Opinion ID: 511032
Heading Depth: 2
Heading Rank: 1

Heading: Arthur Young's Appeal

Text: 12 The first issue is whether the demand notes are securities within the meaning of the Federal Act. While the Federal Act defines a security as any note, 15 U.S.C. Sec. 78c(a)(10), it is nevertheless well settled that these definitional sections are not to be read literally because Congress intended the application of [the federal securities acts] to turn on the economic realities underlying a transaction and not on the name appended thereto, United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621 (1975), and an instrument which seems to fall within the broad sweep of the federal acts is not to be considered a security if the context otherwise requires. Marine Bank v. Weaver, 455 U.S. 551, 556, 102 S.Ct. 1220, 1223, 71 L.Ed.2d 409 (1982); see Smith International, Inc. v. Texas Commerce Bank, 844 F.2d 1193, 1199 n. 4 (5th Cir.1988); cf., Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985). 2 Thus, the wide-ranging definition of a security found in the [Federal] Act is limited by congressional intent not to provide a broad federal remedy for all fraud and by the Supreme Court's practical approach to interpreting the federal securities laws. Union National Bank of Little Rock v. Farmers Bank, 786 F.2d 881, 884 (8th Cir.1986) (footnote omitted). 13 For the demand notes at issue to be considered securities under the Federal Act, they must satisfy the elements of the test developed in SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); see Farmers Bank, 786 F.2d at 884; Kansas State Bank v. Citizens Bank, 737 F.2d 1490, 1494-95 (8th Cir.1984). Even if the Supreme Court should determine it inappropriate to apply the Howey test to an instrument which bears both the name note and the usual characteristics of a security, see supra n. 2, it is no bar in this case because the instrument at issue, while possessing the name, lacks the characteristics. 14 The demand nature of the notes is very uncharacteristic of a security. A demand or short-term note is almost ipso facto not a security unless payment is dependent upon the success of a risky enterprise or the parties contemplate indefinite extension of the note or perhaps conversion to stock. Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257-58 (9th Cir.1976); see Kansas State Bank, 737 F.2d at 1494. Neither of the conditions is present here. Because the demand notes are uncharacteristic of a security, we look to the economic reality of the transaction to determine their status. See Howey, 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). 15 The Howey test defines a security as (1) an investment; (2) in a common enterprise; (3) with a reasonable expectation of profits; (4) to be derived from the entrepreneurial or managerial efforts of others. Id. at 301, 66 S.Ct. at 1104. 16 Applying this standard, we conclude that the demand notes are not securities under federal law. First, these notes were short-term loans with fixed interest rates which were used for operating funds. See Farmers Bank, 786 F.2d at 884-85. The Co-op initiated this program because it could obtain funds at rates lower than those offered by banks; the members deposited their money with the Co-op in order to earn a higher return than could be obtained from a bank. Thus, under the first element of the Howey test, this transaction was much more akin to a commercial lending arrangement than an investment transaction. See Farmers Bank, 786 F.2d at 884-85. Moreover, the third element of the Howey test, i.e., a reasonable expectation of profit, is lacking in this case. 17 Profit, however, does not mean any return beyond principal. Rather, it is profit of the type typically associated with an investment. This includes 'capital appreciation resulting from the development of the initial investment    or a participation in earnings resulting from the use of investors' funds   . 18 Kansas State Bank, 737 F.2d at 1495, quoting Forman, 421 U.S. at 852, 95 S.Ct. at 2060. Here, the interest rate was fixed by an established market rate. The demand noteholders did not participate in the Co-op's earnings by virtue of their ownership of the demand notes, nor was there any prospect of capital appreciation. Therefore, the demand noteholders did not expect a profit as that term is defined in Howey. 19 Because these demand notes were uncharacteristic of securities, and also failed the Howey test, we conclude that they were not securities within the meaning of the Federal Act. The Class has thus failed to state a claim under section 10(b) of the Federal Act, 15 U.S.C. Sec. 78j(b). 20 The second issue is whether the demand notes are securities within the meaning of the Arkansas Act. In Smith v. State, 266 Ark. 861, 587 S.W.2d 50, 52 (App.1979), cert. denied, 445 U.S. 905, 100 S.Ct. 1082, 63 L.Ed.2d 321 (1980), the Arkansas Court of Appeals identified five significant common characteristics of a security: (1) the investment of money or money's worth; (2) investment in a venture; (3) the expectation of some benefit to the investor as a result of the investment; (4) contribution towards risk capital of the venture; and (5) the absence of direct control over the investment or policy decisions concerning the venture. Judge Harris, a senior district judge for the Western District of Arkansas, recently held that [t]he Arkansas definition of a security is essentially identical to the definition under the federal securities laws and the criteria followed [in Smith and Howey ] in making a determination on whether an instrument is a security is also the same. First Financial Federal Savings & Loan Assn. v. E.F. Hutton Mortgage Corp., 652 F.Supp. 471, 475 (W.D.Ark.), aff'd, 834 F.2d 685 (8th Cir.1987). 3 See Farmers Bank, 786 F.2d at 885. It follows, therefore, that the Class is not entitled to relief under the Arkansas Act. Accordingly, the district court's denial of Arthur Young's motion for j.n.o.v. is reversed. 21 This disposition requires us to vacate the district court's award of fees and costs in favor of the Class and Trustee and against Arthur Young. Moreover, the case is remanded, and the district court is directed to award reasonable costs to Arthur Young and against the Class and the Trustee. See Fed.R.Civ.P. 54(d).