Legal Definitions - label-and-significant-characteristics test

The label-and-significant-characteristics test is a legal principle used in securities law to determine whether a financial instrument should be treated as a "stock" and therefore be subject to the regulations designed to protect investors in the stock market.

This test applies if an instrument meets two conditions:

• It is labeled as a stock or something very similar (e.g., "share," "equity unit").
• It possesses the significant characteristics typically associated with traditional shares of stock (e.g., the right to receive dividends, voting rights, transferability, or the capacity to appreciate in value).

If both conditions are met, the instrument will be regulated under securities laws, regardless of any unique name or structure it might have.

Examples:

• Startup "Founder Shares":

  A new technology startup issues special "Founder Shares" to its initial investors. In the company's internal documents and offering materials, these are explicitly referred to as "shares" and grant the holders voting rights in company decisions, a claim on future profits (dividends), and the ability to sell their stake to other approved investors. Even though they are called "Founder Shares" rather than standard "Common Stock," the label (shares) and the significant characteristics (voting rights, dividends, transferability) would likely cause them to be treated as stock under the label-and-significant-characteristics test, subjecting their issuance and trading to securities regulations.

• Real Estate Investment Trust (REIT) "Units":

  A company that owns and manages a portfolio of commercial properties offers "Trust Units" to the public. These units are traded on a major stock exchange, entitle holders to regular cash distributions (similar to dividends) from the trust's rental income, and represent a fractional ownership interest in the trust's underlying assets. The company's prospectus refers to them as "equity units." Here, the label ("Trust Units," "equity units") strongly suggests a stock-like instrument, and the significant characteristics (exchange trading, regular distributions, fractional ownership) are typical of stock. Consequently, these "Trust Units" would be classified as stock under the label-and-significant-characteristics test and fall under securities laws.

• Cooperative "Membership Interests":

  An agricultural cooperative issues "Membership Interests" to its farmer members. The cooperative's bylaws explicitly state that these interests are "shares" in the cooperative, entitle members to vote on cooperative governance, and provide a share of the cooperative's annual profits based on their patronage. While called "Membership Interests," the label within the bylaws ("shares") and the significant characteristics (voting rights, profit sharing) align closely with traditional stock. Therefore, these "Membership Interests" would likely be subject to securities regulations under the label-and-significant-characteristics test, despite their cooperative context.