Rule 144 Solution
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Notes and debentures are securities when they have certain qualities or features.  In general, a note or debenture that is convertible according to its terms into the issuing company’s common stock can be deemed a security for purposes of Rule 144.  The Supreme Court has determined that under the “family resemblance test” set forth in the Howie case, “a note is presumed to be a security unless it bears a strong resemblance, determined by examining four specified factors, to one of a judicially crafted list of categories of instrument that are not securities”.

In the Reves case, the Supreme Court, applying four relevant factors, found

  1. “the[notes were sold] to raise capital, and purchasers bought them to earn a profit in the form of interest, so that they are most naturally conceived as investments in a business enterprise;
  2. there was “common trading” of the notes, which were offered and sold to a broad segment of the public;
  3. the public reasonably perceived from advertisements for the notes that they were investments, and there were no countervailing factors that would have led a reasonable person to question this characterization; and
  4. there was no risk-reducing factor that would make the application of the Securities Acts unnecessary, since the notes were uncollateralized and uninsured and would escape federal regulation entirely if the Acts were held not to apply”.

The Supreme Court in Reves continues (quoting another case): “types of notes that are not “securities” include “the note delivered in consumer financing, the note secured by a mortgage on a home, the short-term note secured by a lien on a small business or some of its assets, the note evidencing a character’ loan to a bank customer, short-term notes secured by an assignment of accounts receivable, or a note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized)”.

In the view of Rule144Solution.com, a note, bond or debenture that is convertible into common stock reflects and investment intent, as compared to a commercial transaction, and should be deemed to be a security. Even if the instrument has no conversion feature, its amount, maturity, use of proceeds and intent of the parties may suggest the funding was made for investment purposes. If the note were given to satisfy accounts payable or for purchase of inventory, for example, the note would not be deemed to be a security.

Analysis of a debt instrument to determine whether or not it is a security can present complex issues that cannot be covered in the foregoing summary. If you have question regarding the nature of the debt instrument you hold, please send a copy by email attachment to Rule144Soluntion.com.

If the debt instrument you hold is a security, it can be converted according to its terms into or exchanged for common stock and your holding period begins on the date you or your predecessor advanced fund against or provided consideration for the debt instrument.

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