In a win for banks and private credit lenders, the U.S. Court of Appeals, Second Circuit recently ruled a $1.8 billion leveraged loan was not a security.

The United States syndicated loan market had been anxiously waiting for an appellate court decision in Kirschner v. JP Morgan Chase Bank on whether syndicated loans should be considered securities, which would have exposed an industry that does billions of dollars in business annually to federal and state securities regulations.

“The District Court did not erroneously dismiss plaintiff’s state-law securities claims because plaintiff failed to plausibly suggest that the notes are securities,” Circuit Judge Jose Cabranes wrote.

Legal experts said a ruling against JPMorgan would have meant higher costs for borrowers because syndicated loans would have to comply with securities laws on the federal and state levels. Business groups, including the Loan Syndications and Trading Association, lobbied against deeming syndicated loans as securities, even filing an amicus brief supporting the lenders’ argument. Meanwhile, the appeals court sought input from the U.S. Securities and Exchange Commission, but the federal agency declined to weigh in.

In Kirschner, a $1.8 billion loan made to Millennium Laboratories LLC months before it filed for bankruptcy became the focus of a lawsuit after the defendant banks sold Millennium’s debt obligations to approximately 70 institutional investor groups, comprised of roughly 400 mutual funds, hedge funds, and other institutional investors.

After the bankruptcy filing, the trustee representing those investors, Marc Kirschner, accused the banks that formed the syndicate of misleading investors about Millennium’s business risks (Millennium entered Chapter 11 after a False Claims Act settlement with the U.S. Justice Department and a litigation loss to a business rival), and argued loan syndicate notes possess many of the attributes of high-yield bonds and should be regulated as securities.

A district court judge disagreed, dismissing the case and holding that syndicated loans were not securities under the “family resemblance” test adopted by the U.S. Supreme Court in Reves v. Ernst & Young.

SEC Declines to Weigh in on Kirschner Case

On appeal, the U.S. Court of Appeals, Second Circuit sought input from the SEC. After requesting three extensions, the SEC ultimately declined to weigh in:

“Despite diligent efforts to respond to the Court’s order and provide the Commission’s views, the staff is unfortunately not in a position to file a brief on behalf of the Commission in this matter. We greatly appreciate the Court’s indulgence and regret any inconvenience this may have caused the Court or the parties.”

Kirschner argued the SEC’s decision to stay on the sidelines signified how complex the issue is and that the court should return the case to the district court and ask for more due diligence and an appropriate factual record of how the case does or does not meet the standards set forth in Reves.

The defendant banks argued the SEC’s decision was a sign consensus on the issue could not be reached. They pointed out syndicate loans have been handled as loans, not securities, for 30 years, and Congress, the SEC, the U.S. Treasury and the market all recognized loans as different from securities. The banks suggested there is no reason the appellate court should disrupt settled law and market consensus by overturning the district court’s decision.

The SEC’s decision could be interpreted both ways and leads to speculation over why it made a very deliberate decision (with three extension requests) to not weigh in. Many experts believed the SEC’s stance to be important and are unclear why it would give up the chance to influence the outcome of the case. The outcome could curtail the government’s ability to regulate the syndicated loan market.