Legal Corner: What is a Security? part 1

I am happy to announce that this blog will now be broadcasting a regular Legal Corner discussing the legal aspects of recent court decisions and regulations involved that apply to the peer to peer lending industry.

 

Our legal expert is Jonathan Wilson of Taylor English Duma. Jonathan is an expert in crowdfunding and has used these methods to draft private placement memoranda that have successfully funded for his clients.  He is also tremendously well informed on the legal aspects and decisions that affect peer to peer lending.  Jonathan's bio can be found here and his own blog here.  I am very happy to have him here and here is his first post below.  My interjections and explanations will be noted with parentheses otherwise this is all from Jonathan's wise perspective.

Peer-to-peer (“P2P”) lending is changing the way businesses find start-up capital and may soon change the way banks lend to their small business clients.  As this website can attest, many small businesses and potential investors are trying to find ways to make P2P lending work for their business objectives.

Stu Lustman, this blog’s founder, asked me to put together a series of posts on some of the legal bases and issues behind P2P lending and this is the first in that series.  I am a lawyer here in Atlanta and devote much of my practice to securities law matters and capital-raising for small and emerging businesses.

In this series, which I hope to publish on a weekly basis over the next few months, I’ll cover some of the legal issues involved with P2P lending.

At the outset, though, it’s important to realize that nearly all of the legal issues relating to P2P lending are “securities” law issues.  This sometimes surprises business people, who think that “securities” are nothing more than stocks and bonds that are purchased from a national exchange (like the NASDAQ or the NYSE).  To understand P2P lending it’s important to understand what a security is.

While the U.S. has lots of securities laws, they don’t do a good job of defining what a “security” is and this leads to a great deal of confusion.

For example, the Securities Exchange Act of 1934 (the “Exchange Act” or the “1934 Act”) defines a security as:

The term “security” means any note, stock, treasury stock, security future, security-based swap, 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 subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, 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 instrument commonly known as a “security”; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.

That doesn’t help much, does it?  It pretty much defines a “security” as, well, you know, a “security”.

(Stu here, the 'any note' part above since all p2p loans are notes, participation in which means when you buy a piece of an investment and interest therein are a part of the reason why p2p loans are considered securities)

Predictably, whenever the government passes a law that’s vague or ambiguous, litigation results.  And, as a result of litigation over the definition of a “security” we obtained the best definition available through a case called Securities and Exchange Commission v. W.J. Howey & Co  (the “Howey” case).

(Later this week, we will have a more detailed discussion of Howey and why p2p loans fall under securities laws)

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+