• Dr. Mark Lee Levine, Professor

Is a “Note” Used in Connection with Real Estate a Security?

Although it may not be the norm, concern with Federal and state securities laws often arise in the real estate field. It may be that most of the time this issue of securities applies, if at all in the real estate field, to the area of commercial real estate. Yet, the concern has been litigated in residential cases, too.

To back up a moment, it is clear that there are Federal and state laws that impact what one must do to comply with the law of securities, where the sale of the interest constitutes a security. That is, the Federal and state jurisdictions come in to play, if at all in the field of securities, where there is an interest being sold that the law, Federal and/or state law, classifies as a security.

Such position begs the issue: If the securities laws only apply when there is a security involved, what constitutes a security under the body of law in the state and Federal jurisdictions? The answer to this question is that most states defer and/or follow the definition of a security as employed under Federal law. Thus, what is the Federal definition? The answer lies in the 1933 Securities Act, where the legislature defined a security as:

“SEC. 2. (a) DEFINITIONS.—When used in this title, unless the context otherwise requires— (1) The term ‘‘security’’ means any note, (emphasis supplied) stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’,….”

Many, many cases on the Federal and state level turn on whether there is or is not a security present to invoke the Federal and/or state jurisdiction. This issue is examined in many sources. (See, for example, Levine, Mark Lee and Feigin, Phil, Real Estate Securities, Part I, Chapter 2.) However, the issue of focus on this Tip is whether a “note” constitutes a security under the Federal and state laws. One might assume that clearly a note is a security, given the above definition that states that a note is a security! However, case law has made it clear that not all notes are securities. For example, a note given by a borrower to a bank, to finance the purchase of a house, is almost always not a security for the above definition in the securities laws.

Confusing? Yes. In fact, this issue of determining when a note is a security for these laws has been examined in many cases. Recently, the issue arose again. In a case decided in September, 2020, the Colorado Supreme Court (CSC) in Thompson v People (Advance Sheet, # 18SC543; 2020 CO 72) looked at a note involved in a case where the Securities Commission for Colorado brought an action against an individual, Thompson. The Commission alleged that Mr. Thompson violated the Colorado securities laws in selling a note that was a security, where such security was not properly registered or exempt from registration under the Colorado law.

Mr. Thompson worked as a real estate developer in his firm. He was working with undeveloped lots in Colorado. Mr. Thompson solicited an investment from a couple. A note was issued to the couple, to borrow money from them. (There are additional facts that do not have to be reviewed for purposes of this Tip.) The key was that the couple, the Witts, invested a good deal of money, thinking they would earn some quick profit. Thus, Thompson signed a note to the Witts and the Witts invested/loaned 2.4 million to Thompson. Eventually, the note came due and the Witts were not paid; Thompson defaulted.

The Witts sued for their money. They also contacted law enforcement. A criminal action was brought against Thompson for securities fraud. For the securities laws to apply in this setting, the Court had to find that there was a security involved; that is, the note had to constitute a security under the 1933 Securities Act, noted above. The CSC concluded that a note can constitute a security, with the CSC following the rule that the United State Supreme Court (USSC) held in Reves v Ernst & Young, 494 US 56 (1990). That rule adopted what is called the “family resemblance test.” Under that rule, a note is presumed to be a security, unless it comes within one of seven categories of non-securities. The USSC stated:

“Under that test, a note is presumed to be a security unless it fits into one of seven enumerated categories of non-securities: (1) notes delivered in consumer financing; (2) notes secured by a mortgage on a home; (3) short-term notes secured by liens on a small business or some of its assets; (4) notes evidencing a “character” loan to a bank customer; (5) short-term notes secured by an assignment of accounts receivable; (6) notes that simply formalize an open-account debt incurred in the ordinary course of business; or (7) notes evidencing loans by commercial banks for current operations.”

The USSC added that this presumption that a note is a security, if it does not fit within one of the seven groups excluded, can be overcome if the note in question bears a “strong family resemblance” to one of those types of notes. In determining this test, the USSC said the Court should consider four factors.

1. What prompted the parties to enter in to the transaction? Was it for investment or for personal use? That is, was the main motivation? If it is for profit, it is likely to be a security.

2. Was the plan for distribution for investment?

3. What are the reasonable expectations of the investing public? Was this an investment?

4. Is there some other regulatory scheme that reduces the risk, thus rendering the application of the securities laws unnecessary?

The CSC concluded that the note in question was a security. The CSC adopted the reasoning of the USSC and did not follow the prior CSC positions on how to determine if a note was a security. The Court held that the note signed by Thompson and given to the borrow (Witts), did not come within the seven exceptions areas stated above. The CSC said the note in question showed a “strong family resemblance” to what is a security in the investment sense. Thus, the note was a security. In turn, the CSC found that the lower court in Colorado was correct in holding that Thompson violated the securities laws in Colorado.

This reasoning supports the position in Colorado, as in many states: A note can constitute a security under the securities laws.

What this means is that real estate practitioners, among others, must be aware that even a note, such as in the Thompson case, can be a security; this in turn means the Federal and state securities laws can create liability for one not following the applicable securities laws.


Dr. Mark Lee Levine,

Professor, University of Denver

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Denver, CO, USA


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