What is a “Security”

February 14, 2015

Reves v. Ernst & Young

In Reves v. Ernst & Young, 494 U.S. 1092, 110 S.Ct. 1840, the Court considers whether certain demand notes issued by the Farmers Cooperative of Arkansas and Oklahoma are “securities” within the meaning of Section 3(a)(10) of the Securities Exchange Act of 1934.  The Court determines that they are.

The case is important for understanding whether “notes” are investments and therefore considered “securities” or whether notes are not securities because they are issued merely in a commercial or consumer context.

The Court finds that the “family resemblance” test is to be applied to distinguish between a note that is and is not a security.  Under this test, a note is presumed to be a “security.”  The presumption can be rebutted only by showing that the note bears a strong resemblance (determined by examining four specified factors) to one of a judicially crafted list of categories of instruments that are not securities.  If the instrument is not sufficiently similar to a listed item, the court must decide whether another category should be added by examining certain common factors.

The judicially crafted list of categories includes the following types of instruments:

  1. Note delivered in consumer financing;
  2. Note secured by a mortgage on a home;
  3. Short-term note secured by a lien on a small business or some of its assets;
  4. Note evidencing a “character” loan to a bank customer;
  5. Short-term notes secured by an assignment of accounts receivable;
  6. Note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized).

If a note is to be added to this list, courts should consider the following factors:

  1. Examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into the transaction.  If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a “security.”  If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash flow difficulties or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a “security.”
  2. Examine the plan of distribution of the instrument to determined whether there is “common trading for speculation or investment.”
  3. Examine the reasonable expectations of the investing public.  The Court will consider instruments to be “securities” on the basis of public expectations even where an economic analysis of the particular transaction may suggest that the notes are not securities in that transaction.
  4. Examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument thereby rendering application of the Securities Act unnecessary.

Securities Law Deadlines

April 20, 2011

Minimum 25 day period:

Rule 15c2-12(b)(4) has a minimum 25 day period, as described in the example language below:

The City further agrees to notify the Representative of any material developments affecting the City or the Bonds of which the City becomes aware between the date of this Bond Purchase Agreement and a date that is 25 days after the later of the date of Closing or the end of the underwriting period for purposes of the Rule, notice of which date the Underwriters shall deliver to the City if later than the Closing date.  After such notification, if, in the opinion of the City and the Representative, a change would be required in the Official Statement so that it does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading, then such change will be made by amendment or supplement, and the Official Statement as so amended or supplemented will be supplied to the Underwriters in reasonable quantity for distribution.


Resale of Securities Basics

May 28, 2010

Statutory Framework:

  • Securities Act of 1933
    • Requires registration of offerings or an exemption therefrom
    • Imposes liability for fraud, sales in violation, etc.
  • Securities Exchange Act of 1934
    • Creates the SEC
    • Requires registration of public companies and periodic reporting
    • Regulates securities industry (intermediaries, exchanges, etc.)
    • Prohibits certain practices
    • Regulates proxy voting, insider trading, etc.
  • Colorado Securities Act, Section 11-51-101 et seq., C.R.S.

Federal and state securities laws are implicated whenever someone sells or offers securities.  Sale/sell is defined as a sale/disposition for value.  See Section 2(a)(3) Securities Act

Registration and prospectus delivery requirements be complied with in connection with any offer (to buy or sell) or sale of a security in interstate commerce or through the use of the mails.  Exceptions apply to exempt securities and offerings qualifying as exempt transactions.  See Section 5 Securities Act.  C.R.S. 11-51-301 works the same way for offers and sales in Colorado. See Section 11-51-102 (scope), C.R.S.

Step-by-Step Analysis:

  1. Is it a security?
    1. If no, federal and state securities laws do not apply
    2. If yes, is it a sale or offer?
      1. If no, registration requirements are inapplicable
      2. If yes, registration requirements apply. Do you qualify for an exemption?
        1. If no, must file registration statement with the SEC and the state
        2. If yes, exemption is either (a) Exempt Security or (b) Exempt Transaction such as a private placement. Done

Registered Offerings:

Sections 7 and 10 of the Securities Act and Section 11-51-302 through 304, C.R.S., regulate the information that must be included in a prospectus/registration statement.  The registration statement is designed to provide investors with the information necessary to make an informed investment decision.  Under federal law, the amount and type of information about the issuer that must be included is based upon the SEC’s different registration forms.  The registration process is extremely time consuming and expensive.

Exemptions from Registration:

Securities Act and the Colorado Statutes provide exemptions from their registration requirements based on (a) the nature of the security (exemption stays with the security – no need to register future resales) and (b) the nature of the transaction (exemption applies only to the specific transaction – each future resale must be registered or conducted under an exemption).

Section 4(1) of the Securities Act exempts transactions by any person other than an issuer, underwriter or dealer. These terms are broad. “Underwriter” is defined in Section 2(a)(11) of the Securities Act and includes, among other things, a person who purchased securities from an issuer or a control person of the issuer with a view to distribute the securities.  “Distribution” is not defined but understood to mean “any offer or sale to public investors.”  There are three main categories of underwriters: (1) Persons acting as agents of the issuer in a distribution; (2) Persons who previously purchased restricted securities from the issuer (with a view to distribute – hinges on “investment intent” and whether the investments have “come to rest” – analysis appears to focus on whether the reseller is in a better informational position based on relationship with the issuer than the buyer); and (3) Persons in control positions with the issuer.

There is a Rule 144 Securities Act safe harbor for the status as an “underwriter.”  A person satisfying this safe harbor is not deemed to engage in a distribution and therefore is not an underwriter. The purchaser in a Rule 144 transaction receives securities that are no longer restricted securities.  Rule 144 not available for the resale of securities initially issued by shell companies unless certain requirements apply.  Rule 144 has certain holding period, current public information, volume limitation, manner of sale limitation and form filing requirements.  Holding periods are between 6 months and 1 year.