41.2 Definition of Security
Are the notes issued by Co-Op “securities”?
In order to answer whether or not these notes are securities we need to understand what a security is. According to our textbook (p.647), the definition of security:
(1) An interest or instrument that is common stock, preferred stock, a bond, a debenture, or a warrant
(2) An interest or instrument that is expressly mentioned in securities acts; and (3) an investment contract.
Next, we can use the family resemblance test to determine if the notes issued by Co-Op can be categorized as securities. The family resemblance test refers to a method of analyzing a debt instrument that is having a horizontal commonality. Horizontal commonality means pooling of interests, not only between the seller and each individual buyer, but also among all those who buy an investment contract in the same venture
The following are the four factors to be considered while applying the family resemblance test:
The motivation that prompts a reasonable buyer and seller to enter into the transaction in question: The Co-Op sold the notes in an effort to raise capital for its general business operations, and purchasers bought them in order to earn a profit in the form of interest.
The plan of distribution of the instrument: the Co-Op offered the notes over an extended period to its 23,000 members, as well as to nonmembers, and more than 1,600 people held notes when the Co-Op filed for bankruptcy.
The reasonable expectations of the investing public: The advertisements for the notes here characterized them as “investments,” and there were no countervailing factors that would have led a reasonable person to question this characterization.
The existence of an alternate regulatory scheme reducing the risk of the instrument: There is no risk-reducing factor to suggest that these instruments are not in fact securities