Opinion ID: 672857
Heading Depth: 2
Heading Rank: 2

Heading: Application of the Reves Factors

Text: 19 The first Reves factor requires a court to examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. 494 U.S. at 66, 110 S.Ct. at 951. The inquiry is whether the motivations are investment (suggesting a security) or commercial or consumer (suggesting a non-security). 20 The district court found that the buyers and seller of the mortgage participations were motivated by commercial rather than investment considerations. The court stated that the complaint indicates that the loan proceeds were to be used for cooperative conversions and renovation of commercial space. The court regarded Eagle as the seller of the mortgage interests, and characterized Eagle's motivations as commercial because it earned a fee for servicing the mortgages while obtaining funds to engage in additional loan transactions. The district court further found that appellants, as buyers, were commercially motivated because they received interest on their investment at a fixed rate and apparently had no prospect for profits in excess of the interest paid and personal guarantees by the principals of Eagle. 21 Appellants argue that this was error in several respects. First, the amended complaint alleged that Laidlaw and Twiste were sellers, as agents of Eagle. Second, the motivations ascribed to Eagle and to appellants by the district court are more properly characterized as investment than commercial. 22 We agree with appellants that the motivations of the parties to this transaction are more accurately characterized as investment rather than commercial. We acknowledge that this may be a close question with respect to the seller--or sellers. Cf. Resolution Trust Corp. v. Stone, 998 F.2d 1534, 1539 (10th Cir.1993). Nevertheless, we believe that the somewhat stronger position is that Eagle was raising funds for its general business activities of making and servicing mortgages. This would seem to be an investment motivation because the seller's purpose [was] to raise money for the general use of a business enterprise or to finance substantial investments. Reves, 494 U.S. at 66, 110 S.Ct. at 951. Moreover, with respect to the buyers, we regard motivation as not even a close question. The instruments were obtained for appellants by their investment adviser as part of their investment portfolios. Appellants sought to invest funds in secure, conservative instruments. Most of the instruments that such investors would take positions in, such as investment grade commercial bonds, would have a fixed rate of return in the form of interest. Such bonds are nonetheless regulated as securities. The Supreme Court has specifically recognized that profit means  'a valuable return on an investment,' which undoubtedly includes interest. Reves, 494 U.S. at 68 n. 4, 110 S.Ct. at 952 n. 4. We therefore believe that the district court erred in finding that the fixed rate of return cut against the presumption that the notes are securities. Since the buyers' motivation was so clearly to invest, we would adhere to this view even if we accepted the district court's characterization of Eagle's motivation. 23 With regard to the effect of the Eagle guarantees, there is a preliminary procedural question: Appellants argue that the district court erred in considering them at all on the basis of unauthenticated documentation submitted with the motion to dismiss, particularly since the documents apparently did not represent all or even most of the transactions at issue. Although this argument is substantial, we need not deal with it. 6 Even on the assumption that there were guarantees, appellants were not directly involved in the transactions, and they had no more opportunity to evaluate the value of the Eagle guarantees than they had to evaluate the underlying mortgages or the participations that they purchased. Moreover, the degree of safety of an investment does not call into doubt the applicability of the securities laws. See Exchange Nat'l Bank, 544 F.2d at 1136 (the securities laws cover debt, even supposedly gilt-edged debt, as well as equity).
24 The district court found that appellants' allegations of a broad plan of distribution, encompassing unsophisticated investors, militate[d] against a finding that the mortgage participations here are not securities. In other words, the plan of distribution supported a finding that regulation of these participations as securities is consistent with Congressional intent to protect unsophisticated investors. 25 Not surprisingly, appellees take issue with this portion of the district court's analysis. In this context, Laidlaw emphasizes that the mortgage participations were purchased through a discretionary account managed solely by Twiste, an experienced and sophisticated investment manager. Therefore, Laidlaw argues, the plan of distribution cuts against application of the securities laws. 26 We do not agree with this contention. By this argument, Laidlaw may be attempting to bring this case factually closer to Banco Espanol, in which we emphasized that restrictions on the marketing of certain loan participations strongly suggested that there was no need for the protection of the federal securities laws. The elements of the plan of distribution that we stressed in Banco Espanol included that only institutional and corporate entities were solicited, detailed individualized presentations were made to potential purchasers and resales were prohibited without the express written permission of the broker. 973 F.2d at 55. The marketing scheme in Banco Espanol was more analogous to a group of highly sophisticated commercial entities engaging in short-term commercial financing arrangements than to the securities markets. In contrast, the record before us does not suggest that the participations here were restricted to sophisticated investors who had the capacity to acquire information about the debtor. Id. 27 In Banco Espanol, we rule[d] only with respect to the loan participations as marketed ... [and] recognize[d] that even if an underlying instrument is not a security, the manner in which participations in that instrument are used, pooled, or marketed might establish that such participations are securities. Id. at 56 (citing Gary Plastic Packaging Corp., 756 F.2d at 240-42). The district court in this case correctly concluded that the broad-based, unrestricted sales to the general investing public alleged in the complaint support a finding that these instruments are within the scope of the federal securities laws. 28
29 Despite finding that the purchasers of these mortgage instruments were unsophisticated, passive investors who had simply placed their money in discretionary accounts with instructions to make conservative investments, the district court concluded that the members of the investing public would reasonably expect that the instruments in this case were not securities. Appellants argue that these findings are inconsistent, and point out that they have alleged that they believed that all of the money in their discretionary accounts was being invested, in accordance with their wishes, rather than being used in commercial loan transactions. The district court apparently believed that investors would not expect these interests to be securities because of the fixed interest rate and the Eagle guarantees. 30 We believe that the district court's analysis of this factor was erroneous. As indicated above, neither the fixed interest rate nor the personal guarantees (assuming they existed) justified characterizing appellants' motivations as anything but investment. Nor do these factors alter the reasonable expectations of investors, pursuing what they believed was a conservative investment strategy through registered professionals in the securities industry, that they were protected by the federal securities laws.
31 In applying the final Reves factor, the district court held that federal securities regulation is unnecessary here because collateralized mortgages are regulated under New York State law. The district judge relied on Singer v. Livoti, 741 F.Supp. 1040 (S.D.N.Y.1990), for the proposition that Congress regarded real property transactions as essentially local in nature and did not intend[ ] to sweep them into the statutory scheme for the regulation of securities transactions. Id. at 1051. 32 Appellants take issue with this analysis on a number of grounds. They point out that the amended complaint specifically alleges that the mortgage participations were not secured and were uncollateralized. Moreover, Singer involved allegations of federal securities fraud on the part of an attorney who helped to arrange financing for a real estate development that later failed. 741 F.Supp. at 1041. In Singer, the judge pointed out: 33 [Mortgage] instruments are ordinarily generated, as this one was, through the intermediary of a licensed professional, such as an attorney, real estate broker or mortgage broker. New York maintains a complete statutory scheme to assure fidelity of these professionals to their clients and customers.... Furthermore, all states provide for public recordation of mortgages, an opportunity for mortgage lenders to search out prior liens and defects in title in the public record before investing, and give statutory protection by such recordation against subsequent encumbrancers of the collateral. 34 Id. at 1050 (citations omitted). Appellants argue that whatever protections might have been provided in the situation described in Singer, they were of little if any use in reducing the risk in the situation before us. Appellants perhaps could have taken discretion from their adviser's hands, conducted face-to-face negotiations with borrowers, inspected the properties involved, checked the records for liens, obtained title insurance and used the services of a lawyer, as persons lending money through mortgages generally do. But, appellants argue, that is not what happened here. Invocation of protections that might apply to the more usual mortgage loan distorts the character of these transactions. 35 Finally, appellants claim that the fourth Reves factor does not contemplate protections under state law, but refers only to protection under federal law that would render application of the securities laws unnecessary. 36 We agree with appellants that the district court erred in concluding that New York State regulations concerning mortgages afforded protection sufficient to render unnecessary the application of the federal securities laws to these mortgage participations. In doing so, we do not decide whether state law can be the source of such alternative protection, although it is true that the cases on which Reves relied in discussing this factor, 494 U.S. at 69, 110 S.Ct. at 953, did involve alternative schemes of federal regulation. See Marine Bank v. Weaver, 455 U.S. 551, 558, 102 S.Ct. 1220, 1224, 71 L.Ed.2d 409 (1982) (federal regulation of banks and FDIC insurance); International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 569-70, 99 S.Ct. 790, 801-02, 58 L.Ed.2d 808 (1979) (ERISA); see also 2 Loss & Seligman at 877 & n. 27. Our holding is limited to the facts as alleged in the complaint, according to which appellants held uncollateralized, speculative participations in mortgages and had not engaged in the usual process for extending such a loan. 37 Appellees argue that appellants did have the protection of federal law, namely the Investment Advisers Act of 1940, 15 U.S.C. Sec. 80b-1 et seq., and ERISA. However, we agree with appellants that the former statute was intended to complement, rather than substitute for, the 1933 and 1934 Acts. Laird v. Integrated Resources, Inc., 897 F.2d 826, 834-35 (5th Cir.1990). With regard to ERISA, it is true that appellants seek to add an ERISA claim in their second amended complaint, but they point out that ERISA would apply to only a small percentage of the participations. Under the circumstances, we need not decide whether appellants are correct in arguing that in this case ERISA cannot come close to serving as a comprehensive replacement for the federal securities laws. 38 Thus, on the limited record before us, we conclude that the district court misapplied the Reves analysis, and that the mortgage participations as alleged in the complaint are notes within the scope of the federal securities laws. 39 We reverse the January 1993 order of the district court, and remand the case for further proceedings consistent with this opinion.