Federal Appeals Court Rules That Leveraged Loans Are Not Securities

The decision follows the SEC’s refusal to weigh in on the trillion-dollar market.


A federal appeals court ruled Thursday that leverage loans are not securities — a decision that was largely expected after the Securities and Exchange Commission declined to weigh in on the issue more than a month ago.

The appeals court had asked the SEC to file an amicus brief in the Second Circuit Court of Appeals in a case that had institutional investors pitted against JPMorgan and Citi, which had led a $1.8 billion leveraged loan for Millennium Laboratories in 2014. The company went bankrupt soon after Millennium reached a $256 million settlement with the SEC over fraudulent practices — leaving investors with no legal recourse.

If such loans had been deemed securities, the banks would be liable for failure to disclose material facts — a prospect that bankers claimed would present an “existential” threat to the $1.4 trillion leveraged loan industry, especially at time when defaults are rising.


Such a designation would also have forced the banks to bolster their capital to back the risky leveraged loans.

The potential impact on banks was apparently severe enough that banking regulators and the Treasury asked the SEC not to intervene in the case. The SEC decades ago had argued that such loans were indeed securities, and individuals knowledgeable about the situation said the regulator had prepared a brief for this case. But the SEC pulled the brief at the last minute after intense high-level lobbying by Treasury officials.

In making its ruling, the appellate court looked at a four-prong test set in a prior case to determine whether the notes at issue were securities. The court did find that the notes were an investment, which weighed in favor of them being considered securities. But although the notes were traded in the secondary market, they were not sold to the general public — an argument against defining them as securities. The appeals court also determined that the buyers of the notes did not perceive them as securities even though the buyers were called “investors” in some of the loan documents.

“We are persuaded that the sophisticated entities that purchased the Notes . . . were given ample notice that the [Notes] were . . . loans and not investments in a business enterprise,” Chief Judge Debra Ann Livingston wrote in the opinion. Finally, the judge said that the banking regulators were adequate in policing the syndicated loan market and protecting consumers.

The decision was a victory for the Loan Syndications and Trading Association, which had been lobbying both the SEC and banking regulators in recent months and also submitted its own amicus briefs to the court.

“We are gratified that the SEC declined to submit a brief and that the Court adopted our view,” said Elliot Ganz, head of advocacy and co-head of policy for the LSTA. “This is a great — and critical — result for the leveraged loan market.”

But investor advocates were dismayed by the ruling.

“This decision leaves investors, many of whom manage money on behalf of retirees and other savers, unnecessarily exposed to the risk of losses with little recourse available to them,” Andrew Park of Americans for Financial Reform, an investor advocacy group, said in a statement. “The shocking circumstances around Millennium Health at the center of this case has reminded everyone what can happen to investors when there are no securities laws.”

Following the court ruling, the group is calling on Congress and banking regulators “to address the repeated mishaps and losses in the $2.5 trillion syndicated ‘loan’ market.”

AFR, which filed an amicus brief in the case in favor of more regulation of the leveraged loan market, has urged regulators, Treasury and the SEC “to ensure that disruption and losses in the syndicated loan and securitized markets do not cascade into the broader economy, leading to further bankruptcies and job losses.”

In its brief, AFR argued that syndicated loans pose “significant economic implications for families and communities” and must be regulated as securities.