What is a Broker-Dealer? - Davis Polk & Wardwell

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§ 1A:4.3 BROKER-DEALER REGULATION (vii) a note evidencing loans by commercial banks for current operations. 275 In determining whether a note bears a strong resemblance to the items on the list or whether another category of instrument should be added to the list, courts consider four factors: (i) motivation of seller and buyer; (ii) plan of distribution of the instrument; (iii) reasonable expectations of the investing public; and (iv) presence of alternative regulatory regime. 276 It should be noted that section 3(a)(10) of the Exchange Act expressly excludes from the definition of “note” “any note . . . which has a maturity at the time of issuance of not exceeding nine months.” 277 However, the SEC has taken the view that the only instruments that qualify for this exclusion are those that fall under section 3(a)(3) of the Securities Act which requires that the note arise out of a current transaction or the proceeds of which have been or are to be used for current transactions. 278 Bank certificates of deposit (CDs), which have been analyzed as a type of “note,” have been the subject of considerable litigation both before and after Reves. The presence or absence or risk reducing factors, such as banking regulations and insurance, has typically played a key role in the determination of whether a CD is a security. In Marine Bank v. Weaver, the Supreme Court held that a federally insured CD was not a security subject to regulation under the Exchange Act. 279 Although the CD in Marine Bank had similarities to other types of long-term debt instruments that are usually treated as securities, the Supreme Court found it important that the CD was issued by a federally regulated bank, which provided the purchaser of the CD protection under federal banking laws and made payment in full to the purchaser of the CD almost guaranteed. Thus, the Court held that this risk reducing factor made it unnecessary to subject these instruments to regulation under the Exchange Act. 280 However, the Court stated that CDs could be securities subject to the Act in other 275. Id.; Exchange Nat. Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, (2d Cir. 1976), and Chem. Bank v. Arthur Andersen & Co., 726 F.2d 930 (2d Cir. 1984), cert. denied, 469 U.S. 884 (1984). 276. For a more detailed discussion of each factor, see Reves, 494 U.S. at 66. 277. Exchange Act § 3(a)(10). 278. See SEC Release No. 33-4412 (Sept. 20, 1961). 279. Marine Bank v. Weaver, 455 U.S. 551 (1982). 280. See id. 1A–62
What Is a Broker-Dealer? § 1A:4.4 contexts, and that instruments “must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served and the factual setting as a whole.” 281 Several Courts extended the Marine Bank exclusion beyond federally regulated banks to the CDs of state-regulated and foreign-regulated banks. On the other hand, some lower courts have treated CDs as securities in certain circumstances. 282 The Court of Appeals for the Ninth Circuit in Wolf v. Banco Nacional de Mexico extended the Marine Bank holding to foreignregulated banks, explaining that the Marine Bank exclusion should apply if “a bank is sufficiently well regulated that there is virtually no risk that insolvency will prevent it from repaying the holder of one of its certificates of deposit in full.” 283 However, the exact scope of foreign bank CDs that will, and will not, be treated as securities is still unsettled. 284 § 1A:4.4 OTC Derivatives [A] Case Law on Derivatives Prior to the Adoption of the Commodity Futures Modernization Act Although some derivative instruments are securities, others are not. For example, OTC options on equity securities or on U.S. government securities are securities within the literal word meaning of section 3(a)(10) of the Exchange Act. Other OTC instruments are less clearly securities. Prior to the enactment of the Commodity Futures Modernization Act of 2000 (“CFMA”), 285 both the SEC and the Commodity Futures Trading Commission (CFTC) 286 (which has exclusive jurisdiction over most commodity futures and options in such futures) sought to assert 281. Id. 282. See Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner, & Smith, Inc., 756 F.2d 230 (2d Cir. 1985) (that federally insured CDs were securities in the context of a CD program in which distributor, Merrill Lynch, performed certain additional services that were relevant to investors’ investment decisions). 283. Wolf v. Banco Nacional de Mexico, S.A., 739 F.2d 1458, 1463 (9th Cir. 1984). 284. See, e.g., SEC v. Sanford Int’l Bank, et al., Case No. 3-09CV0298-L (N.D. Tex. Feb. 17, 2009) (SEC advocates that certain CDs issued by Antiguan bank are securities). 285. Commodity Futures Modernization Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763 (2000). 286. The Commodity Futures Trading Commission Act of 1974, Pub. L. No. 93463 (Oct. 23, 1974), amended the CEA (7 U.S.C. §§ 1-22 (1972) and created the CFTC as an independent regulatory agency with powers greater than those of its predecessor agency, the Commodity Exchange Authority. (Broker-Dealer Reg., Rel. #9, 9/10) 1A–63
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What is a Broker-Dealer? - Davis Polk & Wardwell

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