BOB REVES, ET AL., PETITIONERS V. ARTHUR YOUNG & CO. No. 88-1480 In The Supreme Court Of The United States October Term, 1989 On Writ Of Certiorari To The United States Court Of Appeals For The Eighth Circuit Brief For The Securities And Exchange Commission As Amicus Curiae Supporting Petitioners TABLE OF CONTENTS Question Presented Interest of the Securities and Exchange Commission Statement Summary of argument Argument: Interest-bearing promissory notes, payable on demand, that are widely offered and sold to the public as investments, are securities under the federal securities laws I. A note is a security within the statutory definition, unless it resembles certain types of notes not used for investment purposes that are clearly outside the scope of the federal securities laws II. The Co-Op's interest-bearing, demand promissory notes are securities within the statutory definition, since they do not resemble those categories of notes used for commercial purposes that are clearly outside the scope of the federal securities laws III. The Co-Op's notes need not satisfy the "investment contract" test to qualify as securities since they are "notes" within the statutory definition of security Conclusion QUESTION PRESENTED Whether interest-bearing promissory notes, payable on demand, that are widely sold by a farmers cooperative association to its members and others as investments, are securities under the federal securities laws. INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION This case presents the question whether interest-bearing promissory notes, payable on demand, that are widely sold to the public as investments, are securities under the federal securities laws. The court of appeals held that such notes are not securities. The Securities and Exchange Commission, the agency principally responsible for the administration and enforcement of the federal securities laws, disagrees with both the analysis and the result reached by the court below. Since numerous situations arise in which notes similar to those involved here -- some with a demand feature -- are sold to the public as investments, the court of appeals' decision withdraws the protections of the federal securities laws from the investing public. That decision threatens to undermine the Commission's law enforcement efforts over such investment instruments, /1/ and to preclude private investors from seeking relief under the anti-fraud and registration provisions of the federal securities laws. The Court previously invited the Solicitor General to file a brief in this case at the certiorari stage expressing the views of the United States. STATEMENT 1. The Farmers Co-Op of Arkansas and Oklahoma, Inc. (Co-Op) was an agricultural cooperative that provided a market and supply source for its 23,000 members located throughout northwest Arkansas and northeast Oklahoma. The Co-Op charged only a nominal membership fee. In addition to borrowing money from banks and other financial institutions, the Co-Op obtained funds for its day-to-day operations and business ventures from the sale of interest-bearing promissory notes, payable on demand, to its members and others with whom it conducted business, as part of a self-styled "investment program" (J.A. 5). Pet. App. A13-A14, A72, A76; J.A. 5; Pet. C.A. App. 1905-1908; see J.A. 4. Notes sold through the Co-Op's investment program were available in the minimum denomination of $100, and carried fluctuating interest rates generally higher than those available from local financial institutions. The Co-Op determined the rate of interest each month based on current market rates; the notes were not collateralized. Pet. App. A14, A70, A72; Pet. C.A. App. 1773-1782, 1905-1920. In its widely circulated monthly newsletters, the Co-Op advertised that it had substantial assets backing the participants' "investments" in the program. Those advertisements acknowledged that the investments were not "Federal (sic) Insured," but stated that each investment was "safe . . . secure . . . and available when you need it" (e.g., J.A. 5; Pet. App. 70). The Co-Op disclosed no financial information to investors at the time of sale other than a statement of the Co-Op's total assets. It did, however, distribute condensed versions of audited financial statements to those persons who attended the Co-Op's annual meetings. Pet. App. A14-A15. In the early 1980s, the Co-Op hired respondent, the accounting firm of Arthur Young & Company, to audit and report on its 1981 and 1982 financial statements. Respondent's representatives gave brief presentations at the Co-Op's 1982 and 1983 annual meetings explaining the Co-Op's general financial condition; some 350 of the Co-Op's members attended those meetings. Respondent's representatives also told the members that complete audited financial statements, together with respondent's report on them, were available at the Co-Op's headquarters. Pet. App. A15. 2. Early in 1984, the Co-Op filed for reorganization under Chapter 11 of the Bankruptcy Code, 11 U.S.C. 1101 et seq. At that time, some 1600 individual investors held Co-Op notes having a total face value of $10,000,000. Pet. App. A45, A73. After the Co-Op's financial collapse, petitioners, representing a class of purchasers of the Co-Op's notes, together with the Co-Op's trustee in bankruptcy, filed actions in the United States District Court for the Western District of Arkansas against the Co-Op, its principal officers and directors, respondent, and others. /2/ Petitioners alleged, among other claims, that respondent and the other defendants had committed fraud in connection with the sale of securities -- the Co-Op's notes -- in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), Rule 10b-5, 17 C.F.R. 240.10b-5, and Section 67-1256 of the Arkansas Securities Act, Ark. Stat. Ann. (1980). Pet. App. A11-A12. /3/ During extensive pretrial litigation, certain defendants, joined by respondent, /4/ argued that the Co-Op's notes were not securities under either federal or state law, and thus sought dismissal of petitioners' securities law claims. After examining state law and precedent, together with analogous federal case law, the district court held that the Co-Op's notes were securities under the Arkansas Securities Act. Pet. App. A32-A81. The court found that "salient features of the notes offered by the (Co-Op) direct a conclusion that a broad scale (sic) offering of unsecured debt instruments to a passive public constitutes an investment transaction, rather than a commercial loan" (id. at A39-A40). /5/ In a separate ruling several months later denying defendants' motion for summary judgment, the district court, apparently based on its earlier review of federal law, held that the Co-Op's notes were also securities under the federal securities laws. Pet. App. A30; see also Robertson v. White, 633 F. Supp. 954, 976 (W.D. Ark. 1986). Petitioners' federal and state securities claims against respondent were tried to a jury. After a five-week trial, the jury found respondent liable for violating both federal and state securities laws and awarded petitioners over $6.1 million. Given petitioners' substantial settlements with the other defendants, the district court ordered that the jury's award be subject to a $5.7 million credit, conditioned on approval of those settlements. J.A. 29-30; Pet. App. A11, A17; Resp. C.A. App. 3. /6/ Thereafter, the district court denied respondent's motion for judgment notwithstanding the verdict and its alternative motion for rehearing with respect to the damages issue. Resp. C.A. App. 11-12, 16-82. Respondent appealed from the district court's denial of its post-trial motions. Respondent raised a number of claims, including renewing its contention that the Co-Op's demand notes were not securities under either federal or state securities laws. See Resp. C.A. Br. 33-37. /7/ 3. The court of appeals reversed, holding that the Co-Op's "demand notes * * * are not 'securities' for purposes of either (the) federal or Arkansas securities acts" (Pet. App. A13). /8/ The court of appeals observed that the Securities Exchange Act's definition of a security as including "any note" (15 U.S.C. 78c(a)(10)) does not resolve the issue because "'Congress intended the application of (the federal securities acts) to turn on the economic realities underlying a transaction and not on the name appended thereto.'" Pet. App. A17-A18 (quoting United Housing Found., Inc. v. Forman, 421 U.S. 837, 849 (1975) (brackets in original)). The court further stated that the Co-Op's notes could not be securities unless they met the test set forth in SEC v. W. J. Howey Co., 328 U.S. 293 (1946), for identifying "investment contracts," another term included in the statutory definition. Pet. App. A19-A20. /9/ Before applying the Howey test, however, the court of appeals, in light of this Court's decision in Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985), considered whether the Co-Op's demand notes bear both a name included within the statutory definition of a security and "the usual characteristics of a security" (Pet. App. A20). Although the notes obviously bear the name of a security, the court concluded that "(t)he demand nature of the notes is very uncharacteristic of a security" (id. at A20, A21 (citing Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257-1258 (9th Cir. 1976) (per curiam)). Accordingly, the court held that petitioners could not establish that they had purchased a security on the basis of the term "note" in the statutory definition. The court of appeals therefore proceeded to apply the Howey test, and concluded that the notes failed to satisfy two elements of that test. First, after observing that the Co-Op's members "'deposited' their money with the Co-Op in order to earn a higher return than could be obtained from a bank," the court found that "this transaction was much more akin to a commercial lending arrangement than an investment transaction" (Pet. App. A22). Second, the court concluded that the noteholders' expected return, an interest rate fixed by an established market rate, did not qualify as the requisite "reasonable expectation of profit" under Howey. Id. at A22-A23. Having determined that the Co-Op's demand notes "were uncharacteristic of securities, and also failed the Howey test," the court of appeals held that those notes are not securities under the federal securities laws and therefore reversed the district court's denial of respondent's post-trial motions (Pet. App. A23). /10/ 4. The court of appeals, with four judges dissenting, thereafter denied a petition for rehearing and suggestion for rehearing en banc. SUMMARY OF ARGUMENT I. A. The term "security" is defined in both the Securities Act of 1933 and the Securities Exchange Act of 1934 to include "any note," subject to two qualifications. First, Section 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10), provides that the definition of a security "shall not include * * * any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months," and Section 3(a)(3) of the Securities Act, 15 U.S.C. 77c(a)(3), has a similar exemption from registration. Second, both Acts provide that the statutory definitions of a security are to apply "unless the context otherwise requires." 15 U.S.C. 77b(1); 15 U.S.C. 78c(a)(10). In construing this language, the courts of appeals have resorted to three different tests to determine whether an instrument is a "note" within the meaning of the federal securities laws: (1) the "commercial-investment" test; (2) the "risk capital" test; and (3) the "family resemblance" test. The commercial-investment and risk capital approaches use multi-factor analyses to decide whether a transaction involves an investment covered by the securities laws. In contrast, the Second Circuit's family resemblance test is firmly premised on the statutory definitions and the prefatory "context" clause; as the statutes themselves suggest, the test begins with a presumption that the securities laws encompass any note unless "the context otherwise requires." Although applying different tests for determining the coverage of the term "any note," both this Court and the lower courts have uniformly agreed that the exceptions for notes and certain other debt instruments having a maturity of less than nine months (15 U.S.C. 77c(a)(3): 15 U.S.C. 78c(a)(10)) should be narrowly construed to apply only ato instruments that fit the general description of short-term commercial paper. See Securities Industries Ass'n v. Board of Governors of the Federal Reserve System, 468 U.S. 137, 150-152 (1984). This limiting construction, which follows the longstanding interpretation by the SEC, is necessary to avoid creating "a new and possibly replicable loophole in protecting investors through the Securities Acts." Baurer v. Planning Group, Inc., 668 F.2d 770, 779 (D.C. Cir. 1981). B. Of the three approaches followed by the lower federal courts, the Second Circuit's family resemblance test provides the best way to give content to the definitional provisions. Although Landreth Timber Co. v. Landreth, supra, did not fashion the test for determining when a note is a security, that decision indicated that the analysis must focus on the relevant statutory language, bearing in mind the overriding, broad purpose of the securities laws -- to protect those who purchase financial instruments offered to the public as investments. The family resemblance test for defining a "note" is, we believe, more faithful to the statutory language than is either of the competing tests. That test first looks to and gives force to the statutory language, including the prefatory "context" clause, and presumes than an instrument labelled a "note" is covered by the securities laws unless it resembles certain categories of instruments clearly not used for investment purposes or falls within the statutory exclusion for short-term commercial notes. Purchasers of these instruments do not need the protection provided by the federal securities laws. The family resemblance test also finds support in the general purpose of the federal securities laws to protect those who purchase financial instruments offered to the public as investments, as well as in the relevant legislative history. Congress broadly defined "security" to encompass many financial instruments, including "notes." "Note" was understood during the 1920s and early 1930s, as it is today, to refer to a promise to pay, either on demand or at a fixed or determinable time in the future, a sum certain to order or to bearer. The legislative history of the exemption for commercial debt instruments of less than nine months duration confirms Congress's intention to extend coverage to other types of notes offered and sold to the public as investments. Finally, the family resemblance test has other virtues. Unlike the two alternative approaches, which rely on open-ended, multi-factor analyses, the family resemblance test provides useful guidance and a greater degree of certainty regarding the status of particular types of notes under the securities laws. II. A. The Co-Op's interest-bearing demand notes are within the statutory definition of a security. The notes do not meet either condition under the family resemblance test that would take them outside the statutory definition. The Co-Op, as part of a broad offering, sold the notes to the public in small denominations as an investment. Accordingly, these notes scarcely resemble the types of notes used in commercial transactions clearly outside the scope of the securities laws. Similarly, notes such as the Co-Op's demand notes, which are sold primarily to unsophisticated individual investors, do not fall within the statutory exclusion for short-term notes, since they do not fit the "general notion" of short-term commercial paper not generally available for purchase by ordinary investors. B. Nor does the demand feature of the Co-Op's notes disqualify them from the definitional term "note" under the federal securities laws. A demand feature is not uncharacteristic of a note covered by these laws. See, e.g., Zeller v. Bogue Electric Mfg. Corp., 476 F.2d 795, 800-801 (2d Cir.), cert. denied, 414 U.S. 908 (1973). In other words, "(i)t is the character of the note, not its maturity date, which determines coverage" under the securities laws. SEC v. Continental Commodities Corp., 497 F.2d 516, 525 (5th Cir. 1974). The key factors are that the Co-Op, as part of a broad offering, sold the notes to the public in small denominations as an investment. In focusing exclusively on the demand feature of the notes, the court of appeals mistakenly disregarded those essential features of the transactions at issue. And as other courts have uniformly recognized, where, as here, a debt instrument is offered to the general public in small denominations as an investment, the instrument is a security, regardless of the length of the instrument's term. /11/ III. A. Because the Co-Op's notes fall within the term "note" in the statutory definition of a security, those instruments need not also satisfy the "investment contract" test of SEC v. W. J. Howey Co., 328 U.S. 293 (1946). In Landreth Timber Co. v. Landreth, supra, this Court made clear that "applying the Howey test to traditional stock and all other types of instruments listed in the statutory definition would make the Acts' enumeration of many types of instruments superfluous" (471 U.S. at 692). Since the Co-Op's notes that were sold to the general public in small denominations as investments are "notes" within the statutory definition, they need not also satisfy Howey's residual test. B. Even if the Howey test governed here, the court of appeals misapplied that test. First, the record shows that the Co-Op's notes were issued to and purchased by an unsophisticated public as investments. The notes thus satisfy the "investment" element of the investment contract test. Second, the noteholders' expected return -- a fixed rate of interest -- satisfies the "profit" element of the Howey test. ARGUMENT INTEREST-BEARING PROMISSORY NOTES, PAYABLE ON DEMAND, THAT ARE WIDELY OFFERED AND SOLD TO THE PUBLIC AS INVESTMENTS, ARE SECURITIES UNDER THE FEDERAL SECURITIES LAWS. I. A Note Is A Security Within The Statutory Definition, Unless It Resembles Certain Types Of Notes Not Used For Investment Purposes That Are Clearly Outside The Scope Of The Federal Securities Laws A. The definition of "security" is fundamental to the federal securities laws, since that term "controls the scope of th(e) Act(s)." SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 350 (1943). The term "security" is defined in both the Securities Act and the Exchange Act broadly to include "any note." That sweeping inclusion is, however, subject to two qualifications. First, the definition of a "security" in the Exchange Act excludes "any note, draft, bill of exchange, or banker's acceptance" which has a "maturity at the time of issuance of not exceeding nine months," and the Securities Act has a similar exemption from registration. These are often referred to as the "commercial paper" exceptions. /12/ Second, both the reference to "any note," and the exclusion for certain types of instruments with maturities less than nine months, are qualified (as are all other statutory definitions in both Acts) by the phrase, "unless the context otherwise requires." /13/ Although this Court has not previously resolved the proper definition of a "note" for purposes of the federal securities laws, it has observed that the word "note" is "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." Landreth Timber Co. v. Landreth, 471 U.S. at 694. For that reason, the Court in Landreth said it would "expressly leave until another day" (ibid.) the question whether an instrument might be shown to be a "note" for purposes of the statutory definition of a security "'by proving (only) the document itself'" (ibid., quoting Joiner Leasing Corp., 320 U.S. at 355). The lower courts have also recognized the wide diversity in the types of instruments that are denominated "notes," and have, accordingly, uniformly rejected a literal reading of the statutory definition. Instead, they have resorted to three different tests to determine when an instrument described as a "note" is to be regarded as a "security" for purposes of the securities laws: (1) the "commercial-investment" test; (2) the "risk capital" test; and (3) the "family resemblance" test. See generally 2 L. Loss & J. Seligman, Securities Regulation 880 (3d ed. 1989). /14/ The commercial-investment approach analyzes a number of factors to decide the ultimate issue "whether the plaintiffs are simply borrowers (or lenders) in a commercial transaction who are not protected by the (securities laws) or investors in a securities transaction who are protected." C.N.S. Enterprises, Inc. v. G & G Enterprises, Inc., 508 F.2d 1354, 1359 (7th Cir.), cert. denied, 423 U.S. 825 (1975). These factors include (1) whether the obligations are sold or issued to a single party or to a large class of investors; (2) the characterization of the instruments in relevant financial statements or by the parties themselves; (3) whether the proceeds are to be used to purchase specific assets or services (commercial) or for general financing purposes (investment); (4) the extent of reliance on the efforts of others; (5) whether the noteholders are protected by collateral; (6) the number of notes issued, the number of payees, and the dollar amount of the transaction; and (7) the length of the note's term. C.N.S. Enterprises, Inc., 508 F.2d at 1359, 1361. See also Jacobs, The Meaning of "Security" Under Rule 10b-5, 29 N.Y.L. Sch. L. Rev. 211, 372-375 (1984) (citing other factors used by various courts). The risk capital test, which begins with the commercial-investment test, proceeds to determine "whether the funding party invested 'risk capital.'" Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257 (9th Cir. 1976) (per curiam). Like the commercial-investment approach, the risk capital test involves a multi-factor analysis. The factors include (1) the duration of the instrument; (2) whether it is collateralized; (3) the form of the obligation; (4) the circumstances of the issuance; (5) the relationship between the amount borrowed and the size of the borrower's business; and (6) the contemplated use of the funds. Id. at 1257-1258. On the other hand, the Second Circuit's "family resemblance" test, developed in a series of opinions authored by Judge Henry Friendly, is premised on the language of the statutory definition and the prefatory "context" clause. This approach begins with the plain language of the statute. It presumes that the securities laws encompass any note unless "the context otherwise requires." Exchange Nat'l Bank v. Touche Ross & Co., 544 F.2d 1126, 1138 (2d Cir. 1976) (emphasis in original). A note is, accordingly, regarded as a security unless it bears "a strong family resemblance" to certain categories of notes that are clearly outside the scope of the securities laws. In Exchange Nat'l Bank, 544 F.2d at 1138, the Second Circuit listed the following categories of notes that fall outside the scope of the securities laws (ibid.): the note delivered in consumer financing, the note secured by a mortgage on a home, the short-term note secured by a lien on a small business or some of its assets, the note evidencing a "character" loan to a bank customer, short-term notes secured by an assignment of accounts receivable, or a note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized). In Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 939 (2d Cir.), cert. denied, 469 U.S. 884 (1984), the court added to that list "notes evidencing loans by commercial banks for current operations." Although the lower courts have disagreed over the proper test for determining what is a "note," both this Court and the lower courts have uniformly construed the exemption for "any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months" (15 U.S.C. 77c(a)(3); 15 U.S.C. 78c(a)(10)) to refer only to notes that fit "the general notion of 'commercial paper.'" Zeller, 476 F.2d at 800. See Securities Industries Ass'n v. Board of Governors of the Federal Reserve System, 468 U.S. 137, 150-152 (1984); Holloway v. Peat, Marwick, Mitchell & Co., No. 87-1486 (10th Cir. July 11, 1989), slip op. 11-12; SEC v. American Bd. of Trade, 751 F.2d 529, 538-540 (2d Cir. 1984); Baurer v. Planning Group, Inc., 669 F.2d 770, 775-777 (D.C. Cir. 1981); Sanders v. John Nuveen & Co., 463 F.2d 1075, 1078-1080 (7th Cir.), cert. denied, 409 U.S. 1009 (1972). In so ruling, they have relied on the legislative history of the exemption (discussed at pp. 19-22, infra) and on the SEC's consistent and longstanding interpretation of this provision. See Securities Act Release No. 4412 (Sept. 20, 1961), 1 Fed. Sec. L. Rep. (CCH) Paragraph 2045 (Apr. 24, 1987). More fundamentally, these courts have noted that "(t)o exclude short-term notes that represent genuine investments from the coverage of the 1934 Act would serve no discernible statutory purpose" and "would create a new and possibly replicable loophole in protecting investors through the Securities Acts." Baurer, 669 F.2d at 776, 779. As Judge Friendly has observed: It is inconceivable that Congress intended Section 3(a)(3) to exempt from registration a periodic public offering of the issuer's own notes to small investors simply because their maturity was less than nine months. It is almost equally unlikely that Congress meant that an issuer soliciting broad public investment in notes issued for general corporate purposes should be able to avoid the anti-fraud provisions of the 1934 Act simply by arranging that they should have "a maturity at the time of issuance of not exceeding nine months." American Bd. of Trade, 751 F.2d at 539-540. B. The different approaches developed by the courts of appeals for determining whether an instrument is a "note" obviously overlap to a significant degree. We do not doubt that those approaches would produce similar results in many cases. As one commentator has correctly observed, "(d)espite the diversity of (the three) approaches, they do contain a common core; that is, an issue of notes of whatever maturity sold to more than a few purchasers who are not in the business of loaning money will be deemed securities." Jacobs, supra, 29 N.Y.L. Sch. L. Rev. at 381-382. Yet even though the approaches reflect a "common core," we believe that the Second Circuit's family resemblance approach is, for several reasons, superior to either the commercial-investment test or the risk capital tests. We consequently urge the Court to adopt the Second Circuit's method for implementing the statutory definition. /15/ 1. An important virtue of the family resemblance test is that it conforms most closely to the statutory language. As this Court indicated in Landreth Timber Co. v. Landreth, 471 U.S. at 685, in determining the meaning of "security," as in other matters, it is fundamental to begin with the language of the statute itself. It is, after all, the statute that is law. To be sure, the Court also indicated that the fact that an instrument bears one of the labels mentioned in the statutory definition "is not of itself sufficient to invoke the coverage of the Acts." Id. at 686. Even with respect to traditional stock -- "the paradigm of a security" (id. at 693), quoting Daily v. Morgan, 701 F.2d 496, 503 (5th Cir. 1983)) -- the Court stated that it was necessary to ask whether the stock in question possesses the characteristics "traditionally associated with common stock" (471 U.S. at 687), and whether reading the securities laws to apply to the sale of stock in question would comport "with Congress' remedial purpose in enacting the legislation to protect investors" (ibid.). Nevertheless, the Court clearly rejected the contention that the inquiry into whether an instrument is a security should be conducted exclusively in terms of the economic substance of the transaction, rather than by asking, at least as an initial matter, whether the instrument falls within the terms of one of the categories specifically enumerated in the statute. The Second Circuit's approach to defining a "note," like Landreth's approach to the definition of "stock," begins with the words of the statute. The family resemblance test starts with the language broadly defining a security to include "any note," and the language excluding from that definition "any note * * * which has a maturity at the time of issuance of not exceeding nine months," and then construes these provisions in light of the prefatory clause "unless the context otherwise requires." See, e.g., American Bd. of Trade, 751 F.2d at 538-540; Chemical Bank, 726 F.2d at 939; Exchange Nat'l Bank, 544 F.2d at 1138. Thus, a note of more than nine months maturity is initially presumed to be a security, whereas a note of less than nine months maturity is initially presumed not to fall within the statutory definition. At that point, "(a) party asserting that a note of more than nine months maturity is not within the 1934 Act (or that a note with a maturity of nine months or less is within it) * * * has the burden of showing that the context otherwise requires." Exchange Nat'l Bank, 544 F.2d at 1137-1138 (emphasis in original). By using the "context" clause in this manner, the family resemblance approach is at once faithful to the plain meaning of the statute, and yet affords the flexibility that all courts and commentators have recognized is necessary in order to give effect to the overriding purposes of the securities laws. The commercial-investment and the risk capital approaches, in contrast, provide the necessary flexibility (indeed, as discussed below, they may provide too much flexibility), but they have no apparent nexus to the language of the statutory definition. See also Securities Industries Ass'n, 468 U.S. at 153-154 (rejecting the use of a "functional test" to define the word "note" under the Glass-Steagall Act). 2. The family resemblance test also finds support in the general purposes and history of the federal securities laws. The overriding purpose of the securities laws is to ensure that persons who purchase financial instruments offered to the public as investments are fully and accurately informed about the investment's relevant features, including its risks. Congress enacted the Securities Act in response to President Roosevelt's call for federal regulation of "traffic in investment securities." H.R. Rep. No. 85, 73d Cong., 1st Sess. 1 (1933). Congress was well aware that "the public in the past ha(d) sustained severe losses through practices neither ethical nor honest on the part of many persons and corporations selling securities" (ibid.). Accordingly, Congress insisted that sellers of securities must not conceal any important information from the "buying public" (id. at 2); see also H.R. Rep. No. 1383, 73d Cong., 2d Sess. 1-5 (1934). The family resemblance test is consistent with this overriding purpose. By using the "context" clause to exclude from the definition of "note" certain instruments that are acquired in typical commercial loan transactions, the test excludes from the scope of the definition of "note" only those transactions where Congress's objectives clearly are not implicated. And by invoking the "context" clause to limit the scope of the exclusion for notes of less than nine months maturity to transactions in commercial paper (or its close equivalent), the Second Circuit's approach ensures that the exclusion is not used to frustrate or circumvent the purposes of the statute. The family resemblance test is also consistent with the legislative history. Although little direct evidence exists as to why Congress included the term "any note" in the definition of a security, the historical context suggests that inclusion of this term reflected a congressional desire to define "security" broadly to encompass a wide variety of financial instruments. /16/ "Note" was understood at that time, as it is today, to refer to a promise to pay, either on demand or at a fixed or determinable time in the future, a sum certain to order or to bearer. This was the definition used in the Uniform Negotiable Instruments Act (1897 N.Y. Laws ch. 612), which was first enacted in New York in 1897, and had been enacted in all States by 1924. /17/ That Congress intended to provide protection broadly to members of the public who buy notes as investments is particularly evident from the legislative history of the statutory exemption for notes and certain other debt instruments of less than nine months maturity. The list of excluded instruments, "note, draft, bill of exchange or banker's acceptance," had a well-understood meaning in ordinary business (as opposed to investment) transactions: it referred to what is generally called commercial paper. /18/ Congress recognized that parties to such transactions in the commercial paper market, in which ordinary members of the investing public rarely participated, did not need the same protection as the public at large. Originally, the draft of the bill that became the Securities Act contained no exemption for short-term commercial paper. However, testimony and comments of members of the Federal Reserve Board, the Investment Bankers Association of America, and various commercial paper dealers prompted congressional action. These statements indicated that a limited exemption from registration was warranted since these business financing instruments were not sold to the general public, but rather to a sophisticated class of professionals. /19/ For example, as one representative of the investment banking industry explained: Now, commercial paper and promissory notes are not sold to the public. You and I are never going to lose any money nor is any of the public going to lose any money if that man should happen to default in those notes. Yet under this bill those notes would be characterized and classified as securities. They must be exempted unless you wish to stop the trade of the country in its ordinary rules. Federal Securities Act: Hearing on H.R. 4314 Before the House Comm. on Interstate and Foreign Commerce, 73d Cong., 1st Sess. 179 (1933) (statement of William C. Breed, counsel for the Investment Bankers Association of New York, New Jersey, and Connecticut; also representing the Investment Bankers Association of America) (hereinafter House Hearing). /20/ The specialized uses of the exempted financial instruments show why ordinary public investors did not purchase them. This group of instruments -- "note, draft, bill of exchange, or banker's acceptance" -- appears to have been taken directly from Section 13 of the Federal Reserve Act, ch. 252, Section 402, 42 Stat. 1478, and the Federal Reserve Board's Regulation A. /21/ These commercial paper notes, generally of high quality, were primarily bought and sold within the business community to finance short-term and seasonal needs. See House Hearing 179. /22/ Congress thus excepted from the securities laws only those notes used in this narrow commercial context, described in the legislative history as commercial paper having very short maturation periods (four to six months), sold in large denominations, discountable at the Federal Reserve Bank, and already generally exempt from registration under the securities laws of 32 States. See H.R. Rep. No. 85, 73d Cong., 1st Sess. 15 (1933); House Hearing 179-183. In sum, the legislative history, of Section 3(a)(3) of the Securities Act, which applies equally to the Exchange Act's exclusion in Section 3(a)(10), /23/ shows that Congress intended to extend federal securities law protection to a wide variety of financial instruments denominated "note" that were offered and sold to the public as investments. At the same time, Congress specifically exempted from coverage only a narrow category of "notes" that generally were not part of ordinary investment transactions, i.e., "short-term paper of the type available for discount at a Federal Reserve Bank and of a type which is rarely bought by private investors." H.R. Rep. No. 85, supra, at 15. Congress's specific and limited exemptions for short-term commercial notes reflected its conclusion that, in light of the sophisticated character of the participants in the specialized commercial paper market as it existed in the 1920s and early 1930s, these exemptions would not deny the needed protections of the federal securities laws to ordinary investors in other debt instruments. 3. Apart from being consistent with the statutory scheme of the federal securities laws, the family resemblance test has other virtues. First, that test avoids many of the analytical difficulties inherent in the other approaches. As Judge Friendly pointed out, the commercial-investment and risk capital approaches inject a variety of factors into the analysis "without any instructions as to relative weights." Exchange Nat'l Bank, 544 F.2d at 1137. The determination whether any particular note is a security thus becomes both highly subjective and unpredictable. See ibid.; see also Jacobs, supra, N.Y.L. Sch. L. Rev. 211, 371-372, 377 (1984). /24/ Indeed, many commentators have pointed out the difficulties in applying these two approaches. /25/ The Second Circuit test, in contrast, is easier to apply. It specifies a list of categorical exclusions from the statutory definition for those notes used in obviously commercial, as opposed to investment, transactions (see p. 14, supra). The family resemblance test thus provides better guidance to parties to a transaction to determine if the instruments they plan to use will be protected under the securities laws. Cf. Landreth, 471 U.S. at 696-697 (parties to a transaction should be able to determine whether the securities laws apply before engaging in extended discovery and litigation over "elusive" concepts). II. The Co-Op's Interest-Bearing, Demand Promissory Notes Are Securities Within The Statutory Definition, Since They Do Not Resemble Those Categories Of Notes Used For Commercial Purposes That Are Clearly Outside The Scope Of The Federal Securities Laws A. The Co-Op's interest-bearing, demand promissory notes are "notes" within the statutory definition of a security. These notes are securities under the federal securities laws unless one of two conditions is satisfied: either (1) the notes bear "a strong family resemblance" to certain categories of notes that are clearly outside the scope of the securities laws, such as "notes evidencing loans by commercial banks for current operations," Chemical Bank, 726 F.2d at 939, "note(s) delivered in consumer financing, * * * (or) short-term note(s) secured by a lien on a small business or some of its assets," Exchange Nat'l Bank, 544 F.2d at 1138; or (2) the Co-Op's notes fall within the statutory exclusion for those instruments that fit the "general notion" of short-term commercial paper not generally available for purchase by ordinary investors and having a maturity not exceeding nine months. Zeller, 476 F.2d at 800. The Co-Op's notes fail to meet either condition. The Co-Op, as part of a broad offering, sold the notes to the public in small denominations as an investment. Not only did the Co-Op style and advertise the public offering as an "investment program" (J.A. 5), the Co-Op underscored that point by having the notes carry fluctuating interest rates generally higher than those available from local financial institutions. Furthermore, the so-called "lenders" here were not commercial banks; to the contrary, they were farmers and other nonprofessional investors. The transactions, moreover, did not involve consumer financing, and the notes were neither insured nor collateralized. See, e.g., Pet. App. A70-A72; Pet. C.A. App. 1773-1782, 1905-1920. Accordingly, these notes scarcely resemble the types of notes used in commercial transactions identified by the Second Circuit as clearly falling outside the scope of the securities laws. Compare Chemical Bank, 726 F.2d at 939; Exchange Nat'l Bank, 544 F.2d at 1138. Similarly, notes such as the Co-Op's demand notes, which are sold primarily to unsophisticated individual investors, do not fall within the statutory exclusion for short-term notes. As an initial matter, we observe that there is some question whether a demand note should be regarded as a note "which has a maturity at the time of issuance of not exceeding nine months." A demand note has an indefinite term, and thus may not be regarded as having a fixed term of less than nine months for purposes of the federal securities laws. But even if demand notes sold in a commercial context might otherwise fall within the terms of the exclusion, the Co-Op notes still would not qualify, since they do not fit the "general notion" of short-term commercial paper not generally available for purchase by ordinary investors. Petitioners therefore have sustained their burden under the family resemblance test of showing that the Co-Op's notes remain within the statutory definition and are thus securities under the federal securities laws. /26/ B. The court of appeals nevertheless concluded (Pet. App. A20-A21) that the demand feature of the Co-Op's notes disqualified them from the definitional term "note" under the federal securities laws. However, a demand feature is not uncharacteristic of a note covered by the securities laws. Indeed, at the time Congress enacted the securities laws, "note" was understood, as it is today, to include "demand" instruments. The federal securities laws reflect this common understanding. See pp. 19-22, supra. Consistent with this understanding, most lower courts that have addressed the issue have concluded that a demand feature does not preclude a note from being regarded as a security. In Zeller v. Bogue Electric Mfg. Corp., supra, for example, the Second Circuit held that a demand interest-bearing promissory note, issued to a party "in the position of an investor," is a security in the form of a "note" whose sale could give rise to a claim under Rule 10b-5, when it does not "fit() the general notion of 'commercial paper'" (476 F.2d at 800, 801). /27/ In other words, "it is the character of the note, not its maturity date, which determines coverage" under the securities laws. Continental Commodities Corp., 497 F.2d at 525; see Holloway, slip op. 21-22. /28/ Respondent contends (Br. in Opp. 8-9) that the notes' demand feature, by providing "instant liquidity," eliminates the element of risk essential to an investment transaction covered by the securities laws. But these notes obviously contained elements of risk -- the notes were neither insured nor collaterized. Furthermore, the Co-Op marketed the notes' demand feature not as an aspect of the investment's reduced risk, but as a feature for the purchasers' convenience. See, e.g., J.A. 5 ("NOTES ARE PAYABLE ON DEMAND, so any time you need your money we will write you a check. There is no waiting period." (monthly newsletter)). Moreover, given that the Co-Op advertised the notes as "investments" and announced monthly the current rate of interest, it is apparent that the Co-Op anticipated that noteholders would leave their money with it for extended periods of time. The record confirms that many noteholders in fact did so. See, e.g., Pet. C.A. App. 1491, 1514, 1517, 1526, 1542, 1548, 1558, 1600 (letters of noteholders at time of Co-Op's bankruptcy to trustee in bankruptcy). That there should be no special exemption for demand notes is confirmed by the fact that a "demand" feature does not preclude other types of instruments from being considered securities. See, e.g., SEC v. United Benefit Life Ins. Co., 387 U.S. 202, 205 (1967) (variable annuities); see also Section 2(a)(32) of the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(32) (mutual fund shares). Even if the Co-Op's demand notes are viewed as analogous to an interest-bearing savings account or an account with a savings and loan association, they would not be excluded from the definition of a security on that basis. In Tcherepnin v. Knight, 389 U.S. 332 (1967), this Court held that withdrawable capital shares in a state-chartered savings and loan association are securities. /29/ Contrary to respondent's contention (Br. in Opp. 7), the "critical feature" of the Co-Op's notes is not their demand feature. The key factors are that the Co-Op, as part of a broad offering, sold the notes to the public in small denominations as an investment. In focusing exclusively on the demand feature of the notes, the court of appeals mistakenly disregarded those essential features of the transactions at issue. As other courts have uniformly recognized, where, as here, a debt instrument is offered to the general public in small denominations as an investment, the instrument is a security, regardless of the length of the instrument's term. See, e.g., American Bd. of Trade, 751 F.2d at 538-540; Hunssinger v. Rockford Business Credits, Inc., 745 F.2d 484, 492 (7th Cir. 1984); United States v. Farris, 614 F.2d 634, 641 (9th Cir. 1979), cert. denied, 447 U.S. 926 (1980); Lawler v. Gilliam, 569 F.2d 1283, 1286-1287 (4th Cir. 1978); SEC v. World Radio Mission, 544 F.2d 535, 537-540 (1st Cir. 1976); McClure, 497 F.2d at 493-494. III. The Co-Op's Notes Need Not Satisfy The "Investment Contract" Test To Qualify As Securities Since They Are "Notes" Within The Statutory Definition Of Security A. Because the Co-Op's notes fall within the term "note" in the statutory definition of security, those instruments need not also satisfy the "investment contract" test of SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (see note 9, supra). In Landreth Timber Co. v. Landreth, supra, the court of appeals had held that an instrument that was "stock" within the statutory definition of security nonetheless is not a security unless it satisfied the Howey test (471 U.S. at 685). In reversing the court of appeals' judgment, this Court squarely rejected that reasoning, explaining that the Howey test was designed to determine whether a particular instrument is an "investment contract," not whether it fits within any of the examples listed in the statutory definition of "security." * * * Moreover, applying the Howey test to traditional stock and all other types of instruments listed in the statutory definition would make the Acts' enumeration of many types of instruments superfluous. Id. at 691-692 (emphasis in original); see Holloway, slip op. (19-21). As we have shown, since the Co-Op's notes were sold to the general public in small denominations as investments, they are "notes" within the statutory definition, and need not also meet the Howey residual test for determining coverage under the securities laws. B. Even if the Howey test governed here, the court of appeals misapplied that test. First, the record shows that the Co-Op's notes were issued to and purchased by an unsophisticated public as investments. The Co-Op's self-styled "investment program" is far removed from a commercial lending arrangement. This case is thus distinguishable from Union Nat'l Bank v. Farmers Bank, 786 F.2d 881 (8th Cir. 1986), which involved a loan participation transaction between two banks. Contrary to the court of appeals' unexplained conclusion, the notes satisfy the "investment" element of the investment contract test. Second, the court of appeals erred in concluding that the noteholders' expected return -- a fixed rate of interest -- may not satisfy the "profit" element of the Howey test. The court of appeals mistakenly relied on Kansas State Bank v. Citizens Bank, 737 F.2d 1490, 1495, (8th Cir. 1984), which in turn purported to follow United Housing Found., Inc. v. Forman, 421 U.S. 837, 852 (1975). Kansas State Bank focused on the Forman Court's discussion of "profit" to mean appreciation in value or participation in earnings. That discussion, however, describes only those types of profit considered in the Court's prior cases. Indeed, in Forman the Court made clear that the profit element of the Howey test is satisfied where "the investor is 'attracted solely by the prospects of a return' on his investment" (421 U.S. at 852) -- an apt characterization of an investor's expectation of receiving interest on a debt instrument. Furthermore, in Howey itself, the Court cited as an example of an investment contract falling within the securities laws the agreement in People v. White, 124 Cal. App. 548, 550-551, 12 P.2d 1078, 1079 (Dist. Ct. App. 1932), which involved a promise to return $7500 on a date certain to an investor who placed $5000 with the defendant. See Howey, 328 U.S. at 298 n.4. The Court viewed this agreement as one of "a variety of situations where individuals were led to invest money in a common enterprise with the expectation that they would earn a profit solely through the efforts of the promoter or of some one other than themselves" (id. at 298 (emphasis added)). Thus, as other courts of appeals have correctly held, a fixed rate of interest may constitute a "profit" within the meaning of the Howey test. See, e.g., Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 756 F.2d 230, 240-241 (2d Cir. 1985); El Khadem v. Equity Securities Corp., 494 F.2d 1224, 1229 (9th Cir.), cert. denied, 419 U.S. 900 (1974); but see Union Planters Nat'l Bank v. Commercial Credit Business Loans, 651 F.2d 1174, 1184-1185 (6th Cir.), cert. denied, 454 U.S. 1124 (1981). And, contrary to the reasoning of the court of appeals here, excluding from the protection of the securities laws those instruments in which investors are promised a fixed return, whether in the form of interest or lump-sum payments, would be inconsistent with this Court's directive that the "statutory policy of affording broad protection to investors is not to be thwarted by unrealistic and irrelevant formulae." Howey, 328 U.S. at 301. /30/ CONCLUSION The judgment of the court of appeals should be reversed. Respectfully submitted. KENNETH W. STARR Solicitor General THOMAS W. MERRILL Deputy Solicitor General MICHAEL R. LAZERWITZ Assistant to the Solicitor General DANIEL L. GOELZER General Counsel PAUL GONSON Solicitor JACOB H. STILLMAN Associate General Counsel MARTHA H. MCNEELY Special Counsel RANDALL W. QUINN EVA MARIE CARNEY Attorneys Securities and Exchange Commission JULY 1989 /1/ As a result of the sale of the notes at issue in this case, the Commission initiated an enforcement action for violations of the registration and antifraud provisions of the federal securities laws. The parties resolved that enforcement action by agreeing to the entry of consent injunctions. See SEC v. White, No. CA 86-2015 (W.D. Ark. May 1, 1986); Lit. Release No. 11,011 (Feb. 11, 1986), 35 S.E.C. Docket 84 (Feb. 25, 1986); Lit. Release No. 11,066 (Apr. 17, 1986), 35 S.E.C. Docket 874 (Apr. 29, 1986); Lit. Release No. 11,087 (May 1, 1986), 35 S.E.C. Docket 1076 (May 13, 1986). /2/ The district court later consolidated the complaints of the trustee and petitioners. In September 1985, the district court certified petitioners' class action. See Robertson v. White, 633 F. Supp. 954, 960 (W.D. Ark. 1986). /3/ With respect to respondent, petitioners essentially claimed that the accounting firm had fraudulently induced them to purchase the Co-Op's notes. Petitioners contended, among other things, that respondent deliberately failed to follow generally accepted accounting principles in conducting its audits and thus overvalued one of the Co-Op's major assets. Petitioners also asserted that, had respondent used proper accounting techniques, "the Co-op's insolvency would have been readily apparent," and that respondent "avoided the correct accounting treatment and lied about its reasons for so doing, in order to inflate the assets and net worth of the Co-op" (Pet. App. A16). /4/ See Resp. Amicus Mem. With Respect To Whether The Co-Op Demand Notes Are Securities, Robertson v. White, No. 85-2044 (W.D. Ark.). /5/ The court rejected respondent's argument, based on Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257 (9th Cir. 1976) (per curiam), that the demand feature of the Co-Op's notes took the notes outside the purview of the securities laws. The court first observed that Great Western itself had suggested that demand notes could be considered securities if "'payment is dependent on the success of a risky enterprise'" (Pet. App. A74 (quoting Great Western, 532 F.2d at 1257)). The court then criticized respondent's argument as elevating "form over substance" and permitting the issuer, in this case the Co-op, to choose a form -- i.e., demand notes -- which evades regulation, while allowing it to substantially practice the very evil which blue sky laws were designed to deter: the broadscale, public solicitation of large amounts of unsecured capital for deployment in a speculative venture. Pet. App. A74-A75. The court observed that the Co-Op's notes "contain no restriction as to the use to which the funds may be put" and that this fact "further puts the 'investor' at risk" (id. at A75). Given these circumstances, the court concluded that the Co-Op's notes were securities, "notwithstanding the contention that under other circumstances such an instrument might not be considered an investment" (id. at A76). /6/ Before trial, petitioners had reached settlements with most of the other defendants, who agreed to pay the class members a total of $5,744,780. See Resp. C.A. App. 3. The bankruptcy trustee's separate common law claims against respondent were also tried to the jury. The jury returned verdicts in respondent's favor on those claims. Pet. App. A17. /7/ Respondent also contended that the district court erred in submitting petitioners' federal securities claim to the jury, arguing that respondent had no duty to make any disclosures to the class members, that the record contained no evidence that respondent caused any class member to purchase the Co-Op's notes, and that petitioners had presented no evidence showing that any class member relied on respondent's auditing statements or reports. Resp. C.A. Br. 9-19. Respondent also challenged the evidentiary support for and measure of the damages award (id. at 29-33), and claimed that the district court erred in certifying the class (id. at 37-39). /8/ In light of this disposition, the court of appeals did not reach the additional issues raised by respondent. See note 7, supra. Should the Court agree with our analysis and hold that the Co-Op's notes are securities under the federal securities laws, the court of appeals would be in a position on remand to address the other challenges respondent raised below. /9/ Under the Howey test, the instrument must represent "an investment in a common enterprise with profits to come solely from the efforts of others." Howey, 327 U.S. at 301; see Pet. App. A21. /10/ The court of appeals also determined that the definitions of a security under the federal securities laws and the Arkansas Securities Act "are essentially the same" (Pet. App. A25 n.3). Accordingly, it concluded that the Co-Op's notes are not securities under state law. Id. at A23-A25. /11/ See, e.g., SEC v. American Bd. of Trade, 751 F.2d 529, 538-540 (2d Cir. 1984); Hunssinger v. Rockford Business Credits, Inc., 745 F.2d 484, 492 (7th Cir. 1984); United States v. Farris, 614 F.2d 634, 641 (9th Cir. 1979), cert. denied, 447 U.S. 926 (1980); Lawler v. Gilliam, 569 F.2d 1283, 1286-1287 (4th Cir. 1978); SEC v. World Radio Mission, 544 F.2d 535, 537-540 (1st Cir. 1976); McClure v. First Nat'l Bank, 497 F.2d 490, 493-494 (5th Cir. 1974), cert. denied, 420 U.S. 930 (1975). /12/ Section 3(a)(3) of the Securities Act, 15 U.S.C. 77c(a)(3), exempts from the Act's registration requirements (although not from the antifraud provisions, see Section 17(c) of the Securities Act, 15 U.S.C. 77q(c)) "(a)ny note, draft, bill of exchange, or banker's acceptance * * * which has a maturity at the time of issuance of not exceeding nine months * * *." Similarly, the proviso in Section 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10), excludes from the definition of security "any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months * * *." Section 3(a)(3) of the Securities Act, 15 U.S.C. 77c(a)(3), also requires that such exempted notes be used for "current transaction(s)," a requirement not found in Section 3(a)(10) of the Exchange Act. There are no reported legislative comments regarding this difference between the commercial paper exceptions in the Securities Act and the Exchange Act. See Comment, The Commercial Paper Market and the Securities Acts, 39 U. Chi. L. Rev. 362, 398 (1972). The Court has "repeatedly ruled that the definitions of 'security' in Section 3(a)(10) of the 1934 Act and Section 2(1) of the 1933 Act are virtually identical," and has instructed that those terms be so treated. Landreth Timber Co. v. Landreth, 471 U.S. 681, 686 n.1 (1985). In light of this longstanding interpretive rule, the apparent distinction has not been considered material. /13/ The full text of the definition of "security" as it appears in the Exchange Act, 15 U.S.C. 78c, provides in pertinent part: (a) Definitions. When used in this chapter, unless the context otherwise requires -- * * * * * * (10) 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 of the maturity of which is likewise limited. /14/ Most courts of appeals use the "commercial-investment" test. See, e.g., Futura Development Corp. v. Centex Corp., 761 F.2d 33, 40-41 (1st Cir.), cert. denied, 474 U.S. 850 (1985); C.N.S. Enterprises, Inc. v. G & G Enterprises, Inc., 508 F.2d 1354, 1357-1362 (7th Cir.), cert. denied, 423 U.S. 825 (1975); Zabriskie v. Lewis, 507 F.2d 546, 550-552 (10th Cir. 1974); Bellah v. First Nat'l Bank, 495 F.2d 1109, 1111-1114 (5th Cir. 1974); Lino v. City Investing Co., 487 F.2d 689, 693-696 (3d Cir. 1973). The Ninth Circuit, sometimes joined by the Sixth Circuit, uses the "risk capital" test. See, e.g., Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1256-1260 (9th Cir. 1976) (per curiam); see American Bank & Trust v. Wallace, 702 F.2d 93, 96 (6th Cir. 1983). As we stated previously, the Second Circuit uses the "family resemblance" test. See, e.g., Exchange Nat'l Bank v. Touche Ross & Co., 544 F.2d 1126, 1137-1139 (2d Cir. 1976). /15/ No party below, including the SEC as amicus curiae on the petition for rehearing, requested the court of appeals to follow the Second Circuit's approach. Nevertheless, as we previously pointed out in our brief filed in response to the Court's invitation in this case (Br. 17 n.32), it is not inappropriate for this Court to consider that argument in the first instance. The question presented by petitioners -- whether the Co-Op's notes are securities under the federal securities laws (Pet. i) -- includes the subsidiary (and substantial) issue of the proper test for determining coverage under those laws. See Sup. Ct. R. 21.1(a). Furthermore, the prudential considerations that ordinarily weigh against the Court's addressing an argument not squarely presented below do not obtain here. Federal courts have grappled for years over the proper test for determining whether an instrument is a "note." Thus, there is no doubt that the issue has been adequately addressed by the lower courts. Cf. Carlson v. Green, 446 U.S. 14, 17 n.2 (1980); Blonder-Tongue Laboratories, Inc. v. University of Illinois Found., 402 U.S. 313, 320 n.6 (1971). /16/ State securities statutes enacted before 1933 also defined "security" to include "notes." See J. Long, Blue Sky Law Section 2.01 (rev. ed. 1988). /17/ See Guttman, Article 3 Commercial Paper: An Updating of Well-Tried Concepts, 11 How. L.J. 49, 51 n.23 (1965). The Uniform Negotiable Instruments Law (NIL) was based on the English Bills of Exchange Act of 1882, 45 & 46 Vict. ch. 61, which was in turn a codification of the prior law of negotiable instruments. See Guttman, supra, 11 How. L.J. at 51. The NIL has been superseded by the Uniform Commercial Code, which retains the same definition of note. See U.C.C. Section 3-104 (1977). /18/ See Hicks, Commercial Paper: An Exempted Security Under Section 3(a)(3) of the Securities Act, 24 UCLA L. Rev. 227, 235 n.37 (1976). /19/ See Letter from Chester Morrill, Secretary of the Federal Reserve Board, to Rep. Sam Rayburn, Chairman, House Committee on Interstate and Foreign Commerce (Apr. 3, 1933), quoted in Federal Securities Act: Hearing on H.R. 4314 Before the House Comm. on Interstate and Foreign Commerce, 73d Cong., 1st Sess. 180 (1933) (hereinafter House Hearing); House Hearing 180-181 (statement of William C. Breed, counsel for the Investment Bankers Association of New York, New Jersey, and Connecticut; also representing the Investment Bankers Association of America); Letter from Lane, Roloson & Co. to Sen. Duncan Fletcher (Apr. 1, 1933), quoted in Securities Act: Hearings on S. 875 Before the Senate Comm. on Banking and Currency, 73d Cong., 1st Sess. 94 (1933) (hereinafter Senate Hearings); Letter from McCluney & Co. to Sen. Duncan Fletcher (Apr. 1, 1933), quoted in Senate Hearings 95. The Federal Reserve Board included in its comment letter a draft of the proposed exemption in substantially the form in which it ultimately was adopted by Congress. See House Hearing 180; Senate Hearings 120. /20/ When questioned regarding possible general public interest in investing in these notes, Mr. Breed remarked: "I do not think that there would be much market among the public for commercial short-term paper. It is almost wholly a banking proposition." House Hearing 182. Breed also observed that "(i)t might be that a great big rich man would say, 'Well, I will take some of this short-term paper,' and he might buy it from his bank, but the ordinary public would have nothing whatever to do with it." Id. at 181. See also Comment, supra, 39 U. Chi. L. Rev. at 368-369 (in 1920s and early 1930s, banks purchased approximately 99% of commercial paper sold on the market). /21/ Section 13 of the Federal Reserve Act, which provides for discounting of commercial paper, used the terms "notes, drafts, and bills of exchange." 42 Stat. 1478. Regulation A contained definitions of these terms as well as one for "banker's acceptance." See Hicks, supra, 24 UCLA L. Rev. at 235 n.37. /22/ Congress heard testimony both underscoring the unique nature of these financial instruments and emphasizing that an exemption was essential to prevent "hardship" to the banking institutions which comprised the market for true commercial paper. See Senate Hearings 94-95. And the Federal Reserve Board itself supported this position, stressing that the provisions of the Securities Act should not apply "to short-time paper issued for the purpose of obtaining funds for current transactions in commerce, industry or agriculture and purchased by banks and corporations as a means of employing temporarily idle funds." House Hearing 180. /23/ There are no reported legislative comments regarding the Exchange Act's exclusion of short-term notes. See Comment, supra, 39 U. Chi. L. Rev. at 397. But in light of the virtually identical definitions of "security" in the Securities Act and the Exchange Act, courts have routinely used the legislative history surrounding the Securities Act's exemption for short-term commercial notes to interpret the Exchange Act's exclusion. See, e.g., American Bd. of Trade, 751 F.2d at 538-540; Baurer v. Planning Group, Inc., 669 F.2d 770, 775-777 (D.C. Cir. 1981); McClure, 497 F.2d at 493 n.1. /24/ Professor Jacobs, for example, has observed that factors used in opinions applying the commercial-investment dichotomy are not necessarily the only appropriate ones. Prior opinions are of limited utility since every case is highly fact-oriented, each applicable factor need not receive the same weight, and courts have not uniformly applied the standards. An inability to accurately predict the outcome of a particular case is therefore an inherent drawback of the commercial-investment dichotomy approach. Jacobs, supra, 29 N.Y.L. Sch. L. Rev. at 371-372 (footnotes omitted). Professor Jacobs also notes that the same drawback applies to the risk capital test's multi-factor analysis. Id. at 377. /25/ See, e.g., 2 L. Loss & J. Seligman, Securities Regulations 881-882 (3d ed. 1989); Pollock, Notes Issued in Syndicated Loans -- A New Test to Define Securities, 32 Bus. Law. 537, 541-543 (1977); Sonnenschein, Federal Securities Law Coverage of Note Transactions: The Antifraud Provisions, 35 Bus. Law. 1567, 1603 (1980); Note, The Economic Realities of Defining Notes as Securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, 34 U. Fla. L. Rev. 400, 418 (1982). /26/ Should the Court be disinclined to adopt the Second Circuit's family resemblance test, the Court should nonetheless hold that the Co-Op's notes qualify as securities under either the commercial-investment approach or the risk capital test used by the other courts of appeals. The record in this case shows that the Co-Op widely offered its unsecured notes to the public and sold them to hundreds of farmers in small denominations as an investment opportunity. See, e.g., Pet. App. A70-A72; Pet. C.A. App. 1773-1782, 1905-1920. In our view, the Co-Op's notes are securities under either of the other two approaches employed by the circuits. /27/ Accord Briggs v. Sterner, 529 F. Supp. 1155, 1168 (S.D. Iowa 1981) (demand note held to be a security); The Fund of Funds, Ltd. v. Vesco, (1976-1977) Fed. Sec. L. Rep. (CCH) Paragraph 95,644 at 90,193-90,195 (S.D.N.Y. July 21, 1976) (same). /28/ The court of appeals mistakenly relied on the statement in Great Western Bank & Trust v. Kotz, supra, that a "demand or short-term note is almost ipso facto not a security * * *." First, although for the reasons discussed above (see pp. 19-22, supra) we disagree with the Ninth Circuit's statement, Great Western involved a loan transaction between a bank and an individual (on behalf of a corporation), which was secured in part by collateral in the form of a bank account with a $300,000 mandatory minimum balance. That commercial loan arrangement is quite different from the public offering of an investment opportunity at issue here. Second, although ultimately holding that the transaction did not involve a "note" within the meaning of the federal securities laws, the Great Western court made clear that, of the numerous factors it considered, no single factor compelled its conclusion. 532 F.2d at 1258. /29/ Although the Court's reasoning in Marine Bank v. Weaver, 455 U.S. 551, 558 (1982), would exclude certain accounts from coverage under the securities laws -- accounts subject to a comprehensive scheme of federal banking regulation designed to ensure financial soundness and protect depositors against the risk of insolvency, especially federal deposit insurance -- the Co-Op's notes certainly do not fall within that category. /30/ In addition, the issuer's or seller's method of promoting an instrument is a material factor in determining whether that instrument is an investment contract. See, e.g., SEC v. United Benefit Life Ins. Co., 387 U.S. 202, 211 (1967); SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 353 (1943). Here, as discussed above (see, e.g., pp. 25-26, supra), the record shows that the Co-Op advertised its notes as investments.