from traditional shares of stock. See Grenader v. Spitz, 1975 CCG § 95,300 (S.D.N.Y. September 29, 1975).
Despite such formal legal character of the Penn Tower shares, however, defendant argues that plaintiff's participation in a closely held family corporation precludes him from relief under the 1934 Act. Although defendant's theory has a certain appeal, it is finally unpersuasive. Mindful of the Supreme Court's instruction that the federal securities laws are remedial measures and must be construed flexibly and liberally to effectuate their purposes, Tcherepnin v. Knight, 389 U.S. 332, 337, 88 S. Ct. 548, 19 L. Ed. 2d 564 (1967), we must resist defendant's invitation to delve into the workings of a validly existing business corporation and the relationship of the shareholders, just to make the threshold determination of jurisdiction. Our resistance is especially strong in a case such as this where the inquiry defendant urges could thwart the reasonable expectations of a seller of instruments which, by label and form, would appear, undeniably, to be covered securities. Such inquiry has been necessary only in rare cases, such as Forman, when an instrument denominated as stock lacked the characteristics traditionally associated with stock. Defendant has cited no cases in which a court has pursued such an inquiry when the purchase and sale involved bona fide shares of capital stock of a corporation. Defendant instead relies on cases dealing with other types of securities, such as "investment contracts" and "notes," to argue that plaintiff, because of his activities in Penn Tower's operations, is not a person whom the federal securities laws were designed to protect.
Such reliance is misplaced. The sole reason courts have become involved in analyzing the term "investment contract" is that there exists no statutory or common law definition of that term. The classic test for identifying an investment contract appears in S.E.C. v. Howey Co., 328 U.S. 293, 90 L. Ed. 1244, 66 S. Ct. 1100 (1945). In Howey the Supreme Court elevated substance over form to bring within securities law coverage items not commonly referred to as securities, but possessing the substantive characteristics of securities. Noting that the Acts fail to define the term "investment contract," the Court stated that what distinguishes a transaction involving an investment contract from other commercial dealings is that "the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." 328 U.S. at 301.
While the Howey test, especially the language "solely from efforts of others," has helped courts to identify the somewhat elusive investment contract, its applicability to other less elusive types of securities is debatable.
In any event, since stock, one of the most common forms of securities, carries a traditional and accepted meaning, it is not necessary, as defendant contends, for purposes of section 10(b) that Penn Tower stock meet the test used to identify an investment contract. Indeed, the Forman decision strongly suggests such a conclusion. The Court in Forman applied the Howey test only in part "B" of its opinion, when it determined that the Co-Op City shares were not "investment contracts." By contrast, the Court did not utilize the Howey test in making its earlier finding that the Co-Op City shares did not constitute "stock."
We find further that cases holding that promissory notes are not "securities," despite their literal coverage under the Acts, are also distinguishable from this case. The question whether a note constitutes a covered security depends on whether the note was procured for purposes of speculation or investment or for purposes of making a commercial loan. As a matter of policy, this distinction is a valid one. The federal securities laws are designed to protect investors, not persons engaged in ordinary consumer or commercial loan transactions. Moreover, subjecting ordinary loan transactions to federal securities law regulation would unnecessarily burden commercial paper markets. Thus courts have restricted application of the Acts to those notes procured for investment and have excluded notes issued in the context of a commercial loan transaction. McClure v. First Nat'l. Bank, 497 F.2d 490 (5th Cir. 1974), cert. denied, 420 U.S. 930, 43 L. Ed. 2d 402, 95 S. Ct. 1132 (1975); Lino v. City Investing Co., 487 F.2d 689 (3d Cir. 1973); Zeller v. Bogue Electric Mftg. Corp., 476 F.2d 795, 800 (2d Cir. 1972), cert. denied, 414 U.S. 908, 38 L. Ed. 2d 146, 94 S. Ct. 217 (1973); Sanders v. John Nuveen & Co., Inc., 463 F.2d 1075, 1080 (7th Cir.), cert. denied, 409 U.S. 1009, 93 S. Ct. 443, 34 L. Ed. 2d 302 (1972). In finding that the notes in question were commercial rather than investment paper, the courts in both McClure and Lino did emphasize that the notes were not publicly issued but exchanged in face to face transactions. Defendant, seizing upon this distinction, asserts that a similar emphasis here must lead us to conclude that the sale of plaintiff's stock in Penn Tower is not covered by the 1934 Act. We do not so conclude.
The reason courts have become involved in determining whether a note constitutes a security under the Acts is because instruments denominated notes can be either commercial or investment in nature. Shares of stock in a closely held family corporation do not possess such dual characteristics. Shareholders acquire these shares not with an eye towards personal use or consumption of the underlying interest (which, the Supreme Court found, was the motive of the Co-Op City tenants in Forman, 421 U.S. 837, 851, 44 L. Ed. 2d 621, 95 S. Ct. 2051 (1975)), but rather for the purpose of acquiring an interest in a profit-making venture. An ordinary commercial loan, on the other hand, does not involve the "purchase" of a security. For example, in Lino plaintiff purchased a franchise sales center license from defendant and paid with cash and notes. The court held that the transaction was commercial in nature and did not involve the purchase of securities by defendant. The court reasoned that defendant sold a right to operate a franchise sales center and accepted the note, not to invest in Lino's franchise, but to finance the franchise. Similarly, the court in Bellah v. First Nat'l. Bank, 495 F.2d 1109, (5th Cir. 1974), held that notes executed and delivered to a bank were ordinary commercial loans and fell outside the purview of the Act. The court explained that in extending the loans, the bank merely intended to aid plaintiffs in the operation of their livestock business. In accepting the notes, however, the bank did not seek to profit from the successful operation of the enterprise. Unlike these cases, where the lender did not acquire the note for speculation or investment, this case involves a defendant who clearly purchased his brother's stock in Penn Tower with the hope of realizing a return commensurate with the success of the business.
Finally, to accept defendant's arguments and deny jurisdiction on the ground that an aggrieved shareholder's participation in the operations of a closely held family corporation precludes relief under the 1934 Act could lead to the conclusion that any stock owned by persons involved in the management of a corporation would not constitute stock under the federal securities laws. Such a conclusion, however, would ignore precedent dealing with corporate insider liability. See, e.g., S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969). Nor have courts held that the federal securities laws should not apply when shares of a corporation are closely held, e.g., Thomas v. Duralite Co., Inc., 524 F.2d 577 (3d Cir. 1975), Rochez Bros., Inc. v. Rhoades, 527 F.2d 880 (3d Cir. 1975), aff'g 390 F. Supp. 470 (W.D. Pa. 1974), enforcing 491 F.2d 402 (3d Cir. 1974), aff'g and remanding in part, 353 F. Supp. 795 (W.D.Pa. 1973), or where such shares are held by persons related to each other. E.g., Kardon v. Nat'l. Gypsum Co., 69 F. Supp. 512 (E.D.Pa. 1946), 73 F. Supp. 798 (E.D.Pa.), on request for additional findings of fact, 83 F. Supp. 813 (E.D.Pa. 1947). Moreover, in the case of the sale and purchase of stock, it is well-settled that section 10(b) applies to face to face transactions between private individuals and outside the organized securities markets. E.g., Matheson v. Armbrust, 284 F.2d 670, 674 (9th Cir. 1960), cert. denied, 365 U.S. 870, 5 L. Ed. 2d 860, 81 S. Ct. 904 (1961); Hooper v. Mountain States Securities Corp., 282 F.2d 195, 201 (5th Cir. 1960).
In sum, then, we find that neither the analysis of the Supreme Court in Forman nor the lines of cases dealing with investment contracts and promissory notes preclude our assumption of jurisdiction in this action. Rather we find that plaintiff's sale of instruments that the reasonable person could not but view as shares of stock is clearly a transaction afforded protection by the 1934 Act. We, therefore, deny defendant's motion to dismiss the complaint.
Daniel H. Huyett / J.
NOW, February 12, 1976, upon consideration of the motion of defendant to dismiss and the memoranda of law submitted, IT IS ORDERED that the motion is DENIED.
Daniel H. Huyett / J.