By: Walter Allison

Startups can run afoul of U.S. securities laws without even knowing it. Even if the startup offers, issues, or sells instruments that it never intended to qualify as a security, a court may later determine that those instruments were “investment contracts” (i.e., securities) subject to federal securities law. Thus, it is imperative that businesses of all sizes have some understanding of how securities laws operate and when they apply.

The purpose of this blog post is to provide an overview of how securities law treats notes. Specifically, this post will outline the common law test first announced in the Supreme Court case Reves v. Ernst & Young to inform businesses of the test that would likely be applied to notes that they have issued. The goal is to provide entrepreneurs enough context that they will not inadvertently and unknowingly issue a security when they thought they were just issuing an ordinary note. However, nothing in this post should be construed as legal advice, and specific questions should be directed toward a licensed attorney practicing securities law.

The Definition of “Note”

A note, also called a promissory note, is a written promise to pay a sum of money, at a future time, with no conditions that must be satisfied prior to the payment. The note must include words that identify the note as a note, a distinct promise to pay the specified sum back to a specific individual (the payee), and be signed by the issuer (the person/entity that owes money). Notes are legal instruments, and as such, are regulated and enforceable. Most people encounter notes with regards to consumer financing (e.g., car loans). Many businesses, small and large alike, issue notes in exchange for commercial loans to finance current operations.


Notes as Securities

  • 3(a)(10) of the Securities Exchange Act of 1934 states that “the term ‘security’ means any note” (emphasis added). That’s not true. In drafting securities laws, Congress sought to eliminate serious abuses within securities markets by crafting a broad definition of securities. Because criminals can merely relabel securities instruments in order to avoid the statute’s ambit – e.g., calling a promissory note by another name to avoid the definition’s “any note” phrase – courts focus on the economic reality of the disputed instrument while keeping in mind Congress’ goal. Thus, the Supreme Court has stated that the phrase “any note” within the definition should not be interpreted literally, but rather understood with respect to the analyzed instrument’s economic reality and an eye toward eliminating abuses within securities markets.

Family Resemblance Test

In Reves v. Ernst & Young, the Court examined whether a specific promissory note issued by the Farmers Cooperative of Arkansas and Oklahoma constituted a security. Acknowledging the wide array of instruments that may be properly considered “notes,” the Court adopted the “family resemblance test.”

The family resemblance test begins with the presumption that any note with a term of more than nine months is a security. However, because not all notes are securities, the Court also announced a judicially crafted list of exceptions. The presumption that a note with a term of more than nine months is a security can be rebutted in two ways: 1) demonstrate that the note in question bears a strong family resemblance to one of the exceptions; or 2) demonstrate that the note in question should itself be considered an exception. The judicial list of exceptions is:

1) note delivered in consuming financing

2) note secured by a mortgage on a home

3) short-term note secured by a lien on a small business or its assets

4) note evidencing a ‘character’ loan to a bank customer

5) short-term notes secured by an assignment of accounts receivable

6) a note that simply formalized an open-account debt incurred in the ordinary course of   business

7) notes evidencing loans by commercial banks for current operations


The Court announced four factors to be examined when considering whether a note resembles an item on the list or should itself constitute an exception. First, courts should examine the motivations of the buyer and seller. If the seller’s purpose is to raise money for general business operations and the buyer is primarily interested in profit, the note is more likely a security. If the seller is merely looking to buy a minor asset or correct a cash flow problem and the buyer is not interested primarily in profit, then it is less likely.

Second, courts should examine whether the instrument involves common trading for speculation or investment. Third, courts should assess the public’s expectation; i.e., are the notes in question being characterized as investments? If so, they are more likely to be considered securities. Finally, courts should assess the existence of risk-mitigating factors, such as alternative regulatory schemes or insurance on the notes, that significantly reduce the need for the note in question to be covered by the securities act.


The Supreme Court’s list of such non-security notes is a helpful bright line that empowers entrepreneurs to assess whether the notes their business is issuing might constitute a security. But when in doubt, be cautious and contact a licensed attorney practicing securities law.


Stephen J. Choi & A.C. Pritchard, Securities Regulation, 169-79 (2019)

Promissory Note, Bouvier Law Dictionary (2012)

Reves v. Ernst & Young, 110 S. Ct. 945 (1990).

This topic sentence is an extension of the Reves test, which is why I tried to keep it somewhat ambiguous WRT “Many” as opposed to “most.” For example, any short-term note secured by a lien on a small business or its assets, notes evidencing loans by commercial banks for current operations.


All of that said, this sentence isn’t necessary. I think it could be deleted without losing too much.