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Reves v. Ernst & Young - 494 U.S. 56, 110 S. Ct. 945 (1990)


The following factors apply in deciding whether a transaction involves a "security." First, the court examines the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. Second, the court examines the "plan of distribution" of the instrument to determine whether it is an instrument in which there is common trading for speculation or investment. Third, the court examines the reasonable expectations of the investing public. Finally, the court examines whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.


In order to raise money to support its general business operations, the Farmers Cooperative of Arkansas and Oklahoma (Co-Op) sold uncollateralized and uninsured promissory notes payable on demand by the holder. Offered to both Co-Op members and nonmembers and marketed as an "Investment Program," the notes paid a variable interest rate higher than that of local financial institutions. After the Co-Op filed for bankruptcy, petitioners, holders of the notes, filed suit in the District Court against the Co-Op's auditor, respondent's predecessor, alleging, inter alia, that it had violated the antifraud provisions of the Securities Exchange Act of 1934 -- which regulates certain specified instruments, including "any note[s]" -- and Arkansas' securities laws by intentionally failing to follow generally accepted accounting principles that would have made the Co-Op's insolvency apparent to potential note purchasers.


Were the demand notes "securities" within the meaning of 15 U.S.C.S. § 78c(a)(10)?




The Supreme Court reversed the judgment of the appellate court, which held that the Act's antifraud provisions did not apply because the demand notes were not "securities" within the meaning of 15 U.S.C.S. § 78c(a)(10). Using the "family resemblance" approach, the Court concluded the notes were "securities." The Court considered several factors in making its determination. The co-op sold the notes to raise capital and purchasers bought them to earn a profit in the form of interest. The co-op offered the notes over an extended period to a broad segment of the public. The advertisements characterized the note as "investments." Finally, there was no risk-reducing factor to suggest the notes were not securities.

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