Reves v. Ernst & Young
494 U.S. 56, 1990 U.S. LEXIS 1051, 108 L. Ed. 2d 47 (1990)
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Rule of Law:
A note is presumed to be a security under the Securities Exchange Act of 1934 unless it bears a strong 'family resemblance' to a judicially recognized category of non-security instruments, a determination made by applying a four-factor test that assesses the economic realities of the transaction.
Facts:
- The Farmers Cooperative of Arkansas and Oklahoma (Co-Op), an agricultural cooperative with approximately 23,000 members, sold promissory notes to raise money for its general business operations.
- The notes were payable on demand, uncollateralized, uninsured, and paid a variable rate of interest adjusted monthly to remain higher than local financial institutions.
- The Co-Op marketed the notes as an 'Investment Program' to both members and nonmembers.
- Advertisements for the notes stated, 'The Investment is not Federal [sic] insured but it is . . . Safe . . . Secure . . . and available when you need it.'
- In 1984, the Co-Op filed for bankruptcy.
- At the time of the bankruptcy filing, over 1,600 people held the notes, with a total value of $10 million.
- Arthur Young & Co. served as the Co-Op's auditor during the period the notes were sold.
Procedural Posture:
- A class of note holders (Reves, et al.) sued the Co-Op's auditor, Arthur Young & Co., in the United States District Court, alleging violations of federal and state securities anti-fraud provisions.
- Following a trial, the jury returned a verdict in favor of the note holders, who were awarded a $6.1 million judgment.
- Arthur Young & Co., the defendant, appealed the judgment to the U.S. Court of Appeals for the Eighth Circuit.
- The Eighth Circuit reversed the trial court's judgment, holding that the demand notes were not 'securities' under federal or state law.
- The note holders, the petitioners, successfully petitioned the U.S. Supreme Court for a writ of certiorari to review the Eighth Circuit's decision on the federal issue.
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Issue:
Are the uncollateralized, uninsured, interest-bearing promissory notes payable on demand, issued by an agricultural cooperative to raise capital for its general business operations, 'securities' within the meaning of §3(a)(10) of the Securities Exchange Act of 1934?
Opinions:
Majority - Justice Marshall
Yes, the demand notes issued by the Co-Op are securities. The Court formally adopts the Second Circuit's 'family resemblance' test to determine whether a note is a security. Under this test, a note is presumed to be a security, but this presumption can be rebutted if the note bears a strong resemblance to an enumerated list of instruments that are not securities (e.g., consumer financing notes, home mortgage notes). The resemblance is evaluated using four factors: 1) the motivations of the buyer and seller (investment purpose vs. commercial or consumer purpose); 2) the plan of distribution (whether there is common trading for speculation or investment); 3) the reasonable expectations of the investing public; and 4) whether another regulatory scheme exists that reduces the risk of the instrument. Applying these factors, the Court found the Co-Op's notes were sold to raise capital and purchased for profit (interest), offered to a broad public, marketed as 'investments,' and were not protected by any other regulatory scheme, thus qualifying them as securities. The Court also rejected the argument that the notes were exempt under the nine-month maturity exclusion, holding that the maturity of a demand note is a question of federal law and that its potentially long-term nature places it outside the exclusion's purpose of exempting only short-term commercial paper.
Concurring - Justice Stevens
Yes, the notes are securities. While joining the majority's opinion and adoption of the 'family resemblance' test, the analysis of the nine-month maturity exclusion is even simpler. There is a settled judicial and administrative consensus that the statutory exclusion for notes with a maturity not exceeding nine months applies only to 'commercial paper,' not to investment securities sold to the general public. Because the Co-Op's notes were clearly investment instruments, they cannot fall within this exclusion, regardless of how their maturity is defined. This established interpretation should not be disturbed by the Court.
Concurring-in-part-and-dissenting-in-part - Chief Justice Rehnquist
No, the demand notes are not securities because they are exempted by the statute. While I join the Court’s adoption of the 'family resemblance' test in Part II of its opinion, I dissent from its conclusion that the notes are not covered by the statutory exemption for notes with a maturity not exceeding nine months. At the time the Securities Act was passed, the established common-law definition of a demand note was that it had an immediate maturity; it was due from the moment of its issuance. The plain language of the statute, therefore, exempts these notes. The majority improperly creates ambiguity where none exists and disregards the contemporaneous legal understanding of the term 'maturity' in favor of a purpose-driven interpretation that contradicts the statutory text.
Analysis:
This landmark decision resolved a circuit split by establishing a single, national standard—the 'family resemblance' test—for determining when a note qualifies as a security. By creating a rebuttable presumption that all notes are securities, the ruling places the burden on issuers to demonstrate that an instrument is for a commercial, rather than investment, purpose. The four-factor test provides a flexible, context-driven framework that allows securities law to adapt to novel financial instruments, thereby preventing issuers from evading regulation through clever labeling. This decision significantly strengthened investor protection by ensuring that the determination of a 'security' is based on the economic reality of a transaction, not on its name or form.
