March 16, 2023

Could Syndicated Loans Be Securities?

The enduring regulatory drama over digital assets has focused much attention these past few years on the definition of “security” in the Securities Act and the Exchange Act and the largely judge-made interpretive gloss which outlines the boundaries of that definition. But whether something is a security continues to come up in other contexts, and one recent case being considered by the Second Circuit Court of Appeals revisits the almost sacrosanct conclusion that syndicated loans are not securities. If such loans were deemed to be securities, that could up-end the $2.5 trillion syndicated loan market.

In this Troutman Pepper piece, they note that last Thursday the Second Circuit heard oral arguments in the appeal of Kirschner v. JPMorgan Chase Bank, N.A. The lower court had determined that the syndicated loans in question were not securities, analyzing the question by applying the four-factor “family resemblance” test first articulated by the Supreme Court in Reves v. Ernst & Young. That test presumes that every note is a security other than certain enumerated categories of notes and notes bearing a strong family resemblance to one of those categories. After providing key takeaways from the oral arguments, the Troutman Pepper piece notes:

Regulations, like those applicable to high-yield bonds, entail extra risk. Regulations also carry administrative burdens and costs arising from compliance issues. If loans were securities, investors would pass on these risks and costs to borrowers in the form of higher pricing, stricter terms, and narrower access to capital. These changes would upset the reasonable, settled expectation of market participants that loans as an asset class are not regulated securities, and would lead to inefficiencies in the market.

The Second Circuit panel seemed resistant to interfere with the syndicated loan market where the SEC and federal regulators had to date been unwilling to do so. Although the panel questioned whether the size of the market called for greater scrutiny, the panel implied that regulators could step in if they wanted to do so, and in their absence, sophisticated investors have participated in the market on the basis of this lack of regulation, without the need for Securities Act protections.

The Second Circuit is expected to issue an opinion soon.

– Dave Lynn