A security is a financial instrument, but not all financial instruments are securities. When people think of securities, it is usually stocks or bonds that come to mind. If we are very liberal with our interpretation of what constitutes a stock or bond, this is a reasonable definition—every security is some sort of equity or debt interest. The only precise definition of security is that a security is whatever US law says it is. In the depths of the Great Depression, Congress passed two acts:
The Securities and Exchange Commission (SEC) is the primary regulator of US securities markets. The acts granted certain securities exemptions from most SEC oversight. These are called exempt securities. Today they include
A financial interest is said to be securitized when it is legally structured or packaged as a security. This terminology is most commonly used in the context of securitizations. The 1933 and 1934 Acts define what is or is not a security. Both acts contain similar language. The 1933 act states The term "security" means any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "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. Because many of the terms in this definition are themselves not clearly defined, there may be uncertainty about whether specific instruments or transactions legally are securities. In the 1940 case SEC v. WJ Howey Co., the Supreme Court decided that a sale of a portion of an orange grove bundled with a contract to harvest the oranges and distribute profits did constitute a security. In that case, the court concluded that a transaction should be subject to securities laws if ... the scheme involves the investment of money in a common enterprise with profits to come solely from the efforts of others. Conventionally, common stock, preferred stock, bonds, securitizations, shares of mutual funds and structured notes are all considered securities. Currencies, bank loans, most insurance policies, lottery tickets and derivatives are not securities. Futures are a special case. While they were included in the 1933 Act's definition, they are regulated by the Commodity Futures Trading Commission (CFTC) rather than the SEC. Most practitioners would not consider them to be securities. Years ago, John Hull entitled the first and second editions of his book on financial engineering Futures, Options, and Other Derivative Securities. By the third edition, he realized his mistake. It and subsequent editions have been entitled Futures, Options, and Other Derivatives. It is a testament to the book's influence that others copied the error. Even today, you occasionally hear derivatives erroneously called securities. Outside the US, the term security is used much as described here, although different legal jurisdictions may not conform to definitions specified by US law.
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