When you borrow money, you are selling a note to the person lending you the money.
Both the Securities Act of 1933 and the Arizona Securities Act define security to include “any note.” In some contexts, the courts have determined that a note should not always be considered a security. An analysis of court interpretations
in order to understand when a note may not be a security is a time consuming and complicated task. The main thing you need to know is that you need to consider securities laws when you sell a note; you may wish to consult a securities attorney.
The Arizona Supreme Court has said that all notes are securities and must register unless the Arizona Securities Act provides an exemption. See State v. Tober, 173 Ariz. 206, 841 P.2d 206 (1992). Many transactions in which you borrow
money (sell a note) are probably exempt from registration requirements because they are private placements, such as borrowing from a close relative, or sales to institutional buyers, such as borrowing from a bank or savings institution.
For purposes of Arizona antifraud provisions, an Arizona court of appeals has adopted what is commonly known as the Reves test to determine when a note is not a security. See MacCollum v. Perkinson, 185 Ariz. 179, 913 P.2d 1097 (Ct.
App. 1996). The Reves test was created in 1990 by the United States Supreme Court in Reves v. Ernst & Young, 494 U.S. 56 (1990). Prior to that time, federal courts used a variety of tests to determine when a note
was not a security. Not all states have adopted the Reves test for notes; some use tests developed by federal or state courts prior to Reves.
While the Reves test involves a three-step analysis, it is essentially based on the consideration of four factors. No one factor is dispositive.
- 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. 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.
- Examine the plan of distribution to determine whether there is common trading for speculation or investment. The requisite common trading is established if the instrument is offered and sold to a broad segment of the public.
- Examine the reasonable expectations of the investing public with respect to whether the note is an "investment." Instruments are considered securities on the basis of public expectations, even where an economic analysis of the circumstances
of the particular transaction might suggest that the instruments are not securities.
- Examine whether some factor significantly reduces the risk associated with the instrument, rendering application of securities laws unnecessary. Alternative regulatory schemes, collateral, and insurance are all capable of reducing the risk sufficiently
to render the protection of federal securities laws unnecessary.
For additional information, see SEC - Broken Promises - Promissory Note Fraud.