Key Takeaways
- Calling an investment a “loan” does not avoid securities laws if investors expect profits from a sponsor’s efforts.
- The Supreme Court’s Reves v. Ernst & Young decision does not exempt most friends-and-family loans from being securities.
- Only certain commercial, consumer, or bank-related notes fall outside the definition of a security.
- Private loans used to fund businesses or real estate deals almost always meet the Howey Test and are securities.
- To stay compliant, these investments must be registered or structured under an exemption like Rule 506(b) or 506(c).
Transcript
My name is Tilden Moschetti, syndication attorney with the Moschetti Syndication Law Group. We specialize in Reg D Rule 506b and Rule 506c offerings for syndicators and funds. About at least once a week, I have a meeting with somebody who believes that they have found a loophole around the securities rules. We’re going to talk about whether or not that is a real loophole or not.
The Myth of the “Friends and Family Loan” Loophole
All right, so what is this loophole that we’re talking about? Well, the story goes something like this: “I put a friends and family syndication together, but it actually wasn’t a security because what I did was I took a loan from a friend or family.” Okay, so let’s go through whether or not that is a security.
Reves v. Ernst & Young and the Misunderstood Loan Exception
The big idea where that idea comes from, it’s not crazy that they came up with it. In fact, there was a case called Reves v. Ernst and Young. In that case, the U.S. Supreme Court said that some types of loans are not securities—but not all loans.
A lot of people took that to mean that all loans are not securities. That is not what the Court said.
Types of Loans That Are Not Securities
So what did the Court actually say were not securities?
- Notes delivered in consumer financing (credit cards, personal bank loans)
- Notes secured by a mortgage on a home
- Certain short-term notes secured by liens in ordinary business transactions
- Character loans made by banks to long-standing customers
- Assignments of accounts receivable (e.g., merchant cash advances)
- Notes formalizing open account debt incurred in the ordinary course of business
- Notes evidencing a commercial bank loan for current operations
These all occur in the ordinary course of business, typically with banks or institutional lenders.
Why Friends-and-Family “Loans” Are Still Securities
Unless your friends and family are acting as a commercial bank, these exceptions almost never apply.
In a typical scenario—where someone says, “Lend me money to buy real estate or start my business, and I’ll pay you back with interest”—we go right back to the Howey Test:
- An investor puts in money
- In a common enterprise
- With an expectation of profit
- Based on the efforts of someone else
That is a security, even if it is structured as debt with a fixed rate of return.
Debt Can Still Be a Security
Even if the investment is documented as a promissory note, even if it has a set interest rate, and even if it’s called a “loan,” it is still a security if the investor is passive and relying on the sponsor’s efforts.
Bottom Line for Syndicators
Bottom line: this is not a shortcut. Raising money from friends and family through loans does not avoid securities laws if those investors expect profits from your work.
These transactions must either be registered with the SEC or qualify for an exemption like Regulation D Rule 506(b) or 506(c).
Hope that helps clarify it and keeps you out of hot water. If you’re looking to do a syndication or put together a fund, let’s talk about how to do it compliantly so everyone wins.
My name is Tilden Moschetti. I am a securities attorney specializing in Reg D syndications and funds under Rule 506b and 506c.