Opinion ID: 466510
Heading Depth: 2
Heading Rank: 1

Heading: Security Claims

Text: 14 The first issue is whether Union's participation is a security within the meaning of the Securities Exchange Act of 1934, 15 U.S.C. Secs. 78a-78kk (1982) (the Act). 3 The wide-ranging definition of a security found in the Act 4 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. United Housing Foundation v. Forman, 421 U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621 (1975). The Court emphasizes the economic realities underlying a transaction and does not focus on the name appended thereto. Id. at 849, 95 S.Ct. at 2059. 15 For a participation to be considered a security under the Act, it must satisfy the elements of a test developed in SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). Kansas State Bank v. Citizens Bank, 737 F.2d 1490, 1494-1495 (8th Cir.1984). The Howey test defines a security as 1) an investment 2) in a common venture 3) with a reasonable expectation of profits 4) to be derived from the entrepreneurial or managerial efforts of others. 328 U.S. at 301, 66 S.Ct. at 1104. 16 Applying this standard, we conclude that Union's loan participation is not a security under federal law since it fails to satisfy three of the four Howey criteria. As in Kansas State Bank v. Citizens Bank, 737 F.2d 1490 (8th Cir.1984), the circumstances of the transaction reveal nothing more than an ordinary commercial loan which turned sour. Union's efforts to distinguish Kansas State Bank are unpersuasive. The participation at issue was payable at a fixed interest rate, and the loan was a short-term one used for operating funds. Thus, the participation cannot be found to be an investment within the meaning of the Howey test. See Kansas State Bank v. Citizens Bank, 737 F.2d 1490 (8th Cir.1984). Moreover, Union had no prospect of capital appreciation or profit from any increased earnings in the business. Finally, the requirement that profits be derived from the entrepreneurial or managerial efforts of others is not satisfied. Union's return was based solely upon Tucker Oil's ability to repay the loan since Farmers' role was primarily administrative. 17 In light of the foregoing, we conclude that Union's participation interest was not a security within the meaning of the Act. It has thus failed to state a claim under section 10(b) of the Act, 15 U.S.C. Sec. 78j(b), and the district court correctly dismissed this cause of action. 18 The second issue is whether Union's participation interest is a security within the meaning of Arkansas securities law. With only one relevant difference, 5 the Arkansas definition of a security is identical to that contained in the Act. See Ark.Stat.Ann. Sec. 67-1247(l). Despite this similarity, Union contends that the trial court erred in concluding that the participation was not a security under Arkansas law. It alleges that the Arkansas Supreme Court expressly declined to follow the Howey test in Schultz & Watkins v. Rector-Phillips-Morse, Inc., 261 Ark. 769, 552 S.W.2d 4 (Ark.1977), but instead adopted a more liberal case-by-case approach. 19 The Arkansas Supreme Court stated in Schultz & Watkins, that the Arkansas statute was designed to protect both investors in common stock and those persons who in substance are the investors in the disguised business schemes of another. Id., 552 S.W.2d at 8. Union was not an investor in a disguised business venture; rather, it was engaged in a routine banking transaction. In Schultz & Watkins, the Arkansas court focused on speculative schemes where venture capital is solicited from the public. It gave no indication in that decision that a standard commercial banking transaction would be covered by the state securities law. 20 Subsequently, the definition of a security was further refined in Smith v. State, 266 Ark. 556, 587 S.W.2d 50 (Ct.App.1979), cert. denied, 445 U.S. 905, 100 S.Ct. 1082, 63 L.Ed.2d 321 (1980). The district court considered the Smith test for determining a security under Arkansas law. Smith identified five significant characteristics of traditional securities: 1) investment of money or money's worth; 2) investment in a venture; 3) expectation of some benefit to the investor as a result of the investment; 4) contribution towards the risk capital of the venture; and 5) the absence of direct control over the investment or policy decisions concerning the venture. 587 S.W.2d at 52. The trial court found these factors substantially similar to those in Howey and that the participation was not a security under Arkansas law. Substantial deference is due the district court's interpretation of the law of the state in which it sits, e.g., Kansas State Bank v. Citizens Bank, 737 F.2d 1490 (8th Cir.1984), and we find no error of fact or law in its decision that the participation is not a security under Arkansas law.