Reinventing A Security: Arguments For APublic Interest Definition

In February 1992, the American Stock Exchange sought Securities and Exchange Commission(1) approval to introduce Standard & Poor's Depositary Receipts (SPDR's), a new investment vehicle designed to allow individuals to invest easily in the benchmark Standard & Poor's 500 Composite Stock Price Index (S&P 500).(2) Currently, investors can buy stock in each of the 500 companies,(3) invest in mutual funds that hold S&P 500 stocks, buy options on the S&P 500, or buy S&P 500 futures.Each of these alternatives has its drawbacks. To buy a properly weighted portfolio of all S&P 500 stocks costs millions of dollars, not including commissions. It is also difficult to purchase or dispose of stock in 500 companies contemporaneously. Mutual funds charge fees, either on the purchase or sale of shares or periodically. Options do not pay the dividends declared on the underlying stock during the option period ad expire, at the longest, in three months. Futures have the same limitations as options and, by definition, derive their value not simply from the underlying SAP 500 index but from traders' expectations of the value of the index at expiration.Although the mechanics of SPDR's are complex, the idea behind them is simple.(4) After the October 1987 equity markets crash, investors have shown increasing interest in vehicles that replicate the markets' performance. The wonder is not that the American Stock Exchange introduced SPDRs but that it took them so long to do so. It was not for lack of trying.Three years before SFDRs, in 1989 Judge Easterbrook faced a dilemma, After SEC approval, the American Stock Exchange and other exchanges had introduced Index Participations (IFs), a new investment vehicle designed to allow individuals to invest easily in the S&P 500.(5) Because IFS resembled stock but also resembled a futures contract, a futures exchange brought suit to stop trading in IFs on the ground that only the Commodity Futures Trading Commission (CFTC) has jurisdiction over futures contracts.(6) The United States Court of Appeals for the Seventh Circuit's task, Judge Easterbrook wrote, was to "decide whether tetrahedrons belong in square or round holes."(7) After fourteen pages of analysis, he sided with the futures exchange and CFTC. SFDRs are the exchanges' response to Judge Easterbrook. They are the next tetrahedrons.(8)Although the question whether IPs were securities may have been evanescent,(9) their reincarnation as SFDRs shows that coverage is easily the most enduring and recurring fundamental question in securities regulation. To what instruments do the securities laws apply? Since the October 1987 crash new investment vehicles have proliferated. Over the next decade many more instruments'(10) worth many trillions of dollars(11) will be brought to market. All of them present the question whether the securities laws apply.The most salient consequences of coverage are registration and anti-fraud protection. If an instrument is covered by the securities laws, it must be registered with the SEC unless an exemption can be found. Issuers are subject to severe civil liabilities for failing to register vehicles that, in retrospect, are determined to be securities.(12) If an offering of a new instrument must be registered, the cost can easily run to $350,000 or more.(13) Moreover, if an instrument is a security, the anti-fraud protections attach, even if it is exempt from registration. Those provisions impose liability upon a purchaser or seller who knowingly or recklessly commits fraud in connection with the purchase or sale of a security.The statutory starting places for the definition of "security," section 2(1) of the Securities Act of 1933(14) and section 3(a)(10) of the Securities Exchange Act of 1934,(15) with minor variations begin by enumerating myriad paradigms.(16) They then move to more tenuous variations, (17) and finally culminate with the inclusion of "in general, any interest or instrument commonly known as a security. …