Tcherepnin et al. v. Knight et al.
389 U.S. 332 (1967)
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Rule of Law:
An instrument's status as a 'security' under the Securities Exchange Act of 1934 is determined by its economic reality and substance, not its name or state-law characterization. Withdrawable capital shares in a savings and loan association, which entitle holders to dividends based on profits and voting rights, qualify as securities under this analysis.
Facts:
- A group of individuals (the petitioners) purchased withdrawable capital shares in City Savings Association of Chicago, an Illinois-chartered savings and loan.
- The petitioners made their purchases based on printed solicitations they received from City Savings through the mail.
- These solicitations portrayed City Savings as a financially strong institution and the shares as desirable investments.
- The solicitations failed to disclose that City Savings was controlled by an individual previously convicted of mail fraud related to savings and loan associations.
- The solicitations also failed to disclose that the Association had been denied federal insurance for its accounts due to its unsafe financial policies.
- Additionally, the solicitations omitted that the Association had been forced to restrict withdrawals for existing shareholders due to its financial condition.
- Under Illinois law, these shares entitled the holder to voting rights and dividends contingent on the association's profits.
- City Savings was eventually taken into custody by state officials and began liquidation.
Procedural Posture:
- The petitioners filed a class action lawsuit against City Savings Association in the United States District Court for the Northern District of Illinois, seeking to rescind their share purchases.
- The respondents filed motions to dismiss, arguing the complaint failed to state a cause of action because the shares were not securities under the Securities Exchange Act.
- The District Court denied the motions to dismiss, ruling that the shares were securities.
- The District Court certified its order for an interlocutory appeal to the U.S. Court of Appeals for the Seventh Circuit.
- The Court of Appeals reversed the District Court, holding that the shares were not securities and the District Court therefore lacked jurisdiction.
- The petitioners (appellants at the Supreme Court) were granted a writ of certiorari by the Supreme Court of the United States.
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Issue:
Is a withdrawable capital share in an Illinois savings and loan association a 'security' within the meaning of the Securities Exchange Act of 1934?
Opinions:
Majority - Mr. Chief Justice Warren
Yes, a withdrawable capital share in an Illinois savings and loan association is a 'security' under the Securities Exchange Act of 1934. The Court reasoned that the definition of a security should be construed broadly and flexibly, emphasizing economic reality over form. The shares fit the classic test for an 'investment contract' from S.E.C. v. W.J. Howey Co., as they involved an investment of money in a common enterprise with the expectation of profits derived from the managerial efforts of others. The Court also found the shares fit other statutory terms like 'stock,' 'transferable share,' and 'certificate of interest or participation in any profit-sharing agreement.' Finally, the legislative history of the Securities Act of 1933 showed that savings and loan associations sought an exemption from registration but understood they were subject to the anti-fraud provisions, implying their shares were considered securities from the outset.
Analysis:
This case significantly reinforced the 'economic reality' test for defining a security, confirming that the protections of federal securities laws extend beyond traditional stocks and bonds. By classifying savings and loan shares as securities, the Court expanded the scope of the anti-fraud provisions to cover financial instruments that many consumers might view as simple savings vehicles. This decision solidified the principle that federal law, not state law, governs the definition of a security and ensured that the substance of an investment scheme, rather than its label, determines whether investors receive federal protection.
