The Second Circuit put the leveraged loan market at ease and ruled that those notes are not securities. The Court had asked the Securities and Exchange Commission to offer its opinion on whether they were securities and the SEC declined to do so.
The Second Circuit followed the four factors of the Reeves “family resemblance” test.
1) “[T]he motivations that would prompt a reasonable seller and buyer to enter into” the transaction;
2) “[T]he plan of distribution of the instrument”;
3) “[T]he reasonable expectations of the investing public”; and
4) “[W]hether 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.”
The court found that the company and the note purchasers had different motivations. The company was entering into a commercial transaction. The note purchasers may have been motivated for investment.
Even though there ended up being lots of note purchasers, the distribution was controlled and not made available to the general public.
The court found that the note purchasers should have expected the notes to be treated as loans and not investments in the company.
Finally, the court found that there was some regulatory guidance and the loans were secured by a perfected interest in the company’s assets.
The court found that the notes had a family resemblance to loans issued by banks for commercial purposes. Therefore they are not securities.
The result of the decision is that the note purchasers can’t bring fraud claims under the state securities laws, which would have given them an additional remedy. In end, it was a lot of worrying, with no change in the law. It does stand as a reminder to focus on structuring loan transactions and documents to make sure you hit the points of the Reeves test.
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