No, we do not believe that an individual acquiring a corporation through a stock purchase needs to be an accredited investor under the federal securities laws, as the corporation’s stock does not meet the definition of a “covered security” in this context.

The Securities Act of 1933 requires any security that is sold to either be registered with the SEC or to qualify for an exemption. The definition of “security” is very broad, including any type of investment contract, regardless of what it is called. However, federal courts in Illinois have applied a three-factor test to determine whether stock is a covered security under the Securities Act of 1933 — to be covered, a “security” must be “(1) an investment in a common venture; (2) premised on a reasonable expectation of profits; (3) to be derived from the entrepreneurial or managerial efforts of others.”

We do not believe that the sanitation company’s stock in this case should be treated as a security under that three-factor test. In similar stock transfer situations, federal appellate courts in Illinois have concluded that stock transferred to new business owners did not qualify as covered “securities” where the stock transfer served merely as a method of vesting ownership after the sale of a business to be managed by the new owners. That seems to be the case here. Consequently, we do not believe that the federal securities laws, including the exemption from their requirements for offers and sales of securities to accredited investors, apply to this stock transfer.

For resources related to our guidance, please see:

• Canfield v. Rapp & Son, Inc., 654 F.2d 459, 463 (7th Cir. 1981) (“In Frederiksen v. Poloway, 637 F.2d 1147 (7th Cir.), cert. denied, 451 U.S. 1017, 101 S. Ct. 3006, 69 L. Ed. 2d 389 (1981), this court addressed the question of whether alleged fraud regarding the sale of stock incident to sale of an entire business falls within the scope of the federal securities laws. In Frederiksen, plaintiffs purchased both the assets and stock of the defendant-sole shareholder’s corporation. . . . In holding that the transaction in Frederiksen was not covered by the federal securities laws, this court relied on the leading Supreme Court case of United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S. Ct. 2051, 44 L. Ed. 2d 621 (1975). In Forman, the Court rejected the suggestion that because a transaction is evidenced by the sale of shares called ‘stock,’ it ‘must be considered a security transaction simply because the statutory definition of security includes the words “any … stock.”’ 421 U.S. at 848, 95 S. Ct. at 2058. Instead, the Court held that the applicability of the federal securities laws turns on ‘the economic realities underlying a transaction, and not on the name appended thereto.’ 421 U.S. at 849, 95 S. Ct. at 2059. The Court then set out a test which ‘embodies the essential attributes that run through all of the Court’s decisions defining a security.’ 421 U.S. at 852, 95 S. Ct. at 2060. This ‘economic reality’ test involves three elements: (1) an investment in a common venture; (2) premised on a reasonable expectation of profits; (3) to be derived from the entrepreneurial or managerial efforts of others.”)

• Canfield v. Rapp & Son, Inc., 654 F.2d 459, 463–464 (7th Cir. 1981) (“Rapp's purchase of Twigg clearly fails to satisfy the ‘economic reality’ test. The first element, investment in a common venture, requires a ‘sharing or pooling of funds.’ Frederiksen, 637 F.2d at 1152; Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 101 (7th Cir. 1977). Since Rapp purchased all of the stock of Twigg, there was no sharing or pooling of funds. Rapp also fails to satisfy the third element of the economic reality test that profits be derived from the efforts of others. Rapp took over management and control of Twigg. . . . Thus, the ‘economic realities’ of the transaction indicate not a security transaction, but rather the sale of a business, merely using stock as a method of vesting Rapp with total ownership of Twigg.”)

• Regulation D, 17 CFR 230.506 (“(a) Exemption. Offers and sales of securities by an issuer that satisfy the conditions in paragraph (b) or (c) of this section shall be deemed to be transactions not involving any public offering within the meaning of section 4(a)(2) of the Act. . . .
  (c) Conditions to be met in offerings not subject to limitation on manner of offering

(1) General conditions. To qualify for exemption under this section, sales must satisfy all the terms and conditions of §§ 230.501 and 230.502(a) and (d).

(2) Specific conditions

• (i) Nature of purchasers. All purchasers of securities sold in any offering under paragraph (c) of this section are accredited investors.”)