Lesson 8.1: What Are Securities and Who Issues Them?

Question 1

A private company can become a public company through:

Answer 1

a special purpose acquisition company.

An SPAC raises money through an IPO. It then takes that money and purchases one or more private companies. The effect of this is that the formerly privately held company is now publicly traded through the shares of the SPAC. Private placements allow a private company to raise capital but not take it public. Buyouts can result in a public company going private. When a company liquidates, it no longer exists.

Question 2

Under the Uniform Securities Act, what is not defined as a security?

Answer 2

A fixed annuity is an insurance contract and is not considered a security under the USA. Options on stock (listed or not), interests in limited partnerships, and preorganization certificates are all defined as securities under the USA. It is best to remember those few items that are not securities.

Question 3

An example of a nonissuer transaction?

Answer 3

Secondary offering by an institutional seller

Investors or shareholders routinely receive the proceeds from a secondary transaction. About the only time a secondary offering is an issuer transaction is if the issuer were reselling treasury stock because the proceeds go to the issuer.

Question 4

Barzell Manufacturing Works (BMW) produces structural steel. To raise additional capital to modernize its plant, BMW decides to go public by issuing shares. Doing so would make BMW:

Answer 4

an issuer.

When a company issues shares to the public, it is an issuer. Yes, BMW is also a manufacturer, but the question asks about the effect of issuing shares—answer the question being asked.

Question 5

As defined in the Uniform Securities Act, what is not a security?

Answer 5

Annuity providing a fixed monthly payout

Variable annuities are securities, while fixed annuities are not. Options contracts, interests in limited partnership programs, and common stock are securities under the USA. The key to questions like this is to remember those things that are not securities.

Question 6

Which of the following would not be included in the definition of a security under the Uniform Securities Act?

A) Preferred stock in the Colonel Corn Processing Corporation
B) Common stock in the Shining Silver Mining Company
C) Debentures issued by the XYZ Retirement Planning Company
D) Whole life insurance policies issued by the Dividend Mutual Life Insurance Association of America

Answer 6

D) Whole life insurance policies issued by the Dividend Mutual Life Insurance Association of America

Nonvariable contracts issued by insurance companies are not securities.

Question 7

Investment vehicles is not considered a security under the Uniform Securities Act?

Answer 7

Annuities with a fixed rate of return

A fixed annuity is not defined as a security and is subject to the rules and regulations of the state insurance commissioners. As such, a fixed annuity does not fall under the provisions of the Uniform Securities Act. Even though the U.S. government bonds (and, under certain conditions, the commercial paper) are exempt securities, they are still securities.

Question 8

Which of the following are defined as securities under the Uniform Securities Act?

I. Real estate investment trust certificates
II. Preorganization subscription agreements
III. Shares of treasury stock
IV. Voting-trust certificates issued by a corporation undergoing a reorganization

Answer 8

I, II, III, and IV

All the choices listed are defined as securities under state law. We believe the best thing for you to do is remember those few things that are not securities.

Question 9

A primary issue is:

Answer 9

a new offering of an issuer sold to investors

A primary issue is a new offering of securities by an issuer sold to investors. Transactions between two investors in the over-the-counter market refer to secondary transactions (the market between investors). A sale between investors of securities traded on the New York Stock Exchange is another example of a secondary transaction.

Question 10

As defined in the Uniform Securities Act, an issuer is any person who issues, or proposes to issue, a security for sale to the public. Based on that definition, which of the following is not an issuer?

A) AAA Manufacturing Company, which proposes to offer shares to the public but has not completed the offering
B) The U.S. government announcing an offering of 20-year Treasury bonds
C) The City of Chicago, which is involved in a distribution of tax-exempt highway improvement bonds
D) A partner in the AAA Oil and Gas Partnership selling his interest in the investment

Answer 10

D) A partner in the AAA Oil and Gas Partnership selling his interest in the investment

The Uniform Securities Act defines an issuer as any person who issues, or proposes to issue, a security. The resale of a partnership interest by an investor is a nonissuer sale because the investor is not the issuer. Examples of issuers are municipalities such as the City of Chicago, which issues tax-exempt highway improvement bonds; AAA Manufacturing Company, which proposes to offer shares to the public even though it has not completed the offering; and the United States government, when it offers Treasury bonds.

Question 11

Not included in the definition of a security in the Uniform Securities Act (USA)?

Answer 11

A $100,000 whole life insurance policy

Life insurance and fixed annuities are not listed as securities under the USA, while their variable counterparts are. It is best to concentrate on learning the few things that are not securities.

Question 12

Life insurance companies offer many different products. Which of the following would not be considered a security?

I. Index annuity
II. Modified endowment
III. Variable annuity
IV. Variable life

Answer 12

I and II

Any insurance product that includes the word variable is a security. Otherwise, it is not.

Question 13

In the Howey decision, the U.S. Supreme Court held that in order for an investment contract to be considered a security, it must represent:

Answer 13

an investment of money in a common enterprise with the expectation of profit from the managerial efforts of others.

In the Howey decision, the U.S. Supreme Court held that a security must represent an investment of money in a common enterprise with the expectation of profit from the managerial efforts of others.

Question 14

Which of the following is not a security?

A) A promissory note with a six-month maturity
B) A variable annuity
C) A $1 million whole life insurance policy
D) An interest in a real estate condominium sold with a rental pool

Answer 14

C) A $1 million whole life insurance policy

Under the Uniform Securities Act, whole life insurance policies are not securities. Condominiums used as a personal residence are not securities, but when a rental pool arrangement exists, third-party management seeking a profit for the investor exists, which meets the Howey definition of an investment contract. Commercial paper is an example of a promissory note.

Question 15

Which of the following are nonissuer transactions?

I. An investment manager purchases 100,000 shares of XYZ on the NYSE.
II. An investment adviser sells a block of YYY Corp. shares to an overseas investor in a private transaction.
III. The president of Dot.com, Inc., sells his personal shares of Dot.com on the NYSE.
IV. Dot.com purchases its own shares on the open market in order to place them in Treasury.

Answer 15

I, II, III, and IV

A nonissuer transaction is a transaction in which the proceeds do not directly or indirectly go to the issuer, as in a secondary transaction. When the investment manager purchases XYZ shares on the NYSE, the proceeds of the sale do not go to XYZ Corp. but to the investors who sold the stock. When an investment adviser sells YYY Corp. shares to an overseas private investment group, YYY Corp. does not benefit directly or indirectly because the proceeds go to the investment adviser, not to YYY Corp. When Dot.com purchases its own shares on the open market, the proceeds go to outside investors, not to Dot.com as the purchaser. However, if Dot.com resold its shares, the transaction would be an issuer transaction.

Question 16

Which of the following would be a nonissuer transaction?

I. XYZ Corporation sells 100,000 shares of previously issued common stock out of its treasury.
II. GEMCO Mutual Fund sells 100,000 shares of XYZ Corporation common stock out of its portfolio.
III. Curt sells 1,000 shares of Giggle common stock to Chuck in an isolated transaction.
IV. Dave reinvests his dividend into additional shares of GEMCO Mutual Fund.

Answer 16

II and III

In a nonissuer transaction, the proceeds of the sale go to someone other than the issuer. When a mutual fund liquidates a holding in its portfolio, the fund receives the proceeds, not the issuer. One individual selling his stock to another is the classic example of an isolated nonissuer transaction. A corporation selling stock out of its treasury receives the money from the sale, and dividend reinvestment purchases shares directly from the mutual fund.

Question 17

Under the Uniform Securities Act, the term security refers to all of the following except

A) commodity futures contracts.
B) certificates of deposit for a security.
C) puts, calls, straddles, or options.
D) bonds.

Answer 17

A) commodity futures contracts.

Commodities and futures contracts on commodities are not securities. Just remember the short list of items that are not securities. An ADR is an example of a certificate of deposit for a security; the term does not apply to a bank CD.

Question 18

The Uniform Securities Act would consider which insurance products to be a security?

Answer 18

Variable life insurance

The key is the word variable. Insurance products are excluded from the definition of a security unless the word variable is part of the description. So, variable life and variable annuities are securities—the rest are not.

Question 19

Defined as a security under the Uniform Securities Act?

Answer 19

An investment contract

As a result of the Howey decision, investment contracts are defined as (and often serve as a synonym for) a security under the Uniform Securities Act. A guaranteed, lump-sum payment to a beneficiary is an endowment policy excluded from the definition of a security. Fixed, guaranteed payments made for life or for a specified period are fixed annuity contracts not defined as securities. Commodity futures contracts and the commodities themselves are not securities.

Question 20

Which of the following would not be considered a nonissuer transaction as defined in the Uniform Securities Act?

A) Gates Williams, the largest shareholder in Maxihard Corporation, sells 100,000 shares in a registered secondary transaction.
B) Gemco, traded on the Nasdaq Stock Market, sells 5,000 shares of its stock to LMN Securities Co., a registered market maker in Gemco stock. The stock was donated to Gemco by a former officer of the firm.
C) Buffy Warren, the largest shareholder in Barkshire Mathaway, purchases an additional 50,000 shares on the NYSE.
D) In its capacity as a market maker, XYZ Securities sells 200 shares of Gemco common stock to the corporate treasurer of Gemco, buying for the company’s investment account.

Answer 20

B) Gemco, traded on the Nasdaq Stock Market, sells 5,000 shares of its stock to LMN Securities Co., a registered market maker in Gemco stock. The stock was donated to Gemco by a former officer of the firm.

A nonissuer transaction is one in which the issuer does not receive the proceeds of the sale. When a stockholder sells his shares, he is the one who receives the money, not the issuer. Purchases are never considered issuer transactions because the money is going out, not coming in. When an issuer sells shares, whether in a primary or secondary transaction (as is the case with the donated shares), if it receives the proceeds, it is an issuer transaction.

Question 21

In the SPAC process,

Answer 21

the targeted private company becomes public by virtue of a merger with an SPAC.

After the SPAC has its IPO, the SPAC then merges with a private company, making it a publicly traded security. A major benefit is that becoming a public company as a result of being acquired by an SPAC is accomplished with little of the time and hassle of a traditional IPO. It is incorrect to say that SPACs have complicated operations because they generally have limited or no operations. SPAC founders may invest in or receive private placement warrants. The warrants let investors increase their stake in cases of a successful acquisition and motivate founders to find a good acquisition target.

Question 22

Best describes a nonissuer transaction?

Answer 22

One that occurs between investors in the secondary market

In a nonissuer transaction, none of the proceeds go to the issuer, and the most common nonissuer transaction occurs between investors in the secondary market. An issuer transaction provides capital to issuers.

In a nonissuer transaction, the proceeds do not benefit or go to the issuer directly. In a primary transaction, the proceeds of an underwriting go to the issuing corporation directly.

Question 23

According to the Uniform Securities Act, each of the following is a security except

A) a limited partnership in an oil and gas exploration program.
B) a contract in soybean futures.
C) an interest in a condominium project with a rental pool.
D) a U.S. Treasury bill.

Answer 23

B) a contract in soybean futures.

Interests in a condominium complex that has a rental pool feature, U.S. Treasury bills, and limited partnership interests in oil and gas exploration programs are securities under the USA. The USA excludes certain financial instruments from the term security, such as term and whole insurance policies, commodity futures contracts, and collectibles.

Question 24

An issuer transaction:

Answer 24

is one where the issuer of the securities receives the proceeds of the sale. John’s father, although a founder of the company, purchased shares directly from the company. This transaction is an issuer transaction because the firm received the funds from the sale of the shares. In all the other instances, the firm—the original issuer of the securities—did not receive the proceeds of the transaction. These transactions are called nonissuer transactions.

An issuer is any person who issues or proposes to issue any security for sale to the public. Stock exchange specialists, company directors, and market makers do not issue securities and therefore are not issuers.

Question 25

Not defined as a security under the Uniform Securities Act?

Answer 25

A fixed-annuity contract

A fixed-annuity contract is an insurance contract, not a security. It is only when an insurance contract contains the word variable that it is a security.

Question 26

Joan owns and operates a jewelry store, and she has contracted to purchase 5,000 Swiss watches, paying the watch manufacturer in Swiss francs three months from the date of contract. To protect (hedge) her currency risk, she purchases call options on Swiss francs. What statement best describes her transaction in the Swiss franc calls in light of the Uniform Securities Act (USA)?

Answer 26

She has engaged in a securities transaction because options on foreign currencies are considered to be securities under the USA.

Options, regardless of the underlying asset, are considered securities under the USA. Therefore, Joan engaged in a securities transaction by purchasing call options on the Swiss franc. While there is no prohibition against American investors trading in foreign currency options or futures under the USA, acquiring the currency itself, rather than the option, would not have involved a securities transaction; currency is not a security.

Question 27

Issuer transaction:

Answer 27

When an issuer sells its own securities, it is an issuer transaction. When someone other than the issuer sells securities, it is a nonissuer transaction.

Question 28

Which of the following financial instruments is not considered a security?

A) Collateralized mortgage obligation (CMO)
B) Ginnie Mae certificate
C) Tradable collateralized credit card trust certificate
D) Home mortgage

Answer 28

D) Home mortgage

A home mortgage is a pledge by the mortgagor, or homebuyer, and no security is issued. Ginnie Maes, CMOs, and collateralized credit card trust certificates are collateral-backed securities issued and sold to third-party investors who own an interest in the collateral pool; they trade in markets like any other security.

Question 29

It would not be a prohibited practice under the Uniform Securities Act for an agent to tell a client that:

Answer 29

registered nonexempt securities may properly be sold in the state.

Nonexempt securities are those that must register. The Administrator never approves of any security, passing a licensing exam does not give one the right to assert one’s qualifications, and performance-based compensation is never permitted for agents.

Question 30

Which of the following are securities under the Uniform Securities Act?

I. A variable annuity
II. A subscription right to purchase common stock
III. A condominium purchased solely as a place of residence
IV. Certificate of interest or participation in an oil, gas, or mining partnership

Answer 30

I, II, and IV

Securities include stocks, bonds, notes, certificates of interest in any profit-sharing agreement or participation plan (oil, gas, mining, lease, or real estate partnerships), preorganization certificates or subscription agreements, certificates of deposit for a security, evidence of indebtedness, warrants, rights, options, variable annuities, commodity options, and multilevel distributorships. Excluded from the definition are insurance contracts, endowments with fixed benefits, fixed annuities, Keogh or IRA plans, written confirmations of a trade, futures contracts, real estate held as a personal residence, currencies, precious metals, and collectibles.

Question 31

Whay is considered a security under the provisions of the Uniform Securities Act?

Answer 31

It is always best to remember what is not a security than try to remember all of the things that are. All insurance contracts, other than variable ones, are not securities. Commodities, including precious metals, are not securities.

Collateral trust certificates, investment contracts, options, and option contracts, regardless of the underlying asset, are identified as securities in the Uniform Securities Act and are subject to its provisions. Currencies are not securities, but options on currencies are. The key to questions like this is to remember those things that are not securities.

An investment in an individual condominium used as a residence is not a security. However, an interest in the rental income from a group of condos, where the rent is pooled, is a security under the USA. While the sale of the debentures in this case is an exempt transaction, the debentures are securities. Treasury bills, notes, and bonds are securities, although they are exempt from registration under the USA. A Roth IRA is not a security. Securities may be put in an IRA, but the IRA is not a security. The key to questions like this is to remember those things that are not securities.

Question 32

When could an agent offer a security for sale?

Answer 32

A registration statement has been filed with the SEC and has become effective.

An offer can only be made with an effective prospectus. A red herring (preliminary prospectus) is neither an offer to sell nor an offer of a solicitation to buy; it may only be used to obtain indications of interest.

Question 33

Blue-sky laws pertain to all of the following:

Answer 33

A) the regulation of securities transactions in a state.
B) the registration of securities within a state.
C) the registration of securities salespeople in a state.

Blue-sky (Uniform Securities Act) laws refer to state securities regulation in the state. Blue-sky laws require new securities to be registered with the state and regulate trading of securities in a state.

Question 34

In the Howey decision, the U.S. Supreme Court held that an investment contract is a security if it represents:

Answer 34

an investment of money in a common enterprise with the expectation of profit from the managerial efforts of others.

The Howey decision defined an investment contract as a security when there is (1) an investment of money (2) in a common enterprise (3) where there is an expectation of a profit (4) through the efforts of a third party and not the investor.

Question 35

Under the Uniform Securities Act, the definition of security includes a wide range of items. One of these is a two-party agreement representing a promise to repay a specific sum on a specified date that, if it meets certain requirements, is exempt from registration. This agreement is commonly called:

Answer 35

a promissory note.

This is the basic definition of a promissory note, and it is one of the many items fitting the definition of a security under the USA. On the exam, the most common example of a promissory note is commercial paper. Another place the term appears is when agents offer unregistered promissory notes for sale claiming they are exempt from registration because notes are not securities (false).

Question 36

Under the Uniform Securities Act, which of the following are securities?

I. Stock option contract
II. Treasury stock
III. Keogh plan

Answer 36

I and II

A stock option contract and treasury stock are securities under the USA. A Keogh plan is a vehicle for an investment, but it is not a security in and of itself.

Question 37

As defined in the Uniform Securities Act, the term security would include which of these?

I. Debentures
II. Keogh plans
III. A preorganization subscription
IV. Whole life insurance policies that pay dividends to their policyholders

Answer 37

I and III

It is always easier to remember the things that are not securities—retirement plans, nonvariable insurance policies, collectibles, commodities, condominiums, and currencies. Unless the insurance contract has the word variable, it is not a security.

Question 38

Which of the following is not a security?

A) Corporate equity
B) Corporate debt
C) Variable annuity
D) Participating whole life insurance that pays annual dividends

Answer 38

D) Participating whole life insurance that pays annual dividends

Whole life insurance policies, even those that pay dividends, are not securities; variable life and variable annuities are. Corporate equity is stock, and corporate debt is bonds and debentures.

Question 39

Which of the following is not a security under the Uniform Securities Act?

A) Gold
B) Investment contracts
C) Options on common stock
D) Options on foreign currencies

Answer 39

A) Gold

Precious metals, such as gold, are commodities and are not securities subject to the provisions of the Uniform Securities Act. Options on common stock and foreign currencies are securities subject to the USA. Investment contracts are specifically listed as securities in the USA and subject to its provisions. In an investment contract, a person invests money in a common enterprise with the expectation of profits from the managerial efforts of others. A good example of an investment contract is a share of a mutual fund because it represents an investment of money into a pooled enterprise with the expectation of profits through the efforts of a third party (the fund’s manager).

Question 40

A broker-dealer trading securities as an agent for the account of others is:

Answer 40

not an issuer under the Uniform Securities Act?

A broker-dealer that trades securities as an agent for its clients is not acting in the capacity of an issuer. If the broker-dealer were offering its own shares to the public through underwriting, it would then be an issuer. A corporation that proposes to issue securities but has not as yet done so is, for purposes of the act, an issuer. A company offering its shares to the public in an IPO is an issuer. A company whose shares trade on the NYSE is an issuer whose shares are now trading in the secondary market.

Question 41

An interest in which of the following is a security under the Uniform Securities Act?

I. Evidence of indebtedness
II. Certificate of deposit for a security
III. Oil and gas drilling program
IV. Cattle feeding program

Answer 41

I, II, III, and IV

The best strategy is to memorize the short list of things that are not securities rather than try to remember all of the things that are. An example of a certificate of deposit for a security is an ADR. Oil and gas drilling programs and cattle feeding programs are types of DPPs. A common example of an evidence of indebtedness is a bond or a debenture.

Question 42

Who is responsible for the administration of the Uniform Securities Act in a state?

Answer 42

The Administrator

On this exam, the chief state regulator is the Administrator. The Securities and Exchange Commission is the federal agency, not state agency, that oversees and regulates securities on a national level.

Question 43

The Uniform Securities Act defines all of the following as securities except

A) unlisted options.
B) common stock.
C) term life insurance.
D) fixed-premium variable life insurance policies.

Answer 43

C) term life insurance.

Term life insurance is an insurance contract, not a security. Remember the short list of those items that are not securities.

Question 44

A discussion referring to blue-sky laws would include all of the following except

A) forms requiring issuers selling securities in the state to comply with state securities laws.
B) a state securities law that grants state securities Administrators the power to deny or revoke a broker-dealer’s or an agent’s registration within its state.
C) the Securities Act of 1933 and Securities Exchange Act of 1934.
D) state laws that are designed to protect the public against fraud in securities sales within a state.

Answer 44

C) the Securities Act of 1933 and Securities Exchange Act of 1934.

Blue-sky laws are state securities laws. The Securities Act of 1933 and the Securities Exchange Act of 1934 are federal securities laws.

Question 45

Which of the following is not classified as a security under the Uniform Securities Act?

A) Heating oil futures
B) Options on stocks
C) Bonds issued by a foreign country
D) Stocks

Answer 45

A) Heating oil futures

Commodity futures on items such as gold, silver, wheat, heating oil, and pork bellies are not securities. Options on stocks, and stocks and bonds are securities.​