Is a promissory note a security under the Texas Securities Act? (“TSA”). For starters, the TSA defines “security” to include a “note.” But as a recent Western District of Texas opinion shows, the test is hardly so simple. Vodicka v. Barlin stems from three loans made by the plaintiffs to the defendants, purportedly for a real estate development. No. 1:10-CV-00076-DAE, 2016 U.S. Dist. LEXIS 11283 (W.D. Tex. Feb. 1, 2016). Instead, according to the plaintiffs, the defendants pocketed the money as part of a Ponzi scheme.

At issue in the court’s most-recent opinion was whether the notes issued to the plaintiffs were securities under the TSA. Despite the TSA’s straightforward definition, it only creates a presumption of a security. The presumption can be rebutted by showing the notes are similar to specific types of notes that are not securities. For example, a note securing a home mortgage or a note delivered in consumer financing is typically not a security.

The decision turned on four factors laid out by the United States Supreme Court in Reves v. Ernst & Young, which has been labeled the “family resemblance test.” First, what were the motivations of a reasonable buyer and seller? Because these investors sought a high-interest return, it suggested “an investment rather than a pure commercial or consumer transaction,” and weighed towards a security. Second, was the note subject to common trading for speculation or investment? Since the notes were not commonly traded, and there was no apparent secondary market, that factor weighed against a security. Third, what was the reasonable expectation of the investing public? Based on alleged representations by the defendants, the court determined the notes’ “fundamental character” was that of an investment, and therefore a security. Fourth, were there risk-reducing factors, such as a regulatory scheme, collateral, or insurance? The court found Texas’s limited protections for creditors and debtors were not a regulatory scheme. The notes were not insured, but they were collateralized. Therefore, the court found this factor was neutral.

The court concluded the presumption from the TSA’s definition of a security, coupled with the factors discussed above, established these notes were securities. But the opinion stressed that determining whether a note is a security under the TSA typically requires a detailed analysis.