J. C. and Fern Bellah (the Bellahs), husband and wife, appeal from a district court order dismissing their complaint alleging that the First National Bank of Hereford (the Bank) had committed violations of 15 U.S.C. § 78j(b) (1970) and Rule 10b-5 promulgated pursuant thereto.
This suit had its inception in a 1963 loan by the Bank to the Bellahs to aid them in the development of a livestock business. Continuing misfortunes left the indebtedness unliquidated, and hence on March 20, 1967, the Bellahs executed a six-month promissory note, secured by a deed of trust on real property in favor of the Bank, for the principal sum of $259,121.82. This note renewed all prior credit extended to them. The ancillary deed of trust conveyed 17 tracts of their real property as collateral, inferior to prior liens on the real estate. This combined obligation was subsequently twice renewed.
The most recent renewal is the subject of the instant litigation. On January 29, 1969, the Bellahs executed a promissory note of six-months maturity, collateralized by a deed of trust. They allege in their complaint that the Bank made several misrepresentations concomitant with the execution of the note, inter alia, that the Bellahs need not worry about foreclosure as long as the prior and superior deeds of trust were kept current. This misrepresentation purportedly induced them to forego the initiation of federal bankruptcy reorganization proceedings. In December of 1969, they also arranged for $50,000 to be deposited in the Bank, through the First Mortgage Company of Houston, in exchange for which a certificate of deposit was issued. The Bellahs claim that this transaction was negotiated upon the agreement by the Bank that an equivalent amount would be loaned to them for the purpose of financing and recycling cattle. This latter exchange, allegedly effected to raise the capital structure of the Bank and thereby enable it to make the additional $50,000 loan, never materialized. Moreover, the Bellahs' delinquency on the January 12, 1969 note
The complaint asserted three potential bases for finding subject matter jurisdiction: (1) the note; (2) the deed of trust; and (3) the certificate of deposit. In a truncated opinion, the district court elected to treat the note and ancillary deed of trust as one, and held that irrespective of whether the note and deed of trust were commercial or investment in nature, they fell within the exemption of notes maturing in less than 9 months. See 15 U.S.C. § 78c(a)(10). The court failed to address the contention that the certificate of deposit was a security.
It is in this posture that the case is before us on appeal. The district court correctly considered the note and accompanying deed of trust collectively as one potential basis of jurisdiction. Indeed, if the note were not characterizable as a security, it is difficult to conceive of how the deed of trust which secured it could be so characterized. Accordingly, we proceed to consider whether the note and deed of trust or the certificate of deposit are securities.
A. Note and Deed of Trust
The definitional section of the Securities Exchange Act of 1934, 15 U.S.C. § 78c(a) (10) (1970) provides that unless the context otherwise requires:
Despite the seemingly absolute mandate of this language, numerous other courts have refused to ritualistically apply the section. See Zeller v. Bogue Electric Manufacturing Corp., 476 F.2d 795, 800 (2d Cir. 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); SEC v. Vanco, Inc., 283 F.2d 304 (3d Cir. 1960), aff'g, 166 F.Supp. 422, 423 (D.N.J. 1958); United States v. Hill, 298 F.Supp. 1221, 1226-1227 (D.Conn.1969); Anderson v. Francis I. duPont & Co., 291 F.Supp. 705, 708 (D.Minn.1968); cf. United States v. Rachal, 473 F.2d 1338, 1343 (5th Cir. 1973). Rather, they have deemed notes with maturity dates not exceeding nine months to be subject to the Securities Exchange Act of 1934 where the notes constituted investment paper, not commercial paper. Illustrative of the reasoning underlying such dispositions is that expressed in Zeller v. Bogue Electric Manufacturing Corp., supra at 800:
See also Sanders v. John Nuveen & Co., supra at 1080.
This reasoning gives due recognition to the Supreme Court's admonition in SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195, 84 S.Ct. 275, 285, 11 L.Ed.2d 237, 248 (1963) that anti-fraud securities legislation is to be read "not technically and restrictively,
And it is this reasoning which led us to approve in United States v. Rachal, 473 F.2d 1338, 1343 (5th Cir. 1973) an instruction given by a trial court which provided that the exemption of shortterm notes from the registration provisions of the Securities Exchange Act of 1933 applied only to commercial not investment paper.
The disposition of this appeal hence ultimately hinges upon whether the note executed by the Bellahs can be characterized
In McClure v. First National Bank of Lubbock, supra, Juanita McClure, a onehalf owner of common stock in and Secretary of Gaines City Development (GCD), was allegedly induced by the First National Bank of Lubbock and her former husband who was president of GCD to execute a $200,000 note from GCD to the bank supposedly to liquidate the corporation's bad debts. This note was secured by a deed of trust which mortgaged to the bank a parcel of land which constituted substantially all the assets of the corporation. Further inquiry revealed that the proceeds of this loan were actually applied in payment of her former husband's debt to the bank and not in payment of corporate obligations. Moreover, several years later, McClure executed a separate collateral agreement, pledging to the bank a portion of all her own stock for the purpose of securing a new note which would renew and extend the original note issued by GCD. GCD's delinquency in fulfilling these obligations prompted the bank to institute foreclosure proceedings, pursuant to which all its real estate was sold to the bank.
The district court held that jurisdiction of the subject matter was lacking. Characterizing the alleged transactions as involving no more than mere internal corporate mismanagement, 352 F.Supp. at 458, it concluded that "the transactions involved amount to little more than ordinary commercial loans not intended to be covered by the Act. These transactions are totally unrelated to the abuses involving `trading for speculation or investment,' which abuses Congress in 1934 sought to eliminate." 352 F.Supp. at 457-458.
Lino v. City Investing Co., supra, and Sanders v. John Nuveen & Co., supra, employ reasoning similar to that adopted in McClure. In Lino, a 10b-5 action was instituted by a purchaser of a franchise sales center license for which promissory notes had been issued to the franchisor in partial payment. The Third Circuit characterized the notes as commercial and not investment in nature because it defined logic to assume that City Investing Co. purchased Lino's note and gave as payment, a right to operate a franchise sales center. And in Sanders, the Seventh Circuit expressed its view that "[w]hen a prospective borrower approaches a bank for a loan and gives his note in consideration for it, the bank has purchased commercial paper." 463 F.2d at 1080 (dicta).
We think that the reasoning articulated in these cases is compelling, and supports the conclusion that the note issued by the Bellahs in this case was commercial paper and not investment paper. The record reveals that in extending the loans, the Bank merely intended to aid the Bellahs in the operation of their livestock business. It is bereft of any evidence indicating that the Bank sought to profit from the successful operation of this enterprise. This court's previous remonstrations that under the Act, almost all notes are securities, see Rekant v. Desser, 425 F.2d 872, 878 (5th Cir. 1970); Lehigh Valley Trust Co. v. Central Bank of Jacksonville, 409 F.2d 989, 991-992 (5th Cir. 1969), imply that some notes are
Our disposition is buttressed by a recognition of the unsalutary consequences that would be generated by a contrary result. First, in view of the previously acknowledged similitude of the '33 and '34 Acts, notes subject to the anti-fraud proscriptions of the latter would be amenable to the registration provisions of the former. Registration is a costly procedure, both temporally and financially speaking. Subjection of loan transactions involving a promissory note to the registration requirements would inevitably wreak havoc on the commercial paper market. We have grave doubts that such a result was sought by Congress. Second, the Securities Act of 1933 and the Securities Exchange Act of 1934 create for participants in note transactions a broad but nevertheless not boundless federal forum for vindicating their grievances. We doubt that Congress intended by these Acts to render federal judges the guardians of all beguiled makers or payees. Where, as here, complaints are spawned by a commercial loan transaction, recourse must be had to state not federal courts. Mindful of these policy considerations and the reasoning employed by courts in adumbrating the commercial-investment dichotomy, we reject the Bellahs' claim that the note and the ancillary deed of trust are securities.
B. Certificate of Deposit
Section 78c(a) (10) of the Securities Exchange Act of 1934 includes as a security a "certificate of deposit, for a security." Under the judicial gloss placed on this language, a certificate of deposit issued in exchange for currency is not encompassed within the section because currency is not a security. Superintendent of Insurance of State of New York v. Banker's Life & Casualty Co., 300 F.Supp. 1083, 1099 (S.D.N.Y. 1969), aff'd, 430 F.2d 355 (2d Cir. 1970), rev'd on other grounds, 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971); SEC v. Fifth Avenue Coach Lines, Inc., 289 F.Supp. 3, 31 (S.D.N.Y.1968) aff'd on other grounds, 435 F.2d 510 (2d Cir. 1970). To the extent that the Bellahs rely on a contrary proposition, their argument is thus unavailing.
We confess, however, that we have endeavored in vain to divine the precise theory upon which their contention is bottomed.
Clearly, Superintendent of Insurance of State of New York v. Banker's Life & Casualty Co., 300 F.Supp. 1083 (S.D.N.
Young v. Seaboard Corp., 360 F.Supp. 490 (D.Utah 1973) is of similar inutility. There, shareholders of the now defunct National Bank of Coalville, instituted a section 10b-5 action, claiming that the Seaboard Corporation (Seaboard) had fraudulently precipitated the demise of the bank. Seaboard allegedly caused one million dollars to be deposited in the bank in exchange for certificates of deposit and payment of an illegal finder's fee. The deposits and finder's fees prompted the bank to make at least $450,000 in bad loans, purportedly to Seaboard's designees.
The reasoning employed in treating these deposit and loan transactions as purchases or sales of securities is somewhat obtuse.
To reiterate, we hold that the note and ancillary deed of trust executed by the Bellahs to the Bank is commercial and not investment paper and hence is not embraced by the Securities Exchange Act of 1934. We also conclude that the argument pressed upon us with respect to the certificate of deposit is similarly inefficacious. To this extent, the district court's order is affirmed.
We do not believe, however, that the Bellahs' complaint should be dismissed with prejudice in its entirety. Although not through any fault of the district court, it would appear that the Bellahs may not have had a plenary opportunity to ventilate their claims concerning the certificate of deposit. The arguments which have been presented on appeal have been categorically rejected. And because of the essential commercial nature of the transactions between the Bellahs and the Bank, we are skeptical of the possibility that any additional light which could be shed on this matter would warrant a conclusion contrary to that which we have reached. Nevertheless, lest their rights be forsaken in any respect by the limited review of their certificate of deposit contention, we shall not foreclose them from an opportunity to pursue that theory of liability in the district court, if they are able and inclined to do so. Accordingly, we affirm the dismissal of the complaint, except to the extent that the dismissal was with prejudice as to the certificate of deposit. In all other respects the judgment of the district court is affirmed.
Modified and affirmed.
17 C.F.R. § 240.10b-5 stipulates that:
The SEC has endeavored to explicate the requirements of this section in Securities Act Rel. No. 4412, 26 Fed.Reg. at 9159. This release provides that:
This release, instructive as to the '34 Act's exemption for short-term notes, Zeller v. Bogue Electric Manufacturing Corp., supra at 800, has been construed to disqualify from characterization as commercial paper, a note issued by an individual or corporation in precarious financial condition. See Sanders v. John Nuveen & Co., Inc., supra at 1079; United States v. Hill, supra at 1227. In these two cases, suits were brought seeking to subject the makers of promissory notes to the Securities Exchange Act of 1934. In contrast, in this case, the maker of a promissory note seeks to invoke the Act's prophylactic protection. While we do not disparage the conclusions reached in Hill and Sanders, we do suggest that a maker cannot bring the notes he executes within the Act merely by demonstrating his own lack of fiscal integrity. While the investment-commercial dichotomy is not intractable, it is not as chameleon-like as the Bellahs' contention would render it.
360 F.Supp. at 495-496.