Not a security: Overview, definition, and example
What does "not a security" mean?
"Not a security" refers to a legal classification indicating that a financial asset, transaction, or agreement does not meet the definition of a security under applicable laws, such as the U.S. Securities Act of 1933. If an asset is not considered a security, it is not subject to securities regulations, such as registration, disclosure, and investor protections enforced by agencies like the U.S. Securities and Exchange Commission (SEC).
For example, ordinary commercial contracts, real estate sales, and traditional loans are generally considered not securities because they lack investment characteristics that would require securities regulation.
Why is "not a security" important?
Classifying an asset or transaction as not a security helps businesses and individuals avoid complex regulatory requirements that apply to securities. If an asset is incorrectly classified as a security, it may trigger legal compliance obligations, including SEC registration, financial disclosures, and investor protections.
For businesses, ensuring that an agreement, product, or investment structure is not a security can reduce regulatory risks, compliance costs, and legal liabilities. However, improper classification may result in legal action if authorities determine that a security was sold without proper registration.
Understanding "not a security" through an example
Imagine a company sells a franchise to an individual who wants to operate a fast-food restaurant. The franchise agreement requires the buyer to actively manage the business, making it not a security because it does not involve passive investment expectations like stocks or bonds. If the franchise were marketed as a passive investment opportunity with promised financial returns, regulators might argue that it functions as a security and should be registered accordingly.
In another example, a small business loan issued by a bank is considered not a security because it is a standard lending transaction rather than an investment in ownership or profit-sharing. However, if the loan were structured as an investment with equity participation, it might be classified as a security and subject to additional regulations.
An example of a "not a security" clause
Here’s how a clause like this might appear in a contract:
“The Parties acknowledge and agree that this Agreement and the rights granted herein do not constitute a security under the U.S. Securities Act of 1933 or any applicable securities laws. The transaction shall not be subject to securities registration or regulatory compliance requirements.”
Conclusion
The classification of an asset, contract, or transaction as not a security helps determine whether securities laws apply. Proper classification ensures businesses avoid unnecessary regulatory burdens while preventing legal risks associated with misclassifying investment products. Clearly stating that a transaction is not a security in contracts can help reinforce compliance and reduce regulatory uncertainty.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.