## Facts

- Farmers Cooperative of Arkansas and Oklahoma (Co-Op), an agricultural cooperative with about 23,000 members, raised funds for general operations by selling uncollateralized, uninsured promissory notes payable on demand.
- The notes were marketed as an “Investment Program” to members and nonmembers, offering a variable interest rate set monthly to exceed local financial institutions’ rates.
- Co-Op communications described the program as safe and secure, while acknowledging it was not federally insured.
- In 1984, the Co-Op entered bankruptcy; more than 1,600 holders owned roughly $10 million in notes.
- Noteholders sued the Co-Op’s independent auditor, Ernst & Young (successor to Arthur Young & Co.), alleging audit failures that overstated assets and concealed insolvency, and asserted federal securities-fraud and state-law claims.
- A jury found for the noteholders and awarded damages; the court of appeals reversed, holding the demand notes were not “securities” under federal law.

## Issues

1. Whether the Co-Op’s demand notes are “securities” within the meaning of § 3(a)(10) of the Securities Exchange Act of 1934, which includes “any note.”
2. What test governs when a “note” is excluded from the definition of a security under federal securities law.

## Decision

- The Supreme Court reversed the court of appeals and held the Co-Op’s demand notes were “securities” under the 1934 Act.
- The Court rejected applying the *Howey* “investment contract” test to determine whether an instrument that is a note is a “security.”
- The Court adopted the “family resemblance” approach: notes are presumed to be securities unless the presumption is rebutted.
- Applying the four factors, the Court concluded the presumption was not rebutted because:
  - the Co-Op issued the notes to raise capital for general business operations and purchasers sought profit through interest;
  - the notes were broadly offered to members and nonmembers as part of an investment program;
  - marketing led reasonable purchasers to view the notes as investments; and
  - the notes were uncollateralized and uninsured, with no alternative regulatory protection that made securities regulation unnecessary.
- A dissent would have treated the demand notes as within the statute’s short-term note exclusion because they could be redeemed within nine months.

## Legal Principles

- A note is presumed to be a “security” under § 3(a)(10) unless it bears a strong resemblance to recognized categories of non-security notes.
- Whether a note strongly resembles a non-security category is evaluated by four factors:
  - the motivations of the buyer and seller;
  - the plan of distribution;
  - the reasonable expectations of the investing public; and
  - the existence of another regulatory scheme or risk-reducing factors that make securities-law protection unnecessary.
- The *Howey* test governs “investment contracts” and does not control whether a “note” is a security.
- When a note does not fit an established non-security category, courts may determine whether to recognize a new category by applying the same four-factor analysis.

## Conclusion

The Court classified the Co-Op’s demand notes as securities and established the “family resemblance” framework, requiring courts to presume notes are securities and to use the four-factor test to decide whether that presumption is rebutted for particular note transactions.


Reves v. Ernst & Young, 494 U.S. 56 (1990)