To understand the subject of securities law one needs to appreciate what is meant by the term securities. âSecuritiesâ is a broad term that refers to any form of ownership or beneficial interest in a business entity. A security is a tradeable financial asset that can further be categorised into debt securities (e.g., banknotes, bonds, and debentures) and equity securities (e.g., common stocks).
Securities law relates to the group of laws that seeks to regulate the sale or transfer of these securities or business interests. Typically, securities are investments traded on a stock market. They can include such items as:
Each of these categories can furthermore consist of different types as will be discussed in the following.5
5 Each of the securities has advantages and disadvantages. For example, one of the advantages of issuing shares is that the issuing companies do not have to repay the borrowersâ money except in the event of liquidation. Securities in the US are defined by the Securities Act of 1933. Section 2 (a)(1) of this Act defines securities as follows:
(1) The term âsecurityâ means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, pre-organisation 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 âsecurityâ, 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.
From the above definition, it is clear that the term âsecurityâ includes several different items and has a fairly wide application. However, it should be noted that in general, the term applies to stocks and bonds as traded on the stock exchange.
1.1.1 Purpose of Securities
Securities allow an entity issuing them (known as the issuer) to attract people or institutions willing to invest money (known as the investor). By issuing securities, the entity can raise capital or gain investment in a specific project. For investors, buying and later selling securities allows them to increase the value of the money invested, or to earn dividends paid out over time.
The most well-known type of securities is publicly traded shares. The terms âstocksâ, âsharesâ,6 and âequitiesâ are synonyms for each other and are terms used to describe units of ownership in a company. The owner (known as a shareholder) has a right to a part of the companyâs earnings if a dividend payment is made, as well as voting rights.
6 There are different types or categories of shares, such as ordinary shares and preference shares. These can be further categorised into deferred ordinary shares, non-voting ordinary shares, redeemable shares, preference shares, cumulative shares, and redeemable preference shares. Each of these shares carries a different kind of ownership and confers different kinds of rights within the company to the holder or owner of the share. This will be discussed in greater detail later in this book. 1.1.2 Benefits of Securities
The main aim of investors is to increase the value of their money. By investing in debt securities, such as bonds or by buying shares or equity, investors can grow the value of their investments. In most cases, investors aim to improve their financial position through capital gain (growth),7 or income (interest payments of dividends),8 whilst retaining the ability to convert their investments to cash quickly (in the case of shares).9 , 10
7 This means when the companies increase in value, the share price will usually go up and they will be worth more. 8 Dividends are an income similar to interest. However, interest is paid to depositors who place their money in a bank, while dividends are paid to shareholders who buy shares of a company. Deposits in a bank pay an income which depends on interest rates. It is automatic. No one needs to approve it. Dividends from shares are not automatically paid if the company makes a profit. It is the boardâs decision. 9 This means owners of shares have the right to sell their shares at any time during the listing period in a stock exchange in an easy way. 10 Thomas Anthony Guerriero, How to Understand and Master Securities Laws and Regulations (Trafford: E-Books 2012, isbn: 978-1-4669-5490-8 (e)) 78. Owners of ordinary shares share in the profits of the company (dividends), vote in company decision-making, and have the right to attend an annual meeting.11 Usually, the buyers of ordinary shares in particular companies will be the part-owners of those companies.12
11 Rodney Hobson, Shares Made Simple: A Beginnerâs Guide to the Stock Market (2nd edn, Hamman House 2012) 3. 12 It is generally accepted that the separation of ownership and control of the company is at the root of the corporate governance problem. How owners and managers interact with each other is the subject of different theories, the most popular of which is the agency theory. Agency theory describes the relation between shareholders and managers as a contractual one similar to that between a principal and an agent where the latter has a fiduciary duty to the former. However, it is debatable whether shareholders are actually owners of the company. Lynn Stout stated that shareholders own a share but the company owns itself. It is a separate legal unit and according to company law, directors owe a fiduciary duty to the company. Lynn Stout, âCorporate Governance â What Do Shareholders Really Value?â (YouTube) <www.youtube.com/watch?v=s5Eoy988728>. 1.1.3 Risks of Trading in Securities
Although debt equities and shares have a better financial return over the long term, they are not entirely without risk. Whilst the risk associated with government bonds is low, there have been occasions when sovereign states have defaulted on debt repayments. Corporate bonds, too, have proved to be risky investments. However, the risk associated with debt equities is generally low when compared with the stock market.
The main risk associated with buying stocks is the changing value of the shares. Share prices fluctuate daily which affects the value of the money invested. Furthermore, in the event of a company getting into financial difficulty or going bankrupt, the share price falls to zero meaning a loss of the money invested by the shareholder.
There are three main ca...
