When Are Loans Securities?

The U.S. Securities & Exchange Commission failed to provide any regulatory clarity last week when it declined the Second Circuit Court of Appeals’ invitation to file an amicus brief as to whether a $1.8 billion syndicated loan is a security. In Kirschner v. JPMorgan Chase, N.A., 2020 WL 2614765, Blue Sky L. Rep. P 75,291 (S.D.N.Y., May 22, 2020), the federal district court for the southern district of New York held that this syndicated loan was not a security after applying the “family resemblance test” set forth in Reves v. Ernst & Young, 494 U.S. 56 (1990). Now on appeal, it is incumbent on the Second Circuit to make a decision that has wide-ranging implications on the $2.5 trillion U.S. syndicated loan market.

The “family” under the family resemblance test  is a “list of instruments commonly denominated ‘notes’ that nonetheless fall without the ‘security’ category,” including “(i) the note delivered in consumer financing, (ii) the note secured by a mortgage on a loan, (iii) the short-term note secured by a lien on a small business or some of its assets, (iv) the note evidencing a ‘character’ loan to a bank customer, (v) short-term notes secured by an assignment of accounts receivable, (vi) a note that simply formalizes an open-account debt incurred in the ordinary course of business, and (vii) notes evidencing loans by commercial banks for current operations.” Id. at 65. Then under the test, the presumption that a note is a security is rebutted if it bears a strong resemblance to any members of this “family” based on: (1) “the motivations that would prompt a reasonable seller and buyer to enter into [the transaction];” (2) “the plan of distribution of the instrument;” (3) “the reasonable expectations of the investing public;” and (4) “the existence of another regulatory scheme [to reduce] the risk of the instrument, thereby rendering application of the Securities Act unnecessary.” Id. at 66-67. Lastly, if the note does not bear a strong resemblance, then it still is not a security if it strongly resembles another type of transaction that should be added to this “family.”

The court in Kirschner held that the $1.8 billion syndicated loan was not a security because the second, third, and fourth Reves factors weighed in favor of it being analogous to “notes evidencing loans by commercial banks for current operations.” Now it is the Second Circuit’s turn to render its decision, and then likely the U.S. Supreme Court, considering the implications of subjecting the $2.5 trillion U.S. syndicated loan market to federal securities laws.  

The Reves family resemblance test is one of the more obscure areas of securities law. If you are the holder of a note, then you may be entitled to the additional protections of the securities law pursuant to Reves. And if you are the maker of a note, then you may have to defend against allegations that you issued a security pursuant to Reves. In either case, you may wish to consult with one of the experienced attorneys at Cosgrove Law Group, LLC. Call us at 314-563-2490.