of only one of the issuer's divisions or tied
only to sales figures for one of its products. Pyramid selling schemes usually
have this feature, since certain of the common enterprise's sales rather than its
overall profits usually form the basis of the return or commissions. See, e.g.,
SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974) (holding that
such an arrangement did involve securities). The same can be said of short-
term debt instruments, since their value does not reflect changes in long-term
prospects, or even of debt instruments in general, since their value does not re-
flect variations in a company's prospects above the level of performance that
would enable it to pay principal and interest. Perhaps considerations such as
these lie behind the greater reluctance of courts to consider debt instruments
securities, especially when the loans involved are not risky ones. See, e.g.,
Amfac Mortgage Corp. v. Arizona Mall, Inc., 583 F.2d 426 (9th Cir. 1978) (apply-
ing the "risk capital" test discussed in note 64 supra and accompanying text
and in note 169 infra). Pushing the analysis further, one can see that even eq-
uity, in a leveraged company, has this characteristic: its value will not distin-
guish between the prospects of a bankruptcy in which a significant amount
would be distributed to the debtholders, and a bankruptcy in which very little
would be distributed, so long as equity would be wiped out. Since the capital
allocation process probably proceeds successfully by means of these customary
instruments, no instrument should be disqualified as a security simply because
its value rests on less than all of the factors relevant to the issuer's business, at
least when its value relates to a major part of that business. See SEC v. C.M.
Joiner Leasing Corp., 320 U.S. 344 (1943) (assignments of leasehold interests
held to involve a security when their chief value arose from the prospects of
discovering oil on the land, and when the seller was itself in a position to profit
from such a discovery since the seller retained ownership of nearby land).
Some cases involve hybrid instruments offering prospects for profit that are
only related to a portion of the issuer's business. This is typical, for example,
of interests in real property located in projects operated by the seller or lessor,
such as shopping centers, cooperative housing projects, and condominium de-
velopments. Although the value of the property depends primarily on factors
extraneous to the business of the seller or lessor, to some extent the value rises
and falls with the success of the project as a whole, as with, for example, the
success of the shopping center in attracting customers. The hope of return
wholly independent of the issuer's business is usually substantial, and the
cases since Forman usually, and correctly, find no security to be involved. See,
e.g., De Luz Ranchos Inv., Ltd. v. Coldwell Banker & Co., 608 F.2d 1297 (9th Cir.
1979) (holding that sales of plots of land did not constitute sales of a security
despite representations in the selling literature to the effect that facilities
would be built for a "planned community" in the area and that assistance in
1980] DEFINITION OF SECURITY

ported by the portion of Howey (not part of the three-prong

test) emphasizing that, in the fruit orchard enterprise, the in-
8
vestors "share in the earnings and profits."Xl This part of the
definition also has a certain amount in common with the por-
tion of the three-prong test which, as modified by Daniel and
Forman, requires the instrument to offer a hope of gain from
the managerial or entrepreneurial efforts of others."19

reselling would be provided); Grenader v. Spitz, 537 F.2d 612 (2d Cir.) (holding
that "stock" in a cooperative housing corporation was not a security when it
was nontransferrable and its ownership was a condition of occupation of the
premises), cert. denied, 429 U.S. 1009 (1976); Cordas v. Specialty Restaurants,
Inc., 470 F. Supp. 780 (D. Or. 1979) (holding that a lease of premises for a retail
store in a shopping center was not a security). Of course, the element of de-
pendence on extraneous factors can be diminished to the vanishing point by
collateral arrangements under which the property is reconveyed to the seller or
lessor for use in some common scheme such as vacation rentals to third par-
ties. In such a case, securities are correctly held to be involved. Howey itself
was such a case. See also Cameron v. Outdoor Resorts of America, Inc., 611
F.2d 105 (5th Cir. 1979) (holding that securities were involved in sales of "con-
dominium campsites" that, when the purchaser was absent, the seller was to
rent out and share the proceeds with the purchaser); Securities Act Release
No. 33-5347, 38 Fed. Reg. 1735 (1973) (promulgating, with respect to condomini-
ums, a set of standards reflecting the considerations argued for herein but go-
ing a great deal further; the standards are probably largely superseded by
Forman), reprinted in [1972-1973 Transfer Binder] FED. Sac. L. REP. (CCH)
T 79,163. For similar arrangements involving personal property, see Miller v.
Central Chinchilla Group, Inc., 494 F.2d 414 (8th Cir. 1974) (holding that plain-
tiffs should be permitted to attempt to establish that sales of chinchillas in-
volved securities because, allegedly, the seller led purchasers to believe the
effort involved in caring for the chinchillas was minimal and promised to repur-
chase all offspring at a fixed price); Glen-Arden Commodities, Inc. v. Costan-
tino, 493 F.2d 1027 (2d Cir. 1974) (holding that sales of whiskey warehouse
receipts involved securities when seller or affiliate was to warehouse and mar-
ket the whiskey and remit a profit); Continental Marketing Corp. v. SEC, 387
F.2d 466 (10th Cir. 1967) (holding that the sale of beavers involved securities
when beavers were to be cared for by the company with which seller con-
tracted), cert. denied, 391 U.S. 905 (1968); SEC v. Brigadoon Scotch Distribs.,
Ltd., 388 F. Supp. 1288 (S.D.N.Y. 1975) (holding that sales of portfolios of rare
coins involved securities when selection of the portfolios was done by the seller
and when the purchasers were offered various services such as insurance and
assistance in reselling). Some of these results, notably those in Central
Chinchilla and Brigadoon, are inconsistent with the test proposed in this Arti-
cle. It may be that after Forman these cases would be decided differently. See
Sunshine Kitchens v. Alanthus Corp., 403 F. Supp. 719 (S.D. Fla. 1975) (holding
that, in view of Forman,no security was involved in an agreement under which
Alanthus sold computers to Sunshine but agreed to manage arrangements for
leasing them out to others). But see Smith v. Gross, 604 F.2d 639 (9th Cir. 1979)
(holding that an arrangement for the sale and repurchase of earthworms, de-
scribed by the court as virtually identical to the Central Chinchilla arrange-
ment, involved securities).
118. 328 U.S. at 300.
119. It also has much in common with the indications in Forman that
"profit" means "earnings" or "capital appreciation" resulting from the use of
the investors' funds. See United Hous. Foundation, Inc. v. Forman, 421 U.S. 837,
854 (1975).
 MINNESOTA LAW REVIEW [Vol. 64.893

2. The Instrument Must Be Eligible to Participatein a Public

Market
a. The Nature of the Requirement
Markets are sometimes distinguished according to whether
they are "open" or "negotiated." Robinson and Wrightsman ex-
plain the distinction this way:
The rules of the New York Stock Exchange (NYSE) require that bids
and offers must be made audibly. This means that the NYSE is a kind
of open double auction market. While actual membership in the ex-
change is restricted, anyone of minimum financial respectability can
engage a broker to act for him in that market. It is effectively an "open
market." At the other extreme a loan arranged between a farmer and
his banker is clearly a negotiated transaction. Many transactions fall
between these two limits. The open-market system implies interest
rates and prices that are freely available to anyone who meets the min-
imum tests of market participation-which means, in effect, anyone
who can pay the cash or deliver the securities involved. Furthermore,
the operating rules of open markets are usually standardized. The ne-
gotiated market often results in a price or interest rate that applies to
that one transaction with120
side conditions tailored to fit the special cir-
cumstances of the case.
The term "public market" is intended to mean the "open mar-
ket" described by Robinson and Wrightsman. A market can be-
come less open in various ways and in different respects. The
use of the word "public" is intended to emphasize that if a mar-
ket is less open to the ordinary or unsophisticated investor, or
to the investor not possessed of great wealth, that should be es-
pecially disqualifying.
The proposed definition stipulates that an instrument, even
if it is "financial," is not a security if it is not "eligible" to be
bought and sold in open or public markets.121 The requirement

120. R. ROBINSON &D. WRiGHTSmAN, supra note 84, at 17-18 (1974).

121. This part of the test finds some support in the language in Joiner. The
Court stated that the definition of "security" in the Securities Act was intended
to include "many documents in which there is common trading for speculation
or investment." 320 U.S. at 351 (emphasis added). A comparable focus on eligi-
bility to move in public markets is reflected in article 8 of the Uniform Com-
mercial Code, which requires, as a condition of an instrument's being
considered a "security," that it be "of a type commonly dealt with on securities
exchanges or markets" and that it be "either one of a class or series or by its
terms divisible into a class or series of shares, participations, interests, or obli-
gations." U.C.C. § 8-102. The Official Comment states that at the core of the
definition
is the notion that a security is a share or participation in an enterprise
or an obligation that is of a type commonly traded in organized mar-
kets for such interests or is commonly recognized as a medium for in-
vestment. The ambit of the definition will change as "securities"
trading practices evolve to include or exclude new property interests.
It is believed that the definition will cover anything which securities
markets, including not only the organized exchanges but as well the
 1980] DEFINITION OF SECURITY

of eligibility can be elucidated by the observation that an in-

strument is eligible to participate in a market if it is excluded
only by chance or agreement but not by anything closely re-
lated to the instrument's component parts. Instruments repre-
sent a wide variety of rights and duties, and some of them are,
for example, too personal to the first creator and holder to
make them attractive to outside parties who participate in the
markets. In connection with a lease of an apartment, for exam-
ple, a landlord receives a security deposit, and undertakes to
repay it, often with interest, under certain conditions. Whether
or not he does so in the form of a separate writing or as a part
of the lease contract, he might be considered to be a debtor for
the amount of the deposit and to have given a note represent-
ing the debt. Nevertheless, even though instruments represent-
ing debt are one of the most common forms of securities, are
widely traded on the stock exchanges, and are frequently regis-
tered under the securities laws, we would be most reluctant to
call that particular instrument a security, even if the landlord
wrote it out as a separate document. When we call to mind
some of the peculiarities of that debt-that it is due when the
tenant vacates the apartment, which is at no fixed time, and
that it is subject to offset against other liabilities of the tenant,
including liabilities arising from damage to the apartment-it
becomes apparent that it could never be traded in a public mar-
ket. The Forman case, which involved "stock" that functioned
very nearly as a rent deposit, 1 2 2 might have been decided on
this ground.
Why exclude negotiated markets? The negotiated markets
serve as an important channel of savings to investment and so
serve the purposes that the securities laws were designed to
further. Hoarding and misallocations can damage those mar-
kets and could thereby have contributed to the Great Depres-
sion by directly influencing the general economy and by
"over-the-counter" markets, are likely to regard as suitable for trad-
ing....

Interests such as the stock of closely-held corporations, although

they are not actually traded upon securities exchanges, are intended to
be included within the definitions... by the inclusion of interests "of
a type" commonly traded in those markets.
Id., comment 2. The Official Comment goes on to announce that "[tihis defini-
tion has no bearing upon whether an interest is a 'security' for purposes of fed-
eral securities laws. By the same token the definitions of 'securities' for
purposes of those laws has [sic] no bearing upon whether an interest is a se-
curity within the definition of this Article." Id., comment 3.
122. See text accompanying note 28 supra.
 MINNESOTA LAW REVIEW [Vol. 64:893

spreading mistrust to the public financial markets.123

But there are several reasons why the lawmakers were cor-
rect in focusing on the public markets. The private financial
markets are in significant part comprised of transactions in
which the parties on both sides are large institutions, often
financial intermediaries such as banks; this is so because of the
heavy transaction costs, including the costs of negotiation and
information gathering. 2 4 These large institutions have the ex-
pertise and economic resources to protect themselves against
frauds and many of the other evils that the securities laws were
intended to prevent. Even when an unsophisticated or disad-
vantaged party is involved, the protections of the common law
are more likely to be available if the transaction is in a private
market; in a public market the victim may never learn the iden-
tity of the other party to the transaction and may therefore
have no one to sue. 125 In addition, wrongdoing in the private
markets is less likely to impair confidence in the general
financial marketplace. It is less likely to become generally
known, and more likely to be perceived as unique to the trans-
action or the parties. Someone who buys a worthless bond
through an exchange blames the market. Someone who lends a
thousand dollars to a business associate and does not get it
back blames himself and the associate.

123. The collapse of the Florida land boom in 1926-1928 was cited by one
contemporary analyst in connection with his prediction of a similar collapse on
the financial markets. See J. GALBRAIrH, supra note 95, at 89-90 (citing Address
by Roger Babson, 16th Annual National Business Conference (Sept. 5, 1929), re-
printed in 129:1 THE COMMERCIAL & FINANCIA. CHRONICLE 1530 (1929)). It
should be noted, however, that the Florida land market had attained, during its
boom, many of the characteristics of a public market. See J. GALBRAITH, supra,
at 23-24.
124. See J. LIGHT & W. WHITE, supra note 85, at 183-84.
125. See, e.g., Goodwin v. Agassiz, 283 Mass. 358, 186 N.E. 659 (1933) (presi-
dent of a corporation who purchased shares of the corporation's stock without
full disclosure held not liable under state law, apparently, in part, because the
transaction took place on a stock exchange). The federal securities laws are
frequently interpreted so as not to apply to instances in which adequate state
protections exist. See, e.g., Santa Fe Indus. v. Green, 430 U.S. 462, 478-79 (1977)
(holding that minority shareholders had no remedy under rule lOb-5 for breach
of fiduciary duty in connection with a freeze-out merger because of, inter alia,
the availability of state corporate law remedie.s); Lincoln Nat'l Bank v. Herber,
604 F.2d 1038, 1044 (7th Cir. 1979) (holding that a particular pledge of securities
did not constitute a "sale" within the meaning of the Securities Act or the Ex-
change Act because of, inter alia, the availability of state law protections for
secured transactions).
 1980] DEFINITION OF SECURITY

b. Features Qualifying an Instrument to Participate in a

Public Market
The following are characteristics that an instrument must
have in order to move in the public financial markets and thus
be eligible for inclusion in the category of "security":

(i) The Instrument Must Not Be Unique

When an instrument confers on its holder rights that are
not readily comparable to the rights conferred by any other in-
strument of the issuer, the determination of the price between
a rational seller and buyer must occur within the context of
each transaction in which the instrument is purchased and
sold; by hypothesis there cannot be other contemporaneous
transactions in similar instruments. The public markets cannot
perform their pricing function in such a case, and, as a result,
any transactions in such an instrument will have many of the
most important features of negotiated transactions. For this
reason, an instrument such as a note evidencing a loan with de-
tailed terms different in important respects from those of other
loans to the borrower, 26 or an instrument giving a right to the
profits on a unique farm, cannot conveniently travel in the pub-
lic financial markets and is not a security under the proposed
definition. The bundles of rights in the Howey case-rights to
the proceeds of strips of fruit orchards-were correctly held to
be securities and are not excluded as unique if, as seems to
have been the case, they were roughly the same for each pur-
chaser. But they would not have been securities if they had re-
lated, rather than to adjacent strips of trees, to entire farms
located in various parts of the region, so that the potential
profit could be expected to vary considerably from farm to
farm. 27

126. For a discussion of debt instruments generally, see text accompanying

notes 144-182 infra. For authority supporting the view that uniqueness tends to
disqualify a debt instrument from being a security, see note 170 infra.
127. This portion of the proposed test bears some relationship to the "com-
mon enterprise" requirement of Howey, as interpreted by some courts to re-
quire commonality among investors. See, e.g., Hirk v. Agri-Research Council,
Inc., 561 F.2d 96, 99-102 (7th Cir. 1977) (requiring "a sharing or pooling of funds"
of multiple investors). On the one hand, the test proposed in this Article is
more inclusive, in that it can be satisfied when there is only one investor, pro-
vided a number of identical instruments have been created. Cf. Troyer v. Kar-
cagi, 476 F. Supp. 1142, 1147-48 & n.7 (S.D.N.Y. 1979) (requiring only a "one-to-
one relationship between an investor and an investment manager"--that is,
"vertical commonality"); Titsch Printing, Inc. v. Hastings, 456 F. Supp. 445, 447-
49 (D. Colo. 1978) (holding that a purchase by a single enterprise of all of the
stock of two corporations constituted the sale of securities within the Exchange
 MINNESOTA LAW REVIEW [Vol. 64:893

(ii) The Instrument Must Be Available for Cash or for

Something of General Value

An instrument that cannot by its nature be acquired for

cash, but only in return (as all or part of the purchase price)
for something such as personal labor for a particular employer,
cannot be traded in the public markets and therefore is not a
security.128 Excluded for the same reason are instruments that,
although initially available for cash, cannot by their nature 29
yield a return without an additional contribution of labor.1
These requirements are related to the prong of the Howey test
that speaks of an "investment of money" and to the "solely [or
30
largely] from the efforts of [others]" requirement.
Two qualifications should be noted. First, an instrument
should be deemed available for cash if cash can readily be em-
ployed to acquire it indirectly as well as directly. Shares of
common stock obtainable only by conversion of preferred pass
the test if the preferred is purchasable for cash. Second, an in-
strument should be regarded as available for cash if the only
impediment to cash purchase is a private stipulation or agree-
ment to the contrary. Equity shares that the issuer will convey
only to its executives in return for their labor would pass the
test.
The notable exclusions from the category of "securities"
under this part of the test are employee benefit plans when, be-
cause of the nature of the plan and the relevant tax laws, the
instruments (the interests in the benefit funds) must be ac-

Act definition because of the term "stock" in that definition). On the other
hand, it is more exclusive, in that it cannot be satisfied by the pooling of mon-
ies through the sale of different types of instruments. For what may be some
judicial groping towards the more exclusive portion of the test, see SEC v. Kos-
cot Interplanetary, Inc., 497 F.2d 473, 478 (5th Cir. 1974) ('The critical factor is
not the similitude or coincidence of investor input, but rather the uniformity of
impact of the promoter's efforts.").
128. See Long, supra note 11, at 115.
129. This justifies the results in many of the cases which hold that no secur-
ity was involved in certain distributorship agreements, e.g., Chapman v. Rudd
Paint & Varnish Co., 409 F.2d 635 (9th Cir. 1969), or in certain franchise arrange-
ments, e.g., Mr. Steak, Inc. v. River City Steak, Inc., 400 F.2d 666 (10th Cir. 1972).
Some cases, however, have held pyramid selling schemes to be securities; a re-
turn from such arrangements cannot be obtained without some work as a sales-
person. E.g., SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 (5th Cir.
1974). See also Miller v. Central Chinchilla Group, Inc., 494 F.2d 414 (8th Cir.
1974). Perhaps such cases can be explained on the ground that the work in-
volved was (or was represented to be) part-time, temporary, or, as the court in
Koscot emphasized, ministerial. For an opinion that may indicate a retreat
from Koscot, see Piambino v. Bailey, 610 F.2d 1306 (5th Cir. 1980).
130. See text accompanying note 19 supra.
1980] DEFINITION OF SECURITY

quired largely in exchange for labor for a particular employer

or through a particular union.131

(iii) Return on the Instrument Must Be in Cash or in

Something of General Value
When the instrument offers a return in cash or the like, it
offers something that will appeal equally to all participants in
the public markets. To the extent that the return is in a form
that can be enjoyed profitably only by a few, or can be enjoyed
by some much more than by others, the instrument loses its
appeal to the public markets and is likely to move only in pri-
vate transactions. For example, a nonprofit corporation's
"stock" that offered a return in the form of fuel, tires, and re-
pair facilities for truckers on the West Coast should not be re-
garded as a security; the stock is valuable only to West Coast
truckers. 32 Forman is explicable on this ground. The sup-
posed securities involved in that case were part of a package in
which the chief benefit to the "purchasers" was the right to an
apartment in Co-op City. The market for such a benefit is prob-
ably too small to permit the functioning of the public market
33
pricing mechanism.1

(iv) The Instrument Must Not Possess Other Disqualifying

Features
Other features might tend to disqualify an instrument from
moving in the public financial markets. One such feature, for
example, would be a provision making the amount of the in-
strument's return contingent upon matters partly within the
control of the original holder, as in one recent case involving a
promise to make payments in an amount that would vary ac-
cording to the promisee's tax position.134 Any transferee of
such an instrument would be at a severe disadvantage com-
pared to the original holder. A debt instrument with an ex-

131. For further discussion of employee benefit plans, see text accompany-
ing notes 183-191 infra.
132. See It-Co-Op, [1979 Transfer Binder] FED. SEC. L REP. (CCH) 82,381
(Aug. 29, 1979) (stating that no enforcement would be recommended if "stock"
of the type described in the text were offered and sold without registration
under the Securities Act). But cf. Silver Hills Country Club v. Sobieski, 55 Cal.
2d 811, 361 P.2d 906, 13 Cal. Rptr. 186 (1961) (holding that, under the California
state securities statute, country club memberships involved a security).
133. The Court in Forman observed that the benefit of low rents did not
count as a "profit" within the meaning of Howey because, among other reasons,
"[t]his benefit cannot be liquidated into cash." 421 U.S. at 855.
134. Braniff Airways, Inc. v. LTV Corp., 479 F. Supp. 1279 (N.D. Tex. 1979).
 MINNESOTA LAW REVIEW [Vol. 64:893

tremely short term might also be disqualified; prohibitive

transaction costs tend to limit purchasers and sellers of such
instruments to large institutions, so that the market for the in-
struments necessarily lacks many of the features of the fully
public market.135 Another such disqualifying feature would be
a legal impediment to trading in the public markets: a feature
possessed, for example, by certain nontransferable government
securities issued for specialized purposes such as to provide
benefits from tax-qualified pension plans. A provision reserv-
ing apartments in Co-op City to persons with low incomes is
36
another example of a relevant legal impediment.1

c. Marginal Cases

Many instruments will prove to have both disqualifying

and qualifying features, or to have features that tend to be dis-
qualifying but only in unimportant respects. For example, in-
struments that have unique features are disqualified; thus,
leaseback and servicing arrangements on identical strips of
fruit trees are securities but such arrangements on entire farms
are not. But what about intermediate cases such as leaseback
and servicing arrangements on various-sized plots of fruit trees
in similar but not identical soil conditions? What about the in-
struments representing a privately negotiated debt when there
are two institutional lenders rather than one, so that the instru-
ments, although unique as to all the other debt instruments of
the borrower, are identical to one another? What about a debt
instrument that is unique in its complex prepayment provi-
sions but has the same maturity date as the issuer's other
debt-and the maturity date is a week away? Again, we have
seen that payment of a return in something not cash and not
readily convertable into cash disqualifies the instrument. But
almost everything can be turned into some amount of cash; the

135. For a discussion of the treatment of short-term business debt proposed

herein, and some discussion of the short-term debt market, see text accompa-
nying notes 171-178 infra.
136. In order to rent an apartment in Co-op City, a prospective tenant was
required to have a monthly income of no more than six times the monthly rent.
In addition, preference was given to veterans, the handicapped, and the elderly.
United Hous. Foundation, Inc. v. Forman, 421 U.S. 837, 841 n.1 (1975).
Impediments to transferability that, while not imposed by law, are required
by the nature of the issuer should probably disqualify the instrument as a se-
curity. Country club memberships might be excluded in part on this ground-
the nature of country clubs dictates restrictions on the transfer of member-
ships. But see Silver Hills Country Club v. Sobieski, 55 Cal. 2d 811, 361 P.2d 906,
13 Cal. Rptr. 186 (1961).
1980] DEFINITION OF SECURITY

significance of the West Coast truckers case137 is that the re-

turn is in a form that is of much more value to the recipient
than it is to the market-it cannot readily be turned into
enough cash to make the sale worthwhile. Again, we have seen
that an instrument does not qualify as a security if it cannot be
acquired for cash, so that interests in a pension fund are not se-
curities if they can be obtained only for labor for a particular
employer. But what about a contributory pension fund, to
which the employee, once employed by the company that es-
tablished the fund, can add some of his own money and so in-
crease his prospective pension?
There are two ways of proceeding that will assist in margi-
nal cases. The first approach is theoretical: in adjudicating the
marginal cases, courts should measure the significance of a
supposed disqualifying feature by referring to the degree to
which it tends to restrict transactions in the instrument to ne-
gotiated rather than public markets. This calls for a difficult
calculation involving consideration not only of the nature of the
instrument itself, but also of the quality of the public and nego-
tiated markets. To the extent that the public markets improve
their ability to assess instruments, gather and communicate in-
formation about them, and effect transactions in a cheap and
efficient fashion, and to the extent that participation in the pub-
lic markets is what economists call broad, deep, and resili-
ent,138 instruments will move more readily in them. The
39
introduction and development of the national market system,
for example, may open the public markets to more instruments.
This suggests a practical approach to supplement the theo-
retical one. Economic theory cannot wholly determine which
instruments the public markets will absorb and process; this
depends in part on the habits and practices of the markets, on
the expertise of their participants, and on the extent and effi-
ciency of the market participants' intelligence apparatus.
When an instrument (or one similar to it) is in fact traded in

137. See text accompanying note 132 supra.

138. See C. HENNING, W. PIGoTr & R. Scorr, FINANciAL MARKETS AND THE
ECONOMY 286-87 (2d ed. 1978).
139. The 1975 amendments to the Exchange Act declared that a purpose of
the act is "to remove impediments to and perfect the mechanisms of a national
market system for securities." Act of June 4, 1975, Pub. L No. 94-29, § 2, 89 Stat.
97 (codified at Exchange Act § 2, 15 U.S.C. § 78b (1976)). As a result, impressive
reforms are under way, aimed at ending the quasi-monopolistic privileges of
certain market institutions and insiders, and at establishing electronic linkage
of various stock exchanges and the over-the-counter market. For a lucid and
detailed description, see Exchange Act Release No. 14416, 43 Fed. Reg. 4354
(1978), reprinted in [1978 Transfer Binder] FED. SEC. L. REP. (CCH) 81,502.
 MINNESOTA LAW REVIEW [Vol. 64:893

public markets (on stock exchanges or over the counter), that

should indicate that it is a security. Similarly important are the
requirements imposed by financial market institutions for
processing or otherwise handling instruments in the financial
markets: listing requirements of the stock exchanges are an
example, as are the rating requirements of Moody's or Stan-
dard and Poor's.

C. Two SPECIAL CASES: OPTIONS AND PURPORTED FINANCIAL

INSTRUMENTS
Without modification, the test proposed above would ex-
clude two types of instruments that deserve inclusion as "se-
curities": securities options and instruments that purport to
have all the characteristics of securities but in fact do not.

1. Options and Other "Secondary Securities"

Options to purchase or sell securities, like options on com-
modities, resemble wagers that the security in question will
rise or fall in price; the option holder's prospects of gain have
little to do with the economic performance of the creator of the
option unless the creator happens also to be the issuer of the
underlying security. Therefore, under the tests proposed
above, many options are not "financial instruments" and hence
not securities.
Nevertheless, it would be undesirable to exclude these in-
struments from the definition; they are closely linked with in-
struments that are the object of the protections of the
securities laws. An option that participates in the public mar-
kets can directly affect the market in the underlying security
and is psychologically linked to it as well. Fraud and other mis-
conduct in the options markets is thus likely to undermine con-
fidence in the securities markets generally.140 For this reason it
is desirable to conclude, as the authorities generally do, that
options on securities and similar devices are themselves securi-
ties,14 ' or at least that they constitute 'financial instruments"

140. For a survey of recent studies establishing the impact of options trad-
ing on the market performance of the underlying securities, and on securities
exchanges more generally, see SEC, REPORT OF THE SPECIAL STUDY OF THE OP-
TMONS MARKETS 12-18 (Feb. 15, 1979), excerpted in [1979 Transfer Binder] FED.
SEC. L. REP. (CCH) 81,945, at 81,297-303.
141. Call options are securities because of those portions of the statutory
definitions that refer to a "right to subscribe to or purchase, any of the forego-
ing." Securities Act § 2(1), 15 U.S.C. § 77(b) (1) (1976); Exchange Act § 3(a) (10),
15 U.S.C. § 78(c) (a) (10) (1976). The cases establish that both put and call op-
tions are securities. See, e.g., Kusner v. First Pa. Corp., 531 F.2d 1234, 1238-39
1980] DEFINITION OF SECURITY

under the proposed definition and are securities when they are
eligible to participate in the public markets.

2. PurportedFinancialInstruments
Forgeries of securities would not be considered securities
under the test proposed above; their value does not depend on
the success of the productive activities of the issuer (neither
the purported issuer nor the actual makers-the forgers). Also
excluded would be an instrument that authentically created an
interest in a stated issuer, but an issuer that was falsely held
out as engaging in a productive activity-an issuer that was, for
example, just a shell for receiving money to be looted by the
principals, or an issuer whose only income-producing activity
was to continue defrauding others, as in a Ponzi scheme. When
such instruments participate in the public markets, they under-
mine investor confidence at least as much as when convention-
al financial instruments are traded without adequate
disclosure. Investors are less willing to purchase any financial
instrument when there is a danger that it may not be authentic.
Therefore, the few authorities that exist on the subject are cor-
rect in regarding these devices as securities. 142 The test pro-
posed in this Article should be amended to bring within the
definition of "financial instrument" any instrument that has
been given by its creator the appearance of having features

(3d Cir. 1976) (stating in dictum that "[o]ptions ... are securities"); Lubin v.
Belco Petroleum Corp., [1978 Transfer Binder] FED. SEC. L. REP. (CCH)
96,543, at 94,237 (S.D.N.Y. 1978) (holding that a put is a security for Exchange
Act purposes, when the put in question was issued not by the issuer of the un-
derlying security, but by its general partner); Lloyd v. Industrial Bio-Test Labo-
ratories, Inc., 454 F. Supp. 807, 810-11 (S.D.N.Y. 1978) (holding that a call is a
security for Exchange Act purposes, when the call in question was issued by an
entity unrelated to the issuer of the underlying security).
142. See, e.g., Lawler v. Gilliam, 569 F.2d 1283 (4th Cir. 1978) (holding, with-
out discussing whether the instruments involved were securities, that a remedy
under the Securities Act was available in connection with the offer and sale of
notes in an enterprise that was represented as engaged in the wine-importing
business, but in fact merely served as part of a scheme to defraud investors);
Seeman v. United States, 90 F.2d 88 (5th Cir. 1937) (holding forgeries of bonds
to be securities). See also Goodman v. Hentz & Co., 265 F. Supp. 440 (N.D. lL
1967) (holding that the antifraud provisions of the securities laws applied to the
actions of a broker in representing that he had purchased and sold securities
for customers when in fact he had not). But cf. Curran v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., 554 SEC. REG. L, REP. (BNA) G-l, G-4 (6th Cir. May 12,
1980) (rejecting, on factual grounds, plaintiff's argument that an interest in a
commodity future account should be regarded as a security because plaintiff
had been falsely told that the elements of a common enterprise were present).
For citations to cases of forged instruments and related matters under blue sky
law, see 1 L. Loss, SEcu~rrIs REGULATION 511-12 (2d ed. 1961); 4 id. at 2556-57
(Supp. 1969).
 MINNESOTA LAW REVIEW [Vol. 64.893

that would qualify it as a financial instrument-that is, the fea-

tures of having been issued (1) by a company that produces
goods and services, (2) under circumstances such that the is-
suer will receive the proceeds and be able to use them in its
productive activities, and (3) under circumstances such that
the value of the instrument turns on the success of the produc-
tive activities of the issuer. No elaborate contrivances are nec-
essary to confer such an appearance; the necessary illusion
would normally be created by the words "Common Stock of the
3
Widget Manufacturing Company" at the top of the certificate.14

IV. APPLICATION OF THE DEFINITION TO

PARTICULAR CASES
The following applies the definition proposed above to
some of the major areas of controversy and confusion.

A. CERTAIN DEBT INSTRU-MENTS

Under the Howey test,144 it is difficult to exclude from the

category of "security" any instrument representing an obliga-
tion to pay principal and interest on borrowed funds. Long-
term notes, short-term notes, commercial paper, instruments
representing bank borrowings, and perhaps trade credit, all
pass the three-prong test even after the modifications of Daniel

143. The proposed modification for "purported financial instruments" ob-

tains some support from those portions of the statutory definitions that include
as a security "any instrument ... commonly known as a 'security."' Securities
Act §2(l), 15 U.S.C. §77b(1) (1976); Exchange Act §3(a)(10), 15 U.S.C.
§ 78c(a) (10) (1976). Further support is provided by the statement of the Court
in Joiner that "it is not inappropriate that the promoters' offerings be judged as
being what they were represented to be." 320 U.S. at 353. The corollary point
made above-that merely calling an instrument by some name such as "stock"
provides some indication that it should be counted as a financial instrument-
is supported by those cases that have applied a "literal" test. See text accom-
panying notes 165-169 infra. The Supreme Court in Forman indicated that the
name given to an instrument, although perhaps significant, is not determina-
tive:
In holding that the name given to an instrument is not dispositive,
we do not suggest that the name is wholly irrelevant to the decision
whether it is a security. There may be occasions when the use of a
traditional name such as "stocks" or "bonds" will lead a purchaser jus-
tifiably to assume that the federal securities laws apply.
421 U.S. at 850. The test proposed in this Article would, similarly, determine
the influence to be afforded the name of an instrument by asking what the
name would lead a reasonable party to believe. The test proposed would be
whether a reasonable party would believe that the instrument had the charac-
teristics of a financial instrument rather than whether it was subject to the se-
curities laws.
144. See text accompanying note 19 supra.
1980] DEFINITION OF SECURITY
45
and Fornan.1 The creditor has given value in the hope of
gain in the form of interest arising from the efforts of the bor-
rower. 46 Courts, however, have been unwilling to go as far as
this logic would push them, sensing, for example, that it is in-
correct to characterize a business as issuing securities when-
ever it takes down funds under a line of credit from its bank.
Accordingly, courts have developed supplementary doctrines.
The most important of these doctrines employs the "com-
mercial-investment" distinction. Backtracking from the view
expressed earlier in dictum that "almost all notes are held to
be securities," 47 various circuits, most notably the third, fifth,
and seventh, have adopted the view that debt instruments are
not securities in a "commercial context" but are securities in
an "investment context." 46 Whether the context is commercial
is determined by reference to a number of factors: the number
of parties to whom the instrument was offered or sold-more
than one such party tends to establish an investment con-
text; 49 the motives of the purchaser-a motive to speculate or
"invest" suggests an investment context;15 0 the use to which
the issuer intends to put the proceeds-using them as "venture
capital"'51 or to acquire "investment assets" 52 indicates an in-
vestment context, whereas using them to purchase "consumer
goods or particular business goods or services" indicates a com-
mercial context; 53 the source of the "impetus" for the transac-

145. See text accompanying notes 45-50 supra.

146. "In one sense every lender of money is an investor since he places his
money at risk in anticipation of a profit in the form of interest." C.N.S. Enter-
prises, Inc. v. G. & G. Enterprises, Inc., 508 F.2d 1354, 1359 (7th Cir.), cert. de-
nied, 423 U.S. 825 (1975). See also Exchange Nat'l Bank v. Touche Ross & Co.,
544 F.2d 1126, 1136-37 (2d Cir. 1976).
147. Lehigh Valley Trust Co. v. Central Nat'l Bank, 409 F.2d 989, 991-92 (5th
Cir. 1969).
148. For an exposition of this distinction, see Comment, Commercial Notes
and Definition of 'Security' UnderSecurities Exchange Act of 1934: A Note Is a
Note Is a Note?, 52 NEB. L. REv. 478 (1973).
149. See, e.g., Lino v. City Investing Co., 487 F.2d 689, 694-95 (3d Cir. 1973)
(commercial context established in part by the fact that there was no public
offering of the notes).
150. Id. (quoting McClure v. First Nat'l Bank, 352 F. Supp. 454, 457 (N.D.
Tex. 1973), a f'd, 497 F.2d 490 (5th Cir. 1974), cert. denied, 420 U.S. 930 (1975)).
151. See Zabriskie v. Lewis, 507 F.2d 546, 551-52 (10th Cir. 1974) (holding that
certain notes were securities because, inter alia, they were given to obtain
funds to "promote a corporation"); Lino v. City Investing Co., 487 F.2d 689, 694-
95 (3d Cir. 1973) (arguing that certain notes were not securities because no so-
licitation of venture capital was involved).
152. McClure v. First Nat'l Bank, 497 F.2d 490, 494 (5th Cir. 1974), cert. de-
nied, 420 U.S. 930 (1975); SEC v. Diversified Indus., 465 F. Supp. 104, 110 (D.D.C.
1979).
153. C.N.S. Enterprises, Inc. v. G. & G. Enterprises, Inc., 508 F.2d 1354, 1361
 MINNESOTA LAW REVIEW [Vol. 64:893

tion-if the person with the money provides the impetus, that
tends to establish the transaction as an investment, whereas if
the issuer takes the leading role, that suggests a commercial
transaction; 5 4 and the degree to which the purchaser incurs
risks or "relies" on the issuing entity--placing funds at great
risk, giving [the] note payee extensive collateral rights, [and]
making repayment of [the] funds contingent upon some event"
indicate that the instrument is a security. 5 5 In addition, a note
is more likely to have an investment character if it is part of an
issue with many payees and many notes,' 5 6 if it involves a large
dollar amount,157 if it is long term, 5 8 and if it affords a return
other than in fixed amounts at fixed times or a "gain beyond re-
payment... with interest."' 5 9 The authorities tend to accom-
pany lists of these factors with the observation that
adjudication must proceed on the facts of the individual case,
with differing weights to be assigned to the different factors,
and with the possibility left open that there are more factors to
be discovered.160 A version of the commercial-investment dis-
tinction is proposed in the American Law Institute's Federal
Securities Code.161
The commercial-investment distinction is not helpful in ad-
judication and is liable to criticism as incoherent unless its pro-
ponents can explain it more satisfactorily than in the form of a
laundry list.162 It is a transaction-based form of the "need for

(7th Cir.), cert. denied, 423 U.S. 825 (1975) (citing Comment, supra note 148, at
510-24).
154. See 508 F.2d at 1359.
155. Id. at 1361 (citing Comment, supra note 148, at 510-24).
156. See 508 F.2d at 1361.
157. See id.
158. See, e.g., First Fed. Say. & Loan Ass'n v. Mortgage Corp., 467 F. Supp.
943, 949-50 (N.D. Ala: 1979). Cf. Bellah v. First Nat'l Bank, 495 F.2d 1109, 1112-14
(5th Cir. 1974) (holding that a short-term note did not have an investment char-
acter).
159. Nat'l Bank of Commerce v. All Am.Assurance Co., 583 F.2d 1295, 1301
(5th Cir. 1978).
160. See, e.g., Great W. Bank & Trust v. Kotz, 532 F.2d 1252, 1258 (9th Cir.
1976); C.N.S. Enterprises, Inc. v. G. & G. Enterprises, Inc., 508 F.2d 1354, 1362 &
nn.14-15 (7th Cir.), cert. denied, 423 U.S. 825 (1975).
161. The definition of "security" in the proposed code excludes a "note or
evidence of indebtedness issued in a primarily mercantile or consumer, rather
than investment, transaction not involving a distribution." ALI FED. SECUmrES
CODE § 299.53(b) (3) (Proposed Official Draft, Mar. 15, 1978). A significant part
of the proposed definition is set forth in note 14 supra. The comment to this
section states that it "codifies the mercantile-investment dichotomy that is
emerging as the least imperfect solution to a troublesome problem." Id., com-
ment 3 at 159.
162. The difficulty of applying the distinction was noted by the court in Mc-
Clure v. First Nat'l Bank, 497 F.2d 490, 492 (5th Cir. 1974), cert. denied, 420 U.S.
1980] DEFINITION OF SECURITY
63
regulation" test and suffers from the same drawbacks as
does that test. 64
The commercial-investment test was intelli-
gently criticized by Judge Friendly in Exchange NationalBank
v. Touche Ross & Co.165 Judge Friendly proposed, as an alterna-
tive, that greater attention be paid to the literal language of the
statutory definitions. This approach is called by some the "lit-
eral" test. 66 Judge Friendly, however, was aware that the stat-
utory phrase "unless the context otherwise requires" is an
invitation to go beyond literalism, and he accordingly noted
several instances in which the context does otherwise require:
the note delivered in consumer financing, the note secured by a mort-
gage on a home, the short-term note secured by a lien on a small busi-
ness or some of its assets, the note evidencing a'"character" loan to a
bank customer, short-term notes secured by an assignment of accounts
receivable, or a note which simply formalizes
167
an open-account debt in-
curred in the ordinary course of business.
Although Judge Friendly concluded that the notes at issue
were securities, he mentioned many factors in addition to the
fact that the term "notes" appears in the statutory definition:
The "loan" was negotiated with the Bank's chief administrative officer,
not with a lending officer. The form of the note was dictated not by the
Bank but directly by the borrower and ultimately by NYSE. The notes
themselves bore scant resemblance to the standard forms used in com-
mercial lending ... More important of all [sic] were the subordinated
character of the notes and the knowledge of both parties that the pro-
ceeds would be considered by NYSE as the equivalent of equity capital
for the purpose of enabling Weis further to expand its business by bor-
rowing .... The notes reflected the Bank's foregoing of the usual and
important rights to take as security any property of the borrower that
came into its possession or to exercise a right of set-off. Finally, the
Exchange National loan was no isolated transaction but a part of a

930 (1975). See R. JENNWGS & H. MARSH, supra note 107, at 857 ("the recent
cases have held that whether or not a promissory note is a security depends
upon whether it is a 'commercial' or an 'investment' note, whatever that
means"); Pollock, supra note 10, at 543 ("the reason that no effective list of gen-
eral characteristics has been produced is that there may, in fact, be no gener-
ally recognized concepts of investment or commercial notes, or, if these
concepts do have generally recognized traits, they may overlap to such a de-
gree that no distinction can be drawn").
163. This should be clear from the list of factors set forth above. See Upton
& Katz, "Notes"Are Not Always Securities, 30 Bus. LAw. 763 (1975) ("[t]he fo-
cus is now on the nature of the transaction giving rise to the issuance of the
note"). For a case applying the commercial-investment distinction to one
transaction only-that in which a note was assigned-without reference to the
transaction in which the note was issued, see Old Security Life Ins. Co. v.
Waugneux, 484 F. Supp. 1302 (S.D. Fla. 1980).
164. See text accompanying notes 62-76.
165. 544 F.2d 1126 (2d Cir. 1976).
166. See, e.g., Amfac Mortgage Corp. v. Arizona Mall, Inc., 583 F.2d 426, 431
n.6 (9th Cir. 1978).
167. 544 F.2d at 1138.
 MINNESOTA LAW REVIEW [Vol. 64:893

large financing operation conducted by Weis .... 168

It thus is clear that the "literal" test, like the commercial-in-
vestment test, involves a range of factors-in fact, many of the
same ones. Both tests lack the theoretical grounding necessary
to determine what factors should be relevant and how their im-
69
portance should be assessed.1
The definition suggested in this Article would resolve some
of the major issues about debt instruments in the following
manner.

1. Long-Term Loans to Business Enterprises

This is an area in which some instruments should be secur-
ities and others should not, depending on the structure of the
relationship between the parties. It will be clear in virtually all
cases that "financial instruments" are present: the note or
bond will be a channel by which savings may be transferred to
investment, and the interest on the loan will constitute a profit
dependent upon the productive activities of the enterprise.
Ability to move freely in the public financial markets will not
be impaired by the form in which consideration is paid to the
borrower or back to the lender it is normally cash in both in-
stances.
The principal issue in most long-term loan cases will there-
fore be whether the instrument is so closely "tailored" to the
particular needs of the parties to the transaction as to make the
instrument "unique" and thus ineligible to move in the public
markets. Most instruments representing debts arising from the
typical close and complex relationship between a business and
its principal commercial banker will be tailored to such an ex-
tent that courts should exclude them from the category "secur-
ity." 7 0 For example, an instrument should not be considered a

168. Id. at 1138-39.

169. The same can be said for the "risk capital" test applied by the Ninth
Circuit, under which a debt instrument is a security if the lender "contributed
'risk capital' subject to the 'entrepreneurial or managerial efforts"' of others.
United Cal. Bank v. THC Fin. Corp., 557 F.2d 1351, 1358 (9th Cir. 1977) (quoting
Great W. Bank & Trust v. Kotz, 532 F.2d 1252, 1257 (9th Cir. 1976)). See also
Amfac Mortgage Corp. v. Arizona Mall, Inc., 583 F.2d 426 (9th Cir. 1978); Great
W. Bank & Trust v. Kotz, 532 F.2d 1252 (9th Cir. 1976). In Kotz, the court indi-
cated that the risk capital test is largely identical to the commercial-investment
test. Id. at 1257.
170. See Great W. Bank & Trust v. Kotz, 532 F.2d 1252, 1262 (9th Cir. 1976)
(Wright, J., concurring). In arguing that a note given in exchange for a bank
loan should be excluded from the category of "security," Judge Wright noted:
Rather than relying solely on semi-anonymous and secondhand market
information, as do most investors, the commercial bank deals "face-to-
face" with the promissor. The bank has a superior bargaining position
1980] DEFINITION OF SECURITY

security if it reflects inventory financing on a revolving credit

basis and contains provisions for an interest rate that varies
with the lending bank's prime rate, provisions for inspection by
the bank of books and records, provisions for forwarding of var-
ious documents and financial reports to the bank on a periodic
basis, and provisions for the maintenance by the borrower of a
compensating balance. On the other hand, an instrument
should be deemed a security when it is free from personal par-
ticularities, when the interest rate is set by reference to the
prime rate of banks generally or of some nonparty bank, when
rights of inspection and enforcement of default provisions are
exercisable by a trustee, when the principal amount is fixed
rather than variable and is to be taken all at once rather than
on a revolving basis, and when rights under the debt arrange-
ment are not contingent upon rights and duties arising from ac-
tivities in other areas of the relationships between the parties-
that is, when the instrument can be used "off the peg" by stran-
gers rather than being "tailored" to a particular lender. Some
of the factors in the commercial-investment test-and perhaps
also in Judge Friendly's test-survive as important considera-
tions in this analysis; others do not. The motives of the lender
are irrelevant. The use of the proceeds is irrelevant; all that
survives of this requirement is that the borrower must be a
business engaged in the production of goods or services. The
source of "impetus" for the transaction is irrelevant-certainly
a transaction initiated by the issuer should be within the scope
of the securities laws and not excluded as "commercial." On
the other hand, it is relevant that the instrument is capable of
being offered and sold to a large number of parties, and that it
is one of a large number of similar instruments.
Since there will be many intermediate cases, some pre-
sumptions may be appropriate. It might be appropriate, for ex-
ample, to adopt a presumption that a security is involved in any
borrowing in which the borrower is a business and there are
and can compel wide-ranging disclosures and verification of issues ma-
terial to its decision on the loan application. The bank here obtained a
covenant to permit it to inspect [the borrower's] property and records
"at such times as [the bank] may reasonably request." Far from
purchasing an instrument whose terms were fixed prior to the time of
its offering, the bank negotiated the terms of the note in question.
When it discovered a change in [the borrower's] financial status, it was
able to negotiate new terms and restrictions on [the borrower's] deal-
ings.
But see SEC v. Diversified Indus., Inc., 465 F. Supp. l4, 111 (D.D.C. 1979) (hold-
ing a purchase-money mortgage note to be a security when it was issued by a
corporation to a trust in exchange for land acquired for investment).
 MINNESOTA LAW REVIEW [Vol. 64.893

numerous lenders on identical terms. Any long-term negotia-

ble debt instrument issued by a business should be a security,
and so should any business debt instrument in which the rights
of the lenders are held by a trustee; trusteeship is a device for
facilitating the holding of the instrument by absent, distant par-
ties previously unconnected to the borrower.

2. Short-Term Loans to Business Enterprises

Excluding short-term debt instruments from the definition
of "security" is sometimes dictated by the statutory language,
since instruments with a maturity of less than nine months are
expressly excluded from the definition in the Exchange Act.171
Although the Securities Act does not expressly except short-
term debt instruments from its definition, those instruments
which "arise out of a current transaction or the proceeds of
which have been or are to be used for current transactions" are
excluded from its registration requirements.172 Courts have
gone further and have held that short-term instruments are not
securities even when they are not excluded under the terms of
these provisions.173 This approach is difficult to reconcile with
the tests adopted by the leading cases. The three-prong test of
Howey,174 for example, does not appear to give any basis for
considering the length of a loan's term. The exclusion of short-
term loans is more easily reconciled with the commercial-in-
vestment distinction because the list of factors establishing
that distinction has been stipulated to include term, but most
of the other factors could be as easily satisifed in a short-term
as in a long-term loan.
Since term is merely a matter of degree, it is not surprising
that theories which recognize, as all must, that some debt in-
struments are securities tend also to include some short-term
instruments. The definition proposed in this Article at least ex-
plains why it makes sense to be less inclusive when the instru-
171. Exchange Act § 3(a) (10), 15 U.S.C. § 78c(a) (10) (1976).
172. Securities Act § 3(a) (3), 15 U.S.C. § 77c(a) (3) (1976). Section 3(a) in-
troduces the exempt categories with the phrase, "the provisions of this title
shall not apply to any of the following classes of securities." Id. § 3(a), 15
U.S.C. § 77c(a) (1976) (emphasis added). Section 3(a) (3) is extensively inter-
preted in Securities Act Release No. 4412, 17 C.F.R. 231.4412 (1979), reprintedin
1 FED. SEC. L. REP. (CCH) 2045 (1980).
173. See First Fed. Say. &Loan Ass'n v. Mortgage Corp., 467 F. Supp. 943, 948
(N.D. Ala. 1979). Conversely, courts have held instruments to be securities
when they would have been excluded by the literal language. See, e.g., Zeller v.
Bogue Elec. Mfg. Corp., 476 F.2d 795, 799-800 (2d Cir.), cert. denied, 414 U.S. 908
(1973).
174. See text accompanying note 19 supra.
 1980] DEFINITION OF SECURITY

ment is short-term. The shorter the term, the less an

instrument is like a financial one-the less the hope of gain and
risk of loss depend on the skills and abilities of the borrower.
The market, when processing a proposed twenty-five year bor-
rowing by a major enterprise, has a strong incentive to assess
closely the enterprise's probable success; when processing a
piece of ten-day commercial paper175 proposed to be issued by
the same enterprise, however, the market has little incentive
for such an assessment and is likely to form its judgments
based on factors that relate to the general money market.176
The "eligible to move in the public markets" requirement is
also less readily satisfied when the instrument is short-term be-
cause many short-term instruments-commercial paper, for ex-
ample-are tailored to meet the cash flow needs of the lender
and the borrower177 and because the market in such instru-
ments tends to be almost exclusively a negotiated one involv-
8
ing large institutions. 7
Under the circumstances, it would be consistent with the
proposed definition to frame a presumption or a rule that short-
175. Commercial paper is comprised of short-term, unsecured promissory
notes, normally issued by business enterprises to satisfy current cash require-
ments, and having an average term of 30 days. In the normal functioning of the
commercial paper market, the financial officer of a corporation, foreseeing a
need for cash in the near future, telephones an investment banking house,
which in turn wires to its salespeople around the country the information that
the issue is available, stating the company's credit rating and the desired ma-
turity and rate. Institutions with money on their hands for a short period-
such as insurance companies and pension funds-respond, specifying a desired
maturity date. (Some large issuers place their commercial paper directly
rather than through an investment banker.) The whole process can be com-
pleted so rapidly that the issuing corporation may receive its money by the end
of the day. Once placed, the paper tends to stay placed; because of the short
terms and the fact that the maturity date has been tailored to the needs of the
lender, there is little after-market trading. See J. LIGHT &W. WHITE, supra note
85, at 280-88; Arenson, Commercial PaperSurge, N.Y. Times, Feb. 4, 1979, § 3, at
1, coL 3.
176. It might also be argued that short-term instruments fail the require-
ment of susceptibility to be sold to obtain funds for investment since the pro-
ceeds of sales of such instruments are apt to be used by a business for day-to-
day needs rather than for "investment" in the narrower sense of capital invest-
ment. This is frequently the case with commercial paper, for instance. See
Arenson, supra note 175. In this Article, however, the term "investment" in-
cludes any use in the production of goods and services.
177. J. LIGHT & W. WHITE, supra note 85, at 280.
178. Bank loans constitute by far the largest form of short-term business
debt (about $112 billion), followed by loans from finance companies (about $45
billion) and commercial paper (about $13 billion). Id. at 260 (amounts out-
standing on Dec. 31, 1977). Commercial paper is purchased largely by institu-
tions such as pension funds and insurance companies. Arenson, supra note
175.
 MINNESOTA LAW REVIEW [Vol. 64:893

term loans to business enterprises are excluded from the cate-

gory "security." Alternatively, instruments with a well-recog-
nized character in the money markets, such as commercial
paper, might be excluded.

3. Consumer Loans and Other Borrowings by Individuals

Courts have generally concluded that no security is in-

volved in borrowings by individuals, such as consumer and res-
idential mortgage loans, despite the difficulty of excluding such
loans under the three-prong Howey test.179 Judge Friendly in
Exchange National Bank called an unsecured short-term per-
sonal loan to an individual "the very archetype of what the se-
curities laws were not intended to cover,"1 80 but noted that
they might be securities if one applied the unmodified Howey
test.18 Some consumer lending even edges towards the "in-
vestment" rather than the "commercial" side of the commer-
cial-investment distinction: some is risky, heavily
collateralized, long-term, and engaged in at the initiation of and
on the impetus of the consumer lender. Consumer loans are
also likely to involve an instrument labelled a "note" and thus
to fall within the literal language of the statute.
The courts' desire to exclude such instruments from the
category of "security" is surely correct, and the definition pro-
posed in this Article would almost always exclude them. They
would seldom qualify as 'Tmancial instruments" because the is-
suer-that is, the individual borrower-is not in a position to
use them for the purpose of producing goods and services to
any noteworthy extent. The individual may produce goods and
services at his place of employment, but a loan to assist him in
purchasing a residence or a boat or in paying his accumulated
utility bills will not contribute much to that effort.182 Further-
more, in the vast majority of cases, the instrument given to evi-
dence the borrowing will be one of a kind; there will normally
be only one lender, one instrument, and a set of terms different

179. See also National Bank of Commerce v. All Am. Assurance Co., 583
F.2d 1295 (5th Cir. 1978) (holding that a promissory note given by an individual
in exchange for bank loan was not a security).
180. Exchange Nat'l Bank v. Touche Ross & Co., 544 F.2d 1126, 1136-37 (2d
Cir. 1976).
181. Id.
182. It might be argued that the proceeds of such loans are invested in the
domestic production of goods and services. A graphic illustration is the case of
a loan for kitchen improvements to be used in cooking for the family. Even if
this argument is correct, the instrument is not a financial one because the
lender's hope of return does not depend on the success of those activities.
 1980] DEFINITION OF SECURITY

from those applicable to any other borrowing in which the con-

sumer is engaged. Consequently the instrument will be ineligi-
ble to move in public markets. Such borrowings are, of course,
generally conducted in negotiated rather than public transac-
tions. The proposed definition therefore excludes consumer
borrowing in all but very unusual circumstances.

B. INTERESTS UNDER EMPLOYEE RETIREMENT PLANS

83
In Daniel,1 the Supreme Court held that the employee's
interest under a union retirement plan pursuant to which the
employers made contributions to a retirement fund was not a
security when the employee's participation was involuntary
(he could not, for example, elect to take cash instead of em-
ployer contributions), when the plan did not contemplate that
the employee would in general make direct contributions, and
when the plan was a "defined benefit plan"--thai is, a plan in
which the amount of retirement benefits is not designed to rise
or fall according to the success of the investments made by the
trustees.18 4 Since then, lower courts have held such interests
not to be securities when the employee's participation was vol-
untary and when he made contributions himself,185 and legisla-
tion has been proposed excluding many such arrangements
from the anti-fraud provisions of the securities laws. 186 The
SEC staff, in an extensive release, has adopted the view that

183. See text accompanying notes 35-41 supra.

184. A "defined benefit plan" is one under which the retirement benefits to
be received by the employee are fixed, and the employer's contribution to the
plans can usually be adjusted as necessary to afford those benefits. (Of course,
the level at which they are "fixed" may have been set to reflect anticipated per-
formance of the securities in which contributions are invested as well as to re-
flect anticipated employer contributions.) A "defined contribution plan," by
contrast, is one in which pension benefits are based on contributions together
with gains, losses, income, and expenses resulting from the securities in which
the contributions are invested; the amount of benefits may thus vary according
to such performance. See Employee Retirement Income Security Act of 1974,
§ 3(34), (35), 29 U.S.C. § 1002(34), (35) (1976). The Daniel plan, however, like
many multi-employer collectively bargained defined benefit plans, differed from
the standard defined benefit plan in that the employers' obligations to contrib-
ute were limited to contractually fixed amounts. See Securities Act Release No.
33-6188, 45 Fed. Reg. 8960 (1980) (to be codified in 17 C.F.R. § 231.6188), reprinted
in 1 FED. SEc. L. REP. (CCH) 1051, at 2073-7 n.29 (1980).
185. See Newkirk v. General Elec. Co., [1980] FED. SEC. L. REP. (CCH)
97,216 (N.D. Cal. Aug. 31, 1979); Tanuggi v. Grolier Inc., 471 F. Supp. 1209
(S.D.N.Y. 1979). Cf. Black v. Payne, 591 F.2d 83 (9th Cir. 1979) (holding that no
security was involved in a compulsory contributory pension plan established
by state statute for state employees).
186. ERISA Improvements Act of 1979, S. 209, 96th Cong., 1st Sess. § 153(7),
at 28-34 (1979).
 MINNESOTA LAW REVIEW [Vol. 64.893

the Daniel analysis should be extended to exclude as securities

employee interests under many, but not all, types of retirement
87
plans.1
When the Howey test is adjusted according to the defini-
tion proposed in this Article, these extensions of Daniel are
readily justified. Interests in such retirement plans are nor-
mally 'Tmancial instruments" since savings can be channeled
to investment through them in such a way that hope of gain
turns on the success with which the fund is operated. (This
conclusion is undermined to the extent that the prospect of re-
turn depends on factors extraneous to the investment success
of the fund, such as forfeitures by other employees or govern-
ment insurance-of-benefits arrangements, 88 and consequently
some such instruments may fail to qualify as securities upon a
close investigation of the particular fund's financial results.)
However, the requirement that the instrument be eligible to
participate in the public markets will tend to exclude many of
these interests. First, nearly all instruments relating to em-
ployee retirement plans are nontransferable (except, upon
death, to designated beneficiaries) because of the requirements
of the laws that provide favorable tax treatment to qualified
plans. 89 This itself prevents the instruments from participat-
ing in a secondary market of any kind, public or negotiated. As
to the primary market, the instruments fail the "readily obtain-
able for cash" requirement-one can normally obtain such an
instrument only in exchange for work done for a particular em-
ployer or through a particular union, and one cannot circum-
vent this requirement by hiring someone else to work on one's
behalf. (Some plans permit additional cash contributions by
the employee, but in the typical case employment is still a con-
dition to participation.) In addition, the instruments may be

187. See Securities Act Release No. 33-6188, supra note 184, reprinted in 1
FED. SEC. L. REP. (CCH) 1051 (1980). This release states, among many other
things, that employee interests will not be treated by the staff as securities for
Securities Act purposes where they are under either involuntary, contributory
plans or voluntary, noncontributory plans. Id., 45 Fed. Reg. at 8964-65, re-
printed in 1 FED. SEC. L. REP. (CCH) 1051, at 2073-9 to -10. However, the re-
lease further states that "the interests of employees in voluntary, contributory,
corporate pension and profit-sharing plans are securities within the meaning of
section 2(1) of the 1933 Act." Id., 45 Fed. Reg. at 8966, reprinted in 1 FED. SEC.
L REP. (CCH) 1051, at 2073-12 (1980).
188. For example, the Pension Benefit Guaranty Corporation provides for
such arrangements. See 29 U.S.C. § 1323(a)-(f) (1976).
189. See, e.g., Employee Retirement Income Security Act of 1974,
§ 206(d) (1), 29 U.S.C. § 1056(d) (1) (1976) (with certain exceptions, "[e] ach pen-
sion plan shall provide that benefits provided under the plan may not be as-
signed or alienated").
1980] DEFINITION OF SECURITY

disqualified from participating in a public market because ben-

efits are allocated according to the circumstances of the individ-
ual beneficiary; each instrument is "unique" within the
meaning of that term in the proposed definition because bene-
fits commence not at some uniform date but, typically, when
the employee reaches the age of 65, dies, or becomes dis-
abled. 190
For these reasons, interests under employee retirement
plans of the standard, tax-qualified varieties are ineligible to
move in the public financial markets (and of course they do not
move in them). They should therefore never be considered se-
curities, whether or not employee participation in them is vol-
untary, whether or not additional employee cash contributions
are permitted, and whether they are of the "defined contribu-
tion" or "defined benefit" variety.191

V. CONCLUSION
In order to alleviate the general uncertainty about the defi-
nition of "security," courts should adopt a governing principle

190. A less important form of uniqueness is involved in a case in which

each instrument differs from the others only in its "maturity" date-the date
the issuer's payments are to begin-because the market's pricing of one such
instrument can be readily applied to another by the use of a discounting
formula. The value of pension plan interests also varies according to the
probability of the holder's early disability. But cf. SEC v. United Benefit Life
Ins. Co., 387 U.S. 202 (1967) (annuity contracts held to involve securities despite
the likely presence of some of these features).
191. For arguments based on the statutory language and legislative history,
see Mundheim & Henderson, Applicability of the Federal Securities Laws to
Pension and Profit-SharingPlans,29 LAW & CoNTEMP. PROB. 795 (1964); Com-
ment, Interests in Pension Plans as Securities: Daniel v. International Bhd. of
Teamsters, 78 CoLnm. L. REV. 184, 193-99 (1978); Comment, Application of the
Federal SecuritiesLaws to Noncontributory,Defined Benefit Pension Plans, 45
U. Cm. I REv. 124, 125-30 (1977). The Chicago Law Review Comment con-
cludes that Congress did not articulate its intentions regarding noncontributory
plans, and that the availability of regulation under the Employee Retirement
Income Security Act of 1974 implies that certain interests in retirement plans
are not securities. See also International Bhd. of Teamsters v. Daniel, 439 U.S.
551, 569-70 (1979).
The view presented in the text with respect to employee plans cannot be
readily extended to retirement plans for the self-employed ("Keogh Plans").
The market for interests under a Keogh Plan is more nearly public because the
only major restriction on participation is the requirement that one be self-em-
ployed. For a description of Keogh Plans and their position under the Internal
Revenue Code and the federal securities laws, see Securities Act Release No.
33-6188, supra note 184 (expressing the view that "voluntary contributions by
participants to such plans would create securities"), reprinted in 1 FED. SEC. L.
REP. (CCH) 1051, at 2073-13 to -14 (1980). Nor does the view presented in the
text extend to the issue whether instruments made by the trustees of funds
under retirement plans involve securities.
 MINNESOTA LAW REVIEW [Vol. 64:893

derived from congressional intent and redefine "security" as a

financial instrument eligible to move in the public financial
markets, together with certain related instruments that closely
affect those markets. This definition may not yet appear in the
language of the cases, but in a certain sense it can already be
said to be law; it is supported by the "character the instrument
is given in commerce" language of the Court in SEC v. C.M.
Joiner Leasing Corp.,192 and is consistent with the results in
other Supreme Court cases. 193 Courts should not be deterred
from adopting it by the three-prong dictum of Howey; though
frequently quoted, that test is more often the object than the
instrument of analysis. An impressive array of cases departs
from its literal terms. It is submitted that the test proposed in
this Article accords with the cases when the Howey test does
not-cases in such areas as commodity options, advance pay-
ments for the purchase of goods, long-term bank loans to enter-
prises, consumer loans, and interests in employee retirement
plans. When portions of the Howey test accord with the results
of the cases, the results are also congruent with the test pro-
posed here and are explained by its rationale. Under the cir-
cumstances, courts mindful of the superior authority afforded
results over language should not hesitate to apply the proposed
test. Similarly, those responsible for developing the proposed
federal securities code should abandon their intention to per-
petuate the laundry-list style of statutory definition194 and in-
stead draft a more coherent definition along the lines proposed
here.

192. 320 U.S. 344, 352 (1943).

193. See text accompanying notes 24-61 supra.
194. The definition of "security" in the proposed Federal Securities Code is
set forth at note 14 supra. By including the term "investment contract" in the
definition, the draftsmen make it very likely that the present case law will con-
tinue in force, with all its confusion, to the detriment of the proposed code's
chances of real success in its stated purpose of simplification.