Reves v. Ernst & Young (494 U.S. 56)

In order to raise money to support its general business operations, the Farmers Cooperative of Arkansas and Oklahoma (Co-Op) sold uncollateralized and uninsured promissory notes payable on demand by the holder. Offered to both Co-Op members and nonmembers and marketed as an "Investment Program," the notes paid a variable interest rate higher than that of local financial institutions. After the Co-Op filed for bankruptcy, petitioners, holders of the notes, filed suit in the District Court against the Co-Op's auditor, respondent's predecessor, alleging, inter alia, that it had violated the antifraud provisions of the Securities Exchange Act of 1934—which regulates certain specified instruments, including "any note[s]"—and Arkansas' securities laws by intentionally failing to follow generally accepted accounting principles that would have made the Co-Op's insolvency apparent to potential note purchasers. Petitioners prevailed at trial, but the Court of Appeals reversed. Applying the test created in SEC v. W.J. Howey Co., 328 U.S. 293, to determine whether an instrument is an "investment contract" to the determination whether the Co-Op's instruments were "notes," the court held that the notes were not securities under the 1934 Act or Arkansas law, and that the statutes' antifraud provisions therefore did not apply.

Held: The demand notes issued by the Co-Op fall under the "note" category of instruments that are "securities." Pp. 60–76.

(a) Congress' purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called. However, notes are used in a variety of settings, not all of which involve investments. Thus, they are not securities per se, but must be defined using the "family resemblance" test. Under that test, a note is presumed to be a security unless it bears a strong resemblance, determined by examining four specified factors, to one of a judicially crafted list of categories of instrument that are not securities. If the instrument is not sufficiently similar to a listed item, a court must decide whether another category should be added by examining the same factors. The application of the Howey test to notes is rejected, since to hold that a "note" is not a "security" unless it meets a test designed for [p57] an entirely different variety of instrument would make the 1933 Securities Act's and 1934 Act's enumeration of many types of instruments superfluous and would be inconsistent with Congress' intent in enacting the laws. Pp. 60–67.

(b) Applying the family resemblance approach, the notes at issue are "securities." They do not resemble any of the enumerated categories of nonsecurities. Nor does an examination of the four relevant factors suggest that they should be treated as nonsecurities: (1) the Co-Op sold them to raise capital, and purchasers bought them to earn a profit in the form of interest, so that they are most naturally conceived as investments in a business enterprise; (2) there was "common trading" of the notes, which were offered and sold to a broad segment of the public; (3) the public reasonably perceived from advertisements for the notes that they were investments, and there were no countervailing factors that would have led a reasonable person to question this characterization; and (4) there was no risk-reducing factor that would make the application of the Securities Acts unnecessary, since the notes were uncollateralized and uninsured and would escape federal regulation entirely if the Acts were held not to apply. The lower court's argument that the demand nature of the notes is very uncharacteristic of a security is unpersuasive, since an instrument's liquidity does not eliminate the risk associated with securities. Pp. 67–70.

(c) Respondent's contention that the notes fall within the statutory exception for "any note which has a maturity at the time of issuance of not exceeding nine months" is rejected, since it rests entirely on the premise that Arkansas' statute of limitations for suits to collect demand notes—which are due immediately—is determinative of the notes' "maturity," as that term is used in the federal Securities Acts. The "maturity" of notes is a question of federal law, and Congress could not have intended that the Acts be applied differently to the same transactions depending on the accident of which State's law happens to apply. Pp. 70–72.

(d) Since, as a matter of federal law, the words of the statutory exception are far from plain with regard to demand notes, the exclusion must be interpreted in accordance with the exception's purpose. Even assuming that Congress intended to create a bright-line rule exempting from coverage all notes of less than nine months' duration on the ground that short-term notes are sufficiently safe that the Securities Acts need not apply, that exemption would not cover the notes at issue here, which do not necessarily have short terms, since demand could just as easily be made years or decades into the future. P. 72–73.

856 F.2d 52, reversed and remanded.

[p58], J., delivered the opinion for a unanimous Court with respect to Part II, and the opinion of the Court with respect to Parts I, III, and IV, in which , and , JJ., joined. , J., filed a concurring opinion, post, p. 73. , C.J., filed an opinion concurring in part and dissenting in part, in which and, JJ., joined, post, p. 76.

John R. McCambridge argued the cause for petitioners. With him on the briefs were Gary M. Elden, Jay R. Hoffman, and Robert R. Cloar.

Michael R. Lazerwitz argued the cause for the Securities and Exchange Commission as amicus curiae urging reversal. With him on the brief were Solicitor General Starr, Deputy Solicitor General Merrill, Daniel L. Goelzer, Paul Gonson, Jacob H. Stillman, Martha H. McNeely, Randall W. Quinn, and Eva Marie Carney.

John Matson argued the cause for respondent. With him on the brief were Carl D. Liggio, Kathryn A. Oberly, and Fred Lovitch.