Opinion ID: 611600
Heading Depth: 2
Heading Rank: 1

Heading: ears as securities

Text: 9 PIIGI contends that the district court erred in ruling as a matter of law that the EARs were securities within the meaning of the Securities Act. We review de novo the district court's ruling on PIIGI's motion for summary judgment, which it affirmed on the plaintiff's motion for directed verdict, that the EARs are not securities. United Bank & Trust Co. v. Kansas Bankers Surety Co., 901 F.2d 1520, 1522 (10th Cir.1990). 10 The Plaintiff alleged that PIIGI committed RICO fraud in the sale of securities by violating the Securities Act of 1933, 15 U.S.C. § 77a et seq. Section 77b(1) of the Act defines a security as: 11 any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a security, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscript to or purchase, any of the foregoing. 12 Both PIIGI and the Plaintiff concentrate their arguments on whether the EARs are notes or investment contracts that are securities under § 77b(1). We hold that the EARs are not notes or investment contracts that qualify as securities under the Act. 3 Accordingly, we reverse the judgment in favor of the Plaintiff on Count 1 (RICO fraud in the sale of securities). 4 We will address first why the EARs are not notes under the Act, and second, why the EARs are not investment contracts under the Act.
13 In Reves v. Ernst & Young (Reves I ), 494 U.S. 56, 65, 110 S.Ct. 945, 951, 108 L.Ed.2d 47 (1990) [Reves I ], the Supreme Court held that the family resemblance test was to be used in deciding whether an instrument denominated a note is a security. Under the Reves I test, we begin with the presumption that the EARs, as notes, are securities. Id.; Holloway v. Peat, Marwick, Mitchell & Co., 900 F.2d 1485, 1487 (10th Cir.), cert. denied, 498 U.S. 958, 111 S.Ct. 386, 112 L.Ed.2d 396 (1990). However, because Congress was concerned with regulating the investment market, rather than creating a general federal cause of action for fraud, our inquiry does not end there. See Reves I, 494 U.S. at 65, 110 S.Ct. at 951. Rather, the presumption that a note is a security may be rebutted if the instrument bears a strong resemblance, in terms of factors identified by the Supreme Court, to an instrument on the judicially crafted list of notes that are not securities. Id. at 64-65, 67, 110 S.Ct. at 951, 952; Holloway, 900 F.2d at 1487. Types of notes that are not securities include: 14 [T]he note delivered in consumer financing, the note secured by a mortgage on a home, the short-term note secured by a lien on a small business or some of its assets, the note evidencing a character loan to a bank customer, short-term notes secured by an assignment of accounts receivable, or a note which simply formalizes an open-account debt incurred in the ordinary course of business ... [and] notes evidencing loans by commercial banks for current operations.... 15 Reves I, 494 U.S. at 65, 110 S.Ct. at 951 (citations and quotations omitted). 16 We begin by noting that EARs certainly share some kinship to consumer financing because they are essentially consumer car loans that PAC purchased from car dealers, packaged with enhancements like insurance and servicing, and re-sold at a fifteen percent premium over the principal. The issue is whether the packaging, enhancements, and secondary marketing to financial institutions are sufficient to cause EARs to be considered securities, or whether the EARs' family resemblance to consumer notes is sufficiently strong to cause EARs to be included within the categories of notes that are not regarded as securities. See Banco Espanol de Credito v. Security Pac. Nat. Bank, 973 F.2d 51, 56 (2d Cir.1992), cert. denied, --- U.S. ----, 113 S.Ct. 2992, 125 L.Ed.2d 687 (1993) (stating that participation in an instrument like a loan might be considered a security because of the manner in which the participation is used, pooled, or marketed--even though the underlying instrument is not a security). For this analysis, we turn to the four factors outlined in Reves I: the motivations of the buyer and seller; the plan of distribution for the instruments; the public's reasonable perceptions; and whether there are any risk-reducing factors suggesting that the instruments are not securities. See Reves I, 494 U.S. at 66-67, 110 S.Ct. at 952. 17 First, we examine the EARs transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. Id. at 66, 110 S.Ct. at 951. 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.'  Id. However, [i]f 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, the note is less sensibly described as a security. Id.; see Holloway, 900 F.2d at 1488 n. 1 (noting that use of proceeds to buy specific assets or services rather than general financing is an objective indicator of motivations of reasonable buyer and seller). 18 Here, PAC was not selling the EARs to raise money for general investments in PAC; rather, it was selling its stock-in-trade. EARs was a product that PAC sold as part of its on-going business activity. Although the buyers obviously hoped to profit from the inherent value of the product purchased, that expected profit was not tied to the profitability of PAC. Instead, the motivation of both parties appears to have been to enter into a commercial transaction. See First Citizens Federal Sav. & Loan v. Worthen Bank & Trust Co., 919 F.2d 510, 515-16 (9th Cir.1990) (construing Arizona law, which looks to the federal statutory definition of security, and holding that a loan participation agreement entered into to finance current operations of buyer was not a security); Banco Espanol, 973 F.2d at 55 (holding same under federal law). 19 Second, we examine the  'plan of distribution'  of the instrument to determine whether it is an instrument in which there is  'common trading for speculation or investment.'  Reves I, 494 U.S. at 66, 110 S.Ct. at 951 (quoting SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351, 353, 64 S.Ct. 120, 123, 124, 88 L.Ed. 88 (1943)). To establish that there is common trading in an instrument, all that need be shown is that the instruments are offered and sold to a broad segment of the public; the instrument need not have been traded on an exchange. Reves I, 494 U.S. at 68, 110 S.Ct. at 953. The EARs here were not offered to a broad segment of the public but, instead, were sold to a very specialized and sophisticated secondary market that consisted of certain financial institutions and insurance companies, and they were not purchased for any potential speculative or trading value. We therefore do not believe that the Plaintiff has established that the EARs were commonly traded for speculation or investment. See Banco Espanol, 973 F.2d at 55 (affirming the district court's finding that where only institutional and corporate entities were solicited, and where resale of instruments required written approval, the plan of distribution factor cut against a finding that the notes were securities). 20 Third, we examine the public's reasonable perceptions to determine whether the EARs are securities. Reves I, 494 U.S. at 66, 110 S.Ct. at 951-52. The Court in Reves I found that the fact that the notes were advertised as investments and that nothing would have led a reasonable person to question this characterization suggested that the notes were securities. See id. In the instant case, the notes were promoted as investments. However, the investments were primarily in the underlying consumer notes rather than investments in PAC. Thus, at best, this test leads us to no clear conclusions. 21 Fourth, the Supreme Court directs us to determine whether there are any risk-reducing factors that suggest the notes are not in fact securities. Reves I, 494 U.S. at 66, 110 S.Ct. at 952. The existence of other risk-reducing factors diminishes the need for protection under the Securities Act. The Court observed in Reves I that the notes there were uncollateralized, uninsured, and not otherwise subject to federal regulation. Id. at 69, 110 S.Ct. at 953. On the other hand, the EARs at issue in the instant case were often collateralized by the vehicles for which the underlying loans were made. We find that the existence of collateral is a risk-reducing factor that favors finding that the EARs are not securities. 22 On balance, applying the tests specified in Reves I, we hold that PAC's EARs do not qualify as notes that are securities. We therefore turn to the question of whether they qualify as investment contracts that are securities.B. The Investment Contract Test 23 We similarly conclude that the EARs were not a security under the Supreme Court's test for investment contracts. To determine whether a financial product is an investment contract, and therefore a security, the Supreme Court applies a test different from that which it applies to notes: 24 an investment contract ... means a ... scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.... 25 SEC v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244 (1946). The critical inquiry here is whether the plaintiff expected to receive profits from its investment in the EARs. 26 The Supreme Court refined the profits element of the Howey test in United Housing Found., Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). There, the Court defined profits as either capital appreciation resulting from the development of the initial investment, ... or a participation in earnings resulting from the use of investors' funds.... Id. at 852, 95 S.Ct. at 2060. We have interpreted Forman to mean that the receipt of specified interest payments is not the apportionment of profits under Forman. See McVay v. Western Plains Corp., 823 F.2d 1395, 1399 (10th Cir.1987); Uselton v. Commercial Lovelace Motor Freight, Inc., 940 F.2d 564, 576-77 & n. 10 (10th Cir.) (finding profits element met by employee benefit plan that yielded a profit through dividend distribution and appreciation in the value of the stock allocated to their accounts, unlike other benefit plans previously held not to meet the profit prong because they paid fixed or determinable benefits based on factors such as the age at which the participant retired), cert. denied, --- U.S. ----, 112 S.Ct. 589, 116 L.Ed.2d 614 (1991). Although McVay interpreted Forman in the context of a state law cause of action, several other circuits have come to similar conclusions in the context of federal securities law cases. See, e.g., Kansas State Bank v. Citizens Bank, 737 F.2d 1490, 1495 (8th Cir.1984); Union Planters Nat'l Bank v. Commercial Credit Business Loans, Inc., 651 F.2d 1174, 1184-85 (6th Cir.1981), cert. denied, 454 U.S. 1124, 102 S.Ct. 972, 71 L.Ed.2d 111; American Fletcher Mortgage Co. v. United States Steel Credit Corp., 635 F.2d 1247, 1254 (7th Cir.1980), cert. denied, 451 U.S. 911, 101 S.Ct. 1982, 68 L.Ed.2d 300 (1981). Because the Plaintiff received specified interest payments from its investment in EARs, rather than dividends tied to the profitability of PAC or any other entity, the EARs do not meet the profits prong of the Howey test. 27 The Tenth Circuit cases cited by the Plaintiff to support its argument that it was entitled to profits from the EARs under Howey are distinguishable on the ground that the interest owners in those cases received dividend-like payments dependent on the profitability of the venture as opposed to fixed-interest-rate types of payments. See, e.g., McCown v. Heidler, 527 F.2d 204, 209 (10th Cir.1975) (involving real estate investment that would result in a substantial increase in the value of the lots); Gilbert v. Nixon, 429 F.2d 348, 354 (10th Cir.1970) (involving fractional working interests in oil and gas leases); Continental Mktg. Corp. v. SEC, 387 F.2d 466, 470 (10th Cir.1967) (involving investment transaction whereby purchasers bought beavers but left them at ranches where they would be cared for, with the inducement of reaping geometric profits as the beavers reproduced and offspring were sold), cert. denied, 391 U.S. 905, 88 S.Ct. 1655, 20 L.Ed.2d 419 (1968). In addition, two of these cases were issued before Forman explicitly defined profit in 1974. 28 Because the Plaintiffs do not meet the profit prong of the Howey test, we find that the EARs are not securities within the meaning of the Securities Act. We therefore reverse the jury's verdict that PIIGI was liable for RICO securities fraud under Count 1. 29