Court Opinion

ID: 5485054
Source: CourtListenerOpinion
Date Created: 2022-01-10 02:08:46.210316+00
Date Added: 2024-06-11T08:33:25.675902
License: Public Domain

Smith, J.
(dissenting). The question of when a promissory note is a “security” is a familiar one in federal securities law, and has proved very difficult (see e.g. Reves v Ernst & Young, 494 US 56 [1990]; Chemical Bank v Arthur Andersen & Co., 726 F2d 930 [2d Cir 1984]; Exchange Natl. Bank of Chicago v Touche Ross & Co., 544 F2d 1126 [2d Cir 1976]). The authors of the Uniform Commercial Code made the question of what is a “security” for UCC purposes easier, by including in the definition of “security” an element not present in federal securities law: with some exceptions, an obligation is not a security for UCC purposes unless it “may be registered upon books *417maintained for that purpose by or on behalf of the issuer” (UCC 8-102 [a] [15] [i]). Today, the majority effectively undoes the work of the UCC’s authors, by reading this registrability requirement in so broad a way as to make it meaningless.
Though it is not apparent from the majority opinion, registrability is the only significant issue in this case. No one disputes that what the majority calls the “divisibility test” and the “functional test” in the UCC definition of “security” (UCC 8-102 [a] [15] [ii], [iii]) are met here. The majority holds that the notes at issue are “represented by . . . securities] certificate [s]” within the meaning of UCC 8-102 (a) (15) (i), but it does not matter whether the majority is right or wrong about this, because registrability is necessary to make either an uncertificated obligation or a non-bearer certificated obligation into a security. If the obligation is certificated, the certificate must be in either “bearer or registered form” (id.), and the definition of “registered form” requires that “a transfer of the security may be registered upon books maintained for that purpose by or on behalf of the issuer, or the security certificate so states” (UCC 8-102 [a] [13] [ii]). If the obligation is not certificated, it is still a security if it meets the other tests and its “transfer . . . may be registered upon books maintained for that purpose by or on behalf of the issuer” (UCC 8-102 [a] [15] [i]). Registrability is therefore critical, whether there is a certificate or not.
Before considering the meaning of the registrability requirement, it is useful to consider why the UCC’s authors made it part of their definition of “security” — a definition that is completely independent of the federal securities law definition of the same term (see UCC 8-102, Comment 3 [1977 amendments], reprinted in 8 Lawrence’s Anderson on the Uniform Commercial Code § 8-102:1, at 29-30 [3d ed rev 2005]). The apparent reason for the requirement is to facilitate line-drawing — to provide a relatively simple test to distinguish between obligations and interests that are securities and those that are not. As the Comment says: “The definition of ‘registered form’ . . . [s]erves primarily to distinguish Article 8 securities from instruments governed by other law, such as Article 3” (UCC 8-102, Comment 13).
These distinctions matter. For example, the rights and obligations of an issuer and holder of an article 3 negotiable instrument are substantially different from those of an issuer and holder of an article 8 security. The issuer of a security in *418registered form may treat the registered owner as the owner for all purposes, until the security is presented for registration of transfer (see UCC 8-207 [a]). The issuer of an unregistered negotiable instrument does not have that option. The indorser of a negotiable instrument may also be liable to subsequent holders in the event that the issuer defaults (see UCC 3-414). The indorser of an article 8 security, in contrast, makes no warranties with respect to the issuer’s ability to satisfy the underlying obligation (see UCC 8-108).
The need for clear distinctions led the authors of the UCC to adopt the formalistic requirement of registrability. Such formalism would be out of place in the federal securities laws, which have the prevention of fraud and other abuses in securities markets among their primary purposes. Congress wanted to make evasion of the federal securities laws difficult, and accordingly:
“[i]n defining the scope of the market that it wished to regulate, Congress painted with a broad brush. It recognized the virtually limitless scope of human ingenuity, especially in the creation of ‘countless and variable schemes devised by those who seek the use of the money of others on the promise of profits,’ SEC v. W. J. Howey Co., 328 U. S. 293, 299 (1946), and determined that the best way to achieve its goal of protecting investors was ‘to define “the term ‘security’ in sufficiently broad and general terms so as to include within that definition the many types of instruments that in our commercial world fall within the ordinary concept of a security.” ’ [United Housing Foundation, Inc. v Forman, 421 US 837, 847-848 (1975)] (quoting H. R. Rep. No. 85, 73d Cong, 1st Sess., 11 (1933)). Congress therefore did not attempt precisely to cabin the scope of the Securities Acts. Rather, it enacted a definition of ‘security’ sufficiently broad to encompass virtually any instrument that might be sold as an investment” (Reves, 494 US at 60-61).
The UCC is less concerned with frustrating the ingenuity of schemers, and more with providing a workable and predictable code to govern legitimate transactions. The purposes of the UCC are therefore well served by making the line between securities and other interests and obligations as clear as possible — a clarity that is lacking in federal securities law. The “broad *419brush” approach of the federal securities laws prompts participants in transactions to err on the side of caution, and to assume — as the parties in this case did — that anything near the borderline is a “security” for federal purposes. But the goal of the UCC is to mark the border plainly.
Registrability is a test well suited to that goal. It has long been a common practice for issuers of stocks, bonds, notes and other obligations or interests to maintain (or to retain a transfer agent to maintain) books on which the transfers of these obligations and interests may be registered. It is not hard to determine whether such books exist or not. If they do, then “transfer [of the obligation or interest] may be registered upon books maintained for that purpose by or on behalf of the issuer” and the registrability requirement is met.
In this case, no claim is made that McNaughton, the issuer of the notes in suit, maintained (itself or through an agent) transfer books on which transfers of these notes could be registered. McNaughton did have transfer books, and transfers were registered on them — including transfers of certain classes of promissory notes — but those books were not available for registering transfers of the notes at issue here. That should end the inquiry: the registrability requirement is not met, and these notes are not securities.
The majority’s contrary conclusion rests in part on circular reasoning. It finds that these notes “may be” registered because UCC 8-401 would require registration — but that section applies only to “a certificated security in registered form.” Whether the notes are such securities is the very question the majority is deciding.
The majority also seeks to justify its result by overemphasizing some words in the statutes describing the registrability requirement and ignoring others. It emphasizes the words “may be” (majority op at 413-414), which the majority seemingly takes to mean that the notes are registrable if any books could possibly exist in which transfers of the notes could be registered. Read so broadly, the words “may be” deprive the registrability requirement of any meaning — it is always theoretically possible there could be books on which transfers of anything could be registered. The words “may be registered upon books maintained for that purpose” are much more plausibly read to mean that “books maintained for that purpose” must exist, on which transfers may (or may not) be registered. In other words, the *420requirement is met whether transfers are actually registered on the books or not, but not if there are no books “maintained for that purpose” on which registration could occur.
The majority ignores the statutory words “maintained for that purpose.” It concludes that the registrability requirement is met because, if the notes are transferred and McNaughton is informed of the transfer, it must obviously record the information somewhere, so that it will have “a way to keep track of the proper payees” (majority op at 414). On this reading of the statute, it is hard to imagine any transferable obligation of any issuer that would not be registrable. The right question is not whether transfers may be reflected in some way in McNaughton’s books and records — of course they may — but whether they “may be registered upon books maintained for that purpose.”
Confusing registrability upon transfer books with recording in corporate books generally was essentially the error criticized, in another context, by a distinguished panel of the Second Circuit Court of Appeals in Gerard v Helvering (120 F2d 235 [2d Cir 1941, per curiam: L. Hand, Chase and Frank, JJ.]). The issue there was whether payments on a certain bond were a “retirement” of “capital assets” for federal income tax purposes, a question that in turn depended on the registrability of the bond. The court said:
“[the taxpayer] cannot succeed unless [the bond] was ‘in registered form,’ a phrase whose meaning in this context is entirely plain. It refers to the common practice in the issuance of corporate bonds which allows the holder of one or more coupon bonds of a series the option to surrender them and have one bond ‘registered’ upon the books of the obligor or of a transfer agent; or the holder may subscribe for such a bond in the first place. The purpose is to protect the holder by making invalid unregistered transfers, and the bond always so provides upon its face. The mere fact that the debtor keeps books of account upon which the debt appears is altogether immaterial; to construe the statute as the taxpayer asks would in effect make the payment of any corporate debt — ‘evidence of indebtedness’ — a ‘retirement’ of ‘capital assets,’ for almost all corporations keep books. It is scarcely necessary to labor the answer to so plain a misinterpretation” (120 F2d at 235-236 [emphasis added]).
*421I find the majority’s error in interpreting the UCC here to be equally plain.
Chief Judge Kaye and Judges Ciparick, Graffeo and Jones concur with Judge Read; Judge Smith dissents and votes to answer the certified question in the negative in a separate opinion in which Judge Pigott concurs.
Following certification of a question by the United States Court of Appeals for the Second Circuit and acceptance of the question by this Court pursuant to section 500.27 of the Rules of Practice of the Court of Appeals (22 NYCRR 500.27), and after hearing argument by counsel for the parties and consideration of the briefs and the record submitted, certified question answered in the affirmative.