Reves v. Ernst & Young

1990-04-16

Headline: Demand promissory notes sold by a farm cooperative are ruled to be securities, allowing investor fraud claims and exposing auditors and sellers to federal enforcement.

Holding: The Court held that the Co‑Op’s demand promissory notes are federal securities and, under the statute’s purpose, not excluded by the nine‑month exception, so federal securities fraud rules can apply to holders’ claims.

Real World Impact:

Allows investors to sue under federal securities fraud rules for similar demand notes.
Exposes auditors and advisers to liability when investment claims rely on such notes.
Subjects cooperatives and small issuers’ note programs to federal oversight.

Topics: securities definition, investment notes, auditor liability, cooperative investments

Summary

Background

An agricultural cooperative with about 23,000 members sold promissory notes payable on demand to members and nonmembers as an "Investment Program." The notes were uncollateralized, uninsured, and paid a variable interest rate; when the Co-Op later filed for bankruptcy, roughly 1,600 holders held about $10 million in notes. A class of noteholders sued the Co-Op’s auditor, alleging the auditor hid financial problems; they won a $6.1 million judgment at trial, the Eighth Circuit reversed, and the case reached the Court.

Reasoning

The Court adopted a "family resemblance" approach: start with a presumption that notes are securities, but allow that presumption to be rebutted if a note closely resembles listed non‑security categories. The Court explained four key factors for that analysis—buyer and seller motivations, plan of distribution, public expectations, and risk‑reducing regulation—and rejected applying the Howey investment‑contract test to notes. The Court found these demand notes were sold to raise capital, offered broadly as investments, and lacked protections, so they qualify as securities. On the nine‑month exception, the Court said federal law—guided by the statute’s purpose—controls whether demand notes fall outside coverage, and held these notes were not excluded.

Real world impact

The decision lets holders of similar demand notes pursue federal securities fraud claims, and it makes auditors, advisers, and issuers more likely to face federal oversight and liability for such offerings. The ruling is not an automatic rule for every demand note; outcomes could differ if the parties clearly contemplated a demand within nine months or other specific transaction designs.

Dissents or concurrances

Justice Stevens concurred, urging deference to a long line of lower‑court and SEC practice treating the nine‑month carve‑out as aimed at commercial paper. Chief Justice Rehnquist dissented in part, arguing state common‑law meaning of "maturity" treats demand notes as immediately due and therefore exempt.