This is the second installment in a series of posts about SEC enforcement action against Retirement Surety, LLC, Crescendo Financial, LLC, and three associated unregistered brokers based out of Dallas Texas. Read Part 1: The "Gray Area" in Unregistered Brokerage Activity, and Part 3: Punishment for Unregistered Brokerage Activity.
We’ve recently discussed a broker registration case where the SEC charged three individuals with selling securities without proper license in violation of Section 15(a)(1). A central argument in that case is whether or not the short term notes sold were considered securities.
The Securities Exchange Act of 1934 defines “securities” to include “any note,” but excludes those which have a maturity below 9 months from the time of issuance. Presumably that would mean that any note with a maturity of 9 months or longer would be considered a security. However, the decision of court case in 1990, Reves v. Ernst & Young, rebutted that idea. As a result of the case, the U.S. Supreme Court created a list of notes that do not qualify as securities, including:
- notes delivered in consumer financing;
- notes secured by a mortgage on a home;
- notes secured by a lien on a small business or some of its assets;
- notes evidencing a character loan to a bank customer;
- notes secured by an assignment of accounts receivable;
- notes that formalize an open-account debt incurred in the ordinary course of business; or
- notes evidencing loans by commercial banks for current operations.
The Court has determined that if a note does not fit within one of the listed exceptions, then it may be subject to a “family resemblance” test in order to determine whether it qualifies as a security or not. If a note can be shown to have a close resemblance to any of the exceptions or if it causes an additional exception to be added to the list, then it will not qualify as a security. The Court established four factors to be used in this analysis including:
- the buyer and seller’s motivations – whether the seller’s motivation is to raise money for general business use and whether the seller’s motivation is to make a profit;
- if the plan of distribution of the instrument includes “common trading for speculation or investment”;
- the potential investor’s reasonable expectations; and
- whether an existing regulatory scheme significantly reduces the risk of the investment.
In the Verto Capital Management notes case, because the notes are presumed to be securities, the respondents will need to sufficiently prove the notes were to completely mature in less than nine months, that the Verto notes have a family resemblance to one of the enumerated categories, or that they should cause an additional exemption to be added to the list. We will have to wait and see their next move, as the respondents have until November 17, 2017 to file any motions for summary disposition in the case.
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 15 U.S.C. § 78(c)(a)(10).
 Id. (first quoting Exchange National Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1137 (1976); then quoting Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 939 (1984)).
 Id. at 950.
 Id. at 951.