When are debt instruments considered securities?

I have been needing to research this issue for a while, and found this excellent article.

“[U]nder the controlling U.S. Supreme Court ruling (Reves v. Ernst & Young, 110 S.Ct. 945 (1990)), federal law also sets up a rebuttable presumption that a promissory note with a maturity greater than nine months IS a security (as the statute requires) UNLESS it resembles one of a ‘family of notes’ generally not considered to be a security for federal law purposes. The Reves court found the following family of notes not to be securities, regardless of maturity:

  • Notes delivered in consumer financing.
  • Notes secured by a mortgage on a home.
  • Notes secured by a lien on a small business or some of its assets.
  • Notes relating to a “character” loan to a bank customer.
  • Notes that formalize an open-account indebtedness incurred in the ordinary course of business.
  • Short-term notes secured by an assignment of accounts receivable.
  • Notes given in connection with loans by a commercial bank to a business for current operations.

The court went on to hold that notes that do not fit cleanly in one of those categories can be evaluated for family resemblance using the following factors, in no particular order of importance:

  • Whether the borrower’s motivation is to raise money for general business use, and whether the lender’s motivation is to make a profit, including interest.
  • Whether the borrower’s plan of distribution of the note(s) resembles the plan of distribution of a security.
  • Whether the investing public reasonably expects that the note is a security.
  • Whether there is a regulatory scheme that protects the investor other than the securities laws (e.g., notes subject to FDIC regulation).

. . .

So, there is no bright line? The evaluation of a note not clearly within the ‘family of notes’ will be driven by the facts and circumstances of each situation. The presence or absence of any of the factors is not by itself determinative of whether the note sufficiently resembles one of the family of notes excluded from securities regulation.”