Lead Opinion
delivered the opinion of the Court.
This case presents the question whether certain demand notes issued by the Farmers Cooperative of Arkansas and Oklahoma (Co-Op) are “securities” within the meaning of §3(a)(10) of the Securities Exchange Act of 1934. We conclude that they are.
I
The Co-Op is an agricultural cooperative that, at the time relevant here, had approximately 23,000 members. In order to raise money to support its general business operations, the Co-Op sold promissory notes payable on demand by the holder. Although the notes were uncollateralized and uninsured, they paid a variable rate of interest that was adjusted
After the Co-Op filed for bankruptcy, petitioners, a class of holders of the notes, filed suit against Arthur Young & Co., the firm that had audited the Co-Op’s financial statements (and the predecessor to respondent Ernst & Young). Petitioners alleged, inter alia, that Arthur Young had intentionally failed to follow generally accepted accounting principles in its audit, specifically with respect to the valuation of one of the Co-Op’s major assets, a gasohol plant. Petitioners claimed that Arthur Young violated these principles in an effort to inflate the assets and net worth of the Co-Op. Petitioners maintained that, had Arthur Young properly treated the plant in its audits, they would not have purchased demand notes because the Co-Op’s insolvency would have been apparent. On the basis of these allegations, petitioners claimed that Arthur Young had violated the antifraud provisions of the 1934 Act as well as Arkansas’ securities laws.
Petitioners prevailed at trial on both their federal and state claims, receiving a $6.1 million judgment. Arthur Young appealed, claiming that the demand notes were not “securities” under either the 1934 Act or Arkansas law, and that the statutes’ antifraud provisions therefore did not apply. A panel of the Eighth Circuit, agreeing with Arthur Young on both the state and federal issues, reversed. Arthur Young & Co. v. Reves,
II
A
This case requires us to decide whether the note issued by the Co-Op is a “security” within the meaning of the 1934 Act. Section 3(a)(10) of that Act is our starting point:
“The term ‘security’ means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a ‘security’; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is like-wise limited.” 48 Stat. 884, as amended, 15 U. S. C. § 78c(a)(10).
The fundamental purpose undergirding the Securities Acts is “to eliminate serious abuses in a largely unregulated securities market.” United Housing Foundation, Inc. v. Forman,
Congress did not, however, “intend to provide a broad federal remedy for all fraud.” Marine Bank v. Weaver,
We made clear in Landreth Timber that stock was a special case, explicitly limiting our holding to that sort of instrument. Id., at 694. Although we refused finally to rule out a similar per se rule for notes, we intimated that such a rule would be unjustified. Unlike “stock,” we said, “‘note’ may now be viewed as a relatively broad term that encompasses instruments with widely varying characteristics, depending on whether issued in a consumer context, as commercial paper, or in some other investment context.” Ibid, (citing Securities Industry Assn. v. Board of Governors of Federal Reserve System,
Because the Landreth Timber formula cannot sensibly be applied to notes, some other principle must be developed to define the term “note.” A majority of the Courts of Appeals that have considered the issue have adopted, in varying forms, “investment versus commercial” approaches that distinguish, on the basis of all of the circumstances surrounding the transactions, notes issued in an investment context (which are “securities”) from notes issued in a commercial or consumer context (which are not). See, e. g., Futura Development Corp. v. Centex Corp.,
The Second Circuit’s “family resemblance” approach begins wfith a presumption that any note with a term of more than nine months is a “security.” See, e. g., Exchange Nat. Bank of Chicago v. Touche Ross & Co.,
In contrast, the Eighth and District of Columbia Circuits apply the test we created in SEC v. W. J. Howey Co.,
We reject the approaches of those courts that have applied the Hoioey test to notes; Howey provides a mechanism for determining whether an instrument is an “investment contract.” The demand notes here may well not be “investment contracts,” but that does not mean they are not “notes.” To hold that a “note” is not a “security” unless it meets a test designed for an entirely different variety of instrument “would make the Acts’ enumeration of many types of instruments superfluous,” Landreth Timber,
The other two contenders —the “family resemblance” and “investment versus commercial” tests — are really two ways of formulating the same general approach. Because we
We agree that the items identified by the Second Circuit are not properly viewed as “securities.” More guidance, though, is needed. It is impossible to make any meaningful inquiry into whether an instrument bears a “resemblance” to
An examination of the list itself makes clear what those standards should be. In creating its list, the Second Circuit was applying the same factors that this Court has held apply in deciding whether a transaction involves a “security.” First, we examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a “security.” If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash-flow difficulties, or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a “security.” See, e. g., Forman,
We conclude, then, that in determining whether an instrument denominated a “note” is a “security,” courts are to apply the version of the “family resemblance” test that we have articulated here: A note is presumed to be a “security,” and that presumption may be rebutted only by a showing that the note bears a strong resemblance (in terms of the four factors we have identified) to one of the enumerated categories of instrument. If an instrument is not sufficiently similar to an item on the list, the decision whether another category should be added is to be made by examining the same factors.
B
Applying the family resemblance approach to this case, we have little difficulty in concluding that the notes at issue here are “securities.” Ernst & Young admits that “a demand note does not closely resemble any of the Second Circuit’s family resemblance examples.” Brief for Respondent 43. Nor does an examination of the four factors we have identified as being relevant to our inquiry suggest that the demand notes here are not “securities” despite their lack of similarity to any of the enumerated categories. The Co-Op sold the notes in an effort to raise capital for its general business operations, and purchasers bought them in order to earn a profit
As to the plan of distribution, the Co-Op offered the notes over an extended period to its 23,000 members, as well as to nonmembers, and more than 1,600 people held notes when the Co-Op filed for bankruptcy. To be sure, the notes were not traded on an exchange. They were, however, offered and sold to a broad segment of the public, and that is all we have held to be necessary to establish the requisite “common trading” in an instrument. See, e. g., Landreth Timber, supra (stock of closely held corporation not traded on any exchange held to be a “security”); Tcherepnin,
The third factor — the public’s reasonable perceptions — also supports a finding that the notes in this case are “securities.” We have consistently identified the fundamental essence of a
Finally, we find no risk-reducing factor to suggest that these instruments are not in fact securities. The notes are uncollateralized and uninsured. Moreover, unlike the certificates of deposit in Marine Bank, supra, at 557-558, which were insured by the Federal Deposit Insurance Corporation and subject to substantial regulation under the federal banking laws, and unlike the pension plan in Teamsters v. Daniel,
The court below found that “[t]he demand nature of the notes is very uncharacteristic of a security,”
We therefore hold that the notes at issue here are within the term “note” in §3(a)(10).
Ill
Relying on the exception in the statute for “any note . . . which has a maturity at the time of issuance of not exceeding nine months,” 15 U. S. C. § 78c(a)(10), respondent contends that the notes here are not “securities,” even if they would otherwise qualify. Respondent cites Arkansas cases standing for the proposition that, in the context of the state statute of limitations, “[a] note payable on demand is due immediately.” See, e. g., McMahon v. O’Keefe,
Petitioners counter that the “plain words” of the exclusion should not govern. Petitioners cite the legislative history of a similar provision of the 1933 Act, 48 Stat. 76, 15 U. S. C. §77c(a)(3), for the proposition that the purpose of the exclusion is to except from the coverage of the Acts only commercial paper — short-term, high quality instruments issued to fund current operations and-sold only to highly sophisticated investors. See S. Rep. No. 47, 73d Cong., 1st Sess., 3-4 (1933); H. R. Rep. No. 85, 73d Cong., 1st Sess., 15 (1933). Petitioners also emphasize that this Court has repeatedly held (see supra, at 60-63) that the plain words of the definition of a “security” are not dispositive, and that we consider the economic reality of the transaction to determine whether Congress intended the Securities Acts to apply. Petitioners therefore argue, with some force, that reading the exception
We need not decide, however, whether petitioners’ interpretation of the exception is correct, for we conclude that even if we give literal effect to the exception, the notes do not fall within its terms.
Respondent’s contention that the demand notes fall within the “plain words” of the statute rests entirely upon the premise that Arkansas’ statute of limitations for suits to collect demand notes is determinative of the “maturity” of the notes, as that term is used in the federal Securities Acts. The “maturity” of the notes, however, is a question of federal law. To regard States’ statutes of limitations law as controlling the scope of the Securities Acts would be to hold that a particular instrument is a “security” under the 1934 Act in some States, but that the same instrument is not a “security” in others. Compare McMahon, supra, at 106 (statute runs from date of note), with 42 Pa. Cons. Stat. §5525(7) (1988) (statute runs “from the later of either demand or any payment of principal of or interest on the instrument”). We are unpersuaded that Congress intended the Securities Acts to apply differently to the same transactions depending on the accident of which State’s law happens to apply.
The Chief Justice’s argument in partial dissent is but a more artful statement of respondent’s contention, and it suffers from the same defect. The Chief Justice begins by defining “maturity” to mean the time when a note becomes due. Post, at 77 (quoting Black’s Law Dictionary 1170 (3d ed. 1933)). Because a demand note is “immediately ‘due’ such
Neither the law of Arkansas nor that of any other State provides an answer to the federal question, and as a matter of federal law, the words of the statute are far from “plain” with regard to whether demand notes fall within the exclusion. If it- is plausible to regard a demand note as having an immediate maturity because demand could be made immediately, it is also plausible to regard the maturity of a demand note as
IV
For the foregoing reasons, we conclude that the demand notes at issue here fall under the “note” category of instruments that are “securities” under the 1933 and 1934 Acts. We also conclude that, even under respondent’s preferred approach to §3(a)(10)’s exclusion for short-term notes, these demand notes do not fall within the exclusion. Accordingly, we reverse the judgment of the Court of Appeals and remand the case for further proceedings consistent with this opinion.
So ordered.
Notes
We have consistently held that “[t]he definition of a security in § 3(a) (10) of the 1934 Act... is virtually identical [to the definition in the Securities Act of 1933] and, for present purposes, the coverage of the two Acts may be considered the same.” United Housing Foundation, Inc. v. Forman,
An approach founded on economic reality rather than on a set of per se ■rules is subject to the criticism that whether a particular note is a “security” may not be entirely clear at the time it is issued. Such an approach has the corresponding advantage, though, of permitting the SEC and the courts sufficient flexibility to ensure that those who market investments are not able to escape the coverage of the Securities Acts by creating new instruments that w'ould not be covered by a more determinate definition. One could question whether, at the expense of the goal of clarity, Congress overvalued the goal of avoiding manipulation by the clever and dishonest. If Congress erred, however, it is for that body, and not this Court, to correct its mistake.
The Second Circuit’s version of the family resemblance test provided that only notes ivith a term of more than nine months are presumed to be “securities.” See supra, at 63. No presumption of any kind attached to notes of less than nine months’ duration. The Second Circuit’s refusal to extend the presumption to all notes was apparently founded on its interpretation of the statutory exception for notes with a maturity of nine months or less. Because we do not reach the question of how to interpret that exception, see infra, at 71, we likewise express no view on how that exception might affect the presumption that a note is a “security.”
We emphasize that by “profit” in the context of notes, we mean “a valuable return on an investment,” which undoubtedly includes interest. We have, of course, defined “profit” more restrictively in applying the Howey test to what are claimed to be “investment contracts.” See, e. g., Forman,
Concurrence Opinion
concurring.
While I join the Court’s opinion, an important additional consideration supports my conclusion that these notes are se
In my view such a settled construction of an important federal statute should not be disturbed unless and until Congress so decides. “[A]fter a statute has been construed, either by this Court or by a consistent course of decision by other federal judges and agencies, it acquires a meaning that should be as clear as if the judicial gloss had been drafted by the Congress itself.” Shearson/American Express Inc. v. McMahon,
Indeed, the agreement among the Courts of Appeals is made all the more impressive in this case because it is buttressed by the views of the Securities and Exchange Commission. See Securities Act Release No. 33-4412, 26 Fed. Reg. 9158 (1961) (construing § 3(a)(3) of the Securities Act of 1933, the 1933 Act’s counterpart to § 3(a)(10) of the 1934 Act). We have ourselves referred to the exclusion for notes with a maturity not exceeding nine months as an exclusion for “commercial paper.” Securities Industry Assn. v. Board of Governors of Federal Reserve System,
Moreover, I am satisfied that the interpretation of the statute expounded by Judge Sprecher and Judge Friendly was entirely correct. As Judge Friendly has observed, the exclusion for short-term notes must be read in light of the prefatory language in § 2 of the 1933 Act and § 3 of the 1934 Act. See Exchange Nat. Bank of Chicago v. Touche Ross & Co.,
For these reasons and those stated in the opinion of the Court, I conclude that the notes issued by respondents are securities within the meaning of the 1934 Act.
Concurrence Opinion
I join Part II of the Court’s opinion, but dissent from Part III and the statements of the Court’s judgment in Parts I and IV. In Part III, the Court holds that these notes were not covered by the statutory exemption for “any note . . . which has a maturity at the time of issuance of not exceeding nine months.” Treating demand notes as if they were a recent development in the law of negotiable instruments, the Court says “if it is plausible to regard a demand note as having an immediate maturity because demand could be made immediately, it is also plausible to regard the maturity of a demand note as being in excess of nine months because demand could be made many years or decades into the future. Given this ambiguity, the exclusion must be interpreted in accordance with its purpose.” Ante, at 72-73.
In construing any terms whose meanings are less than plain, we depend on the common understanding of those terms at the time of the statute’s creation. See Gilbert v. United States,
“So far as maker and acceptor are concerned, paper payable ... ‘on demand’ is due from the moment of its delivery, and payment may be required on any business day, including the day of its issue, within the statute of limitations. In other words, as to these parties the paper is at maturity all the time, and no demand of payment is necessary before suit thereon.” Bigelow, supra, §349, at 265 (emphasis added; emphasis in original deleted; footnote omitted).
To be sure, demand instruments were considered to have “the peculiar quality of having two maturity dates — one for the purpose of holding to his obligation the party primarily liable (e. g. maker), and the other for enforcing the contracts of parties secondarily liable (e. g. drawer and indorsers).” Bigelow, supra, § 350, at 266 (emphasis omitted). But only the rule of immediate maturity respecting makers of demand notes has any bearing on our examination of the exemption; the language in the Act makes clear that it is the “maturity at time of issuance” with which we are concerned. 15 U. S. C. § 78c(a)(10). Accordingly, in the absence of some compelling indication to the contrary, the maturity date exemption must encompass demand notes because they possess “maturity at the time of issuance of not exceeding nine months.”
The legislative history of the 1934 Act — under which this case arises — contains nothing which would support a restrictive reading of the exemption in question. Nor does the legislative history of § 3(a)(3) of the 1933 Act support the asserted limited construction of the exemption in §3(a)(10) of the 1934 Act. Though the two most pertinent sources of congressional commentary on § 3(a)(3) — H. R. Rep. No. 85, 73d Cong., 1st Sess., 15 (1933) and S. Rep. No. 47, 73d Cong., 1st Sess., 3-4 (1933) — do suggest an intent to limit § 3(a)(3)’s exemption to short-term commercial paper, the references in those Reports to commercial paper simply did not survive in the language of the enactment. Indeed, the Senate Report stated “[n]otes, drafts, bills of exchange, and bankers’ acceptances 'which are commercial paper and arise out of current commercial, agricultural, or industrial transactions, and ivhich are not intended to be marketed to the public, are exempted. . . .” S. Rep. No. 47, supra, at 3-4 (emphasis added). Yet the provision enacted in § 3(a)(3)
Such broadening of the language in the enacted version of § 3(a)(3), relative to the prototype from which it sprang, cannot easily be dismissed in interpreting § 3(a)(3). A fortiori, the legislative history’s restrictive meaning cannot be imputed to the facially broader language in a different provision of another Act. Although I do not doubt that both the 1933 and 1934 Act exemptions encompass short-term commercial paper, the expansive language in the statutory provisions is strong evidence that, in the end, Congress meant for commercial paper merely to be a subset of a larger class of exempted short-term instruments.
The plausibility of imputing a restrictive reading to § 3(a) (10) from the legislative history of § 3(a)(3) is further weakened by the imperfect analogy between the two provisions in terms of both phraseology and nature. Section 3(a)(10) lacks the cryptic phrase in § 3(a)(3) which qualifies the class of instruments eligible for exemption as those arising “out of . . . current transaction[s] or the proceeds of which have been or are to be used for current transactions . ” While that passage somehow may strengthen an argument for limiting the exemption in § 3(a)(3) to commercial paper, its absence in §3(a)(10) conversely militates'against placing the same limitation thereon.
The exemption in § 3(a)(3) excepts the short-term instruments it covers solely from the registration requirements of the 1933 Act. The same instruments are not exempted from the 1933 Act’s antifraud provisions. Compare 15 U. S. C. § 77c(a)(8) with 15 U. S. C. §§77/(2) and 77q(c); see also Securities Industry Assn. v. Board of Governors of Federal
Justice Stevens argues that the suggested limited reading of the exemption in §3(a)(10) of the 1934 Act “harmonizes” the plain terms of that provision with the legislative history of the 1933 Act. Ante, at 76. In his view, such harmony is required by the “context clause” at the beginning of the 1934 Act’s general definition of “security.” It seems to me, instead, that harmony is called for primarily between §3(a)(10)’s general definition and its specific exemption. The fairest reading of the exemption in light of the context clause is that the situation described in the exemption — notes with maturities at issue of less than nine months — is one contextual exception Congress especially wanted courts to recognize. Such a reading does not render the context clause superfluous; it merely leaves it to the judiciary to flesh out additional “context clause” exceptions.
Justice Stevens also states that we have previously referred to the exemption in §3(a)(10) as an exclusion for commercial paper. Ante, at 76 (citing Securities Industry Assn., supra, at 150-152). In the Securities Industry Assn. dictum, however, we described the exemption in §3(a)(10) merely as “encompass[ing]” commercial paper and in no way concluded that the exemption was. limited to commercial paper. See
In sum, there is no justification for looking beyond the plain terms of §3(a)(10), save for ascertaining the meaning of “maturity” with respect to demand notes. That inquiry re
Reference to the state common law of negotiable instruments does not suggest that “Congress intended the Securities Acts to apply differently to the same transactions depending on the accident of which State’s law happens to apply.” See ante, at 71. Rather, in the absence of a federal law of negotiable instruments, cf. De Sylva v. Ballentine,
“That we are dealing with a uniform federal rather than a state definition does not, of course, prevent us from drawing on general state-law principles to determine ‘the ordinary meaning of the words used.’ Well-settled state law can inform our understanding of what Congress had in mind when it employed a term it did not define.”
See also 2A C. Sutherland on Statutory Construction § 50.04, pp. 438-439 (4th ed. 1984) (noting the “utility” found by various courts, including this Court, in “examining a federal statute with reference to the common law of the various states as it existed at the time the statute was enacted”). In 1934, when this statute was enacted, as is true today, the American law of