The Boundary Between Commercial Notes And Securities

The boundary between financing by issuing notes and issuing securities is vague. The development of judicial practice for determining the status of notes under the Securities Act has gone through a long time in America. We can see that the mode of type is fit for solving the problem and alleviating the information deficiency is the guiding value under the mode through the analysis of the judicial practice in America.The thesis is divided into three parts.The first part introduces the legislation and judicial practice on this issue in America, demonstrating its developing process.The Securities Act of 1933 and Securities Exchange Act of 1934 in America include in the statutory definition of a security"any note", but exclude from coverage those notes with maturities of less than nine months.The definitional paragraphs in the two Securities Acts are preceded by the context clause which states"unless the context otherwise requires."Judicial practice plays a more important part in making the boundary between notes and securities which has developed a series of tests including commercial/investment test, risk capital test, family resemblance test, Howey test, Reves'family resemblance test. Among these tests, Reves'family resemblance test is the widely used test at present. This test adopted the list of instruments commonly denominated notes that nonetheless fall without the security category which the second circuit has developed, what's more, it developed four factors. According to this test, a note is presumed to be a security, and that presumption may be rebutted only by showing that the note bears a strong resemblance in the terms of the four factors to one of the enumerated categories. 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. These four factors are: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". On the other hand, 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, the note is less sensibly described as a"security".Second, we examine 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, we examine the reasonable expectations of the investing public: the Court will consider instruments to be"securities"on the basis of such public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not"securities"as used in that transaction.Finally, we examine 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. The second part demonstrates the application of the Reves'family resemblance test.The fourth factor (risk-reducing factor) is designed to balance protecting the investors and not over-burdening the business community.Collateralization, insurance, acceleration provisions and the same can't be risk-reducing factors for the reason that they are all private arrangements. As to which regulatory schemes can be risk-reducing factors, we can discuss the issue from the aspects such as the goal, technique and effect of the regulatory schemes.Among these four factors, the fourth factor should be examined first, or else there will be prolixity and inefficiency in reasoning. Logically, then the third factor should be examined, but through the analysis of its content, we can see that when we examine the third factor, the first and the second factors are examined at the same time.After the fourth factor is examined at first, courts in America use the balancing approach to examine the other three factors which means it is possible to find that an instrument is a security even if one factor is not met strictly. Applying the balancing approach to the analysis of these factors, each factor may have different status and explanation in different cases. There are different angles applying the same four factors twice which realize certainty as well as flexibility and offer us a scientific thinking procedure and analysis framework.There are many similarities among the four factors and the four elements of Howey test, but essential differences exist. First, profit is defined expansively under the four factors; second, the four factors are treated as factors while Howey test includes four elements when the application of factors is looser and more flexible obviously.The uncertainty under Reves'family resemblance test is the cost of financial innovation while the flexibility under it is consistent with the legislative intent of protecting the investors. What's more, the uncertainty will be alleviated gradually with the development of practice.The third part analyzes the mode of regulation on differentiating commercial notes and securities and discusses the guiding value under this mode of regulation. Reves'family resemblance test adopts the mode of type which is different from the mode of concept as each factor for describing types needn't to be met all. The mode of type is richer than the mode of concept. Although the mode of type doesn't have the characters such as simplicity in application, uniqueness in conclusion, certainty in consequence which the mode of concept possesses, its richness and flexibility meet the requirements of differentiating between commercial notes and securities better. Describing a type or ascribing something to a type is a value-guiding thinking procedure and deciding which commercial note is a security is guided by some value necessarily. This value guides us on which factors should be examined and how these factors unite in quantity and intensity can we reach the final conclusion.We can see that the guiding value we seek for should be abstract relatively and so has the character of comprehensiveness by denying agency cost and collective action as the analyzing tools. It not only can explain the issue reasonably, but also can be consistent with the balancing of the factors. Alleviating the information deficiency is the proper guiding value under the balancing of the factors: first, the securities'character of"credence"goods, information asymmetry in the security market, the information's character of public goods make the problem of information become the core one in the security market; second, both the first two factors point to the core value of alleviating the information deficiency. Deciding whether the existence of a commercial note causes the information problem of the security market by analyzing these factors will disclose how these factors unite in quantity and intensity can the commercial note be treated as a security and so the mandatory information disclosure system is applied.