Petition — Polishing Machine Systems, Inc. v. Coffin

Pow Supreme Court, Uf Pry:

FILED’ |

1 JU

IN THE | L 24 1979

SUPREME COURT OF THE UNITED STATES. , :

BEL RODAK, JR., CLERK

OCTOBER TERM, 1979

~qg-ild

NO

POLISHING MACHINE SYSTEMS, INC.,

JOIIN A. TRICOLI, JR.

HELEN TRICOLI, and

NICHOLAS DANIELS,

| Petitioners

|

| v.

RICHARD E. COFFIN,

Respondent.

PETITION FOR WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTII CIRCUIT

W.HL.C. Venable

Michael S. Shelton

COHEN, ABELOFF & STAPLES, P.C.

207 West Franklin Street

Richmond, Virginia 23220

oor

TABLE OF CONTENTS

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STATEMENT OF THE CASE. ..............ccccssccossssescssscsesees

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ARGUMENT IN SUPPORT OF

GRANTING THE WRIT.................

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APPENDIX I: DISTRICT COURT OPINION

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_ APPENDIX II: CIRCUIT COURT OPINION

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TABLE OF CASES

Accord. Emisco Industries, Inc. v. Pro’s Inc.,

Re Be ie Eg. I ns ee En Ty

Polikoff v. Levy, 55 Il. App. 2d 229, 204

N.D. 2d 807, cert. denied 382 U.S. 903 (1965)......

Romney v. Richard Prows, Inc. 289 F.Supp. 313

Cs Se I aicihnahchcaadbis Sgtedcotecenbanaschbctbuceebickesteded

Securities & Exchange Commission v. Howey Co.,

RG: Be ic sickstuabbuninisdaninentincissonsivavecess

United Housing Foundation, Inc. v. Forman,

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IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1979

NO.

POLISHING MACHINE SYSTEMS, INC., et al.,

Petitioner

¥.

RICHARD E. COFFIN,

Respondent.

PETITION FOR WRIT OF CERTIORARI

The petitioners respectfully request that a writ of certiorari

issue to review the judgment and opinion of the United States

Court of Appeals for the Fourth Circuit entered in this matter on

April 25, 1979.

OPINIONS BELOW

The opinion of the Court of Appeals, whose judgment is

herein sought to be reviewed, is reported at 596 F2d 1202 and is

reprinted in the Appendix to this Petition beginning at page 13.

The Order of the United States District Court for the Eastern

District of Virginia, Richmond Division, dated July 28, 1977

which dismissed the respondent’s complaint for lack of juris-

diction and for failure to state a claim upon which relief can

be granted is reprinted in the Appendix to this Petition begin-

ning at page 21.

JURISDICTION

The jurisdiction of this Court is invoked pursuant to 28

U.S.C. $1254 (1). The judgment of the Court of Appeals was

entered on April 25, 1979.

QUESTIONS PRESENTED

The question presented is whether the sale of an interest

in a corporation by means of the transfer of stock certificates

with a concomitant right and obligation to participate in the

management of the corporation is a sale of “‘securities”’ within

the purview of the Securities Act of 1933 and the Securities

Exchange Act of 1934.

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1979

NO.

POLISHING MACHINE SYSTEMS, INC., et al.,

Petitioner

Vv.

RICHARD E. COFFIN,

Respondent.

PETITION FOR WRIT OF CERTIORARI

The petitioners respectfully request that a writ of certiorari

issue to review the judgment and opinion of the United States

Court of Appeals for the Fourth Circuit entered in this matter on

April 25, 1979.

OPINIONS BELOW

The opinion of the Court of Appeals, whose judgment is

herein sought to be reviewed, is reported at 596 F2d 1202 and is

reprinted in the Appendix to this Petition beginning at page 13.

The Order of the United States District Court for the Eastern

District of Virginia, Richmond Division, dated July 28, 1977

which dismissed the respondent’s complaint for lack of juris -

diction and for failure to state a claim upon which relief can

be granted is reprinted in the Appendix to this Petition begin-

ning at page 21.

JURISDICTION

The jurisdiction of this Court is invoked pursuant to 28

U.S.C. $1254 (1). The judgment of the Court of Appeals was

entered on April 25, 1979.

QUESTIONS PRESENTED

The question presented is whether the sale of an interest

in a corporation by means of the transfer of stock certificates

with a concomitant right and obligation to participate in the

management of the corporation is a sale of “‘securities’’ within

the purview of the Securities Act of 1933 and the Securities

Exchange Act of 1934.

STATUTORY PROVISIONS INVOLVED

This case involves the definition of the term “security” as

set forth in the Securities Act of 1933 and the Securities Exchange

Act of 1934. The Securities Act of 1933, 15 U.S.C. § 77b(1) (1971) -

provides as follows:

The term “security” means any note, stock,

treasury stock, bond, debenture, evidence of

indebtedness, certificate of interest or partici-

pation in any profit-sharing agreement, collateral-

trust certificate, preorganization certificate or

subscription, transferable share, investment

contract, voting-trust certificate, certificate

of deposit for a security, fractional undivided

interest in oil, gas, or other mineral rights, or,

in general, any interest or instrument commonly

known as a “security” or any certificate of interest

or participation in, temporary or interim certificate

for, receipt for, guarantee of, or warrant or right

to subscribe to or purchase, any of the foregoing.

Similar provisions are found in the Securities Exchange Act of

1934, 15 U.S.C. §78c(10) (1971) which provides as follows:

The term “security” means any note, stock, treasury

stock, bond debenture, certificate of interest or

participation in any profit-sharing agreement or

in any oil, gas, or other mineral royalty or lease,

any collateral-trust certificate, preorganization

certificate or subscription, transferable share,

investment contract, voting-trust certificate, cer-

tificate of deposit, for a security, or in general,

any instrument commonly known as a “security”,

or any certificate of interest or participation in,

a

temporary or interim certificate for, receipt for,

or warrant or right to subscribe to or purchase,

any of the foregoing; but shall not include currency

or any note, draft, bill of exchange, or banker’s

acceptance which has a maturity at the time of

issuance of not exceeding nine months, exclusive

of days of grace, or any renewal thereof the maturity

of which is 'ikewise limited.

STATEMENT OF THE CASE

This is a civil action brought by Richard E. Coffin (“‘Re-

spondent’’), in the United States District Court for the Eastern

District of Virginia, Richmond District, to recover compensatory

and punitive damages for misrepresentations allegedly made to

him in connection with his purchase of stock in Polishing Machine

Systems, Inc. The district court dismissed the action for lack

of federal jurisdiction and for failure to state a claim upon which

relief can be granted. The action was dismissed upon motion made

by the petitioners pursuant to Rule 12(b) (1); (b) (6) of the

Federal Rules of Civil Procedure. The United States Court of

Appeals for the Fourth Circuit reversed and remanded in an option

entered on April 25, 1979.

STATEMENT OF MATERIAL FACTS

The claim of the respondent was dismissed by the district court

-4-

upon motion which accepted as true the allegations set forth

in the complaint. These allegations show that the respondent

was induced to purchase a 50% interest in the common stock of

Polishing Machine Systems, Inc. for the sum of $30,000.00.

Under the agreement which effected the transaction, the re-

spondent was to share on an equal basis in the overall operation

of Polishing Machine Systems, Inc., devoting his full time to

duties as executive vice president of the corporation. As alleged

in the complaint, Mr. Coffin became “‘an active participant in

the business and affairs of Polishing Machine Systems, Inc. as

required by the Agreement.”” Complaint, q12.

After subsequently gaining access to the corporation’s

books, Mr. Coffin learned that certain representations alleged to

have been made to him during the negotations were materially

false and misleading. Specifically, the allegations provide that

Mr. Coffin discovered that Tricoli had converted corporate

assets to his own use and left Polishing Machine insolvent.

Mr. Coffin then brought this action in the district court to re-

cover damages under the federal securities acts, the Virginia

blue sky statute, and the common law of fraud.

-5-

RULINGS BELOW

In an Order entered July 28, 1977, the district court

granted the petitioners’ motion to dismiss for lack of jurisdiction

pursuant to Fed. R. Civ. P. 1 2(b) (1) and for failure to state a

claim upon which relief can be granted pursuant to Fed. R. Civ.

P. 12(b) (6).

In a Memorandum Opinion filed the same day, the district

court ruled that no federal question existed under the securities

laws because the investment made by Mr. Coffin was not a

“security” as defined by decisions of the United States Supreme

Court. The district court noted that “the law must look to the

substance and not the form” of a transaction involving stock.

Following the rulings of this Court in Securities & Exchange

Commission v. Howey Co., 328 U.S. 293 (1946) and United

Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975), the

district court concluded that even though the form of the trans-

action utilized stock which had all of the attributes of ordinary

stock, the substance of the transaction was not the sale of

securities but the sale of a one-half interest in an ongoing business

for which the purchaser was not to be an investor but rather an

6-

active and significant participant. Noting that Mr. Coffin pur-

chased a full one-half interest in the business, agreed to work

and devote his full time and effort to its affairs, served as an

officer, and shared on an equal basis in the management of the

“company, the district court found that Mr. Coffin was not

induced to invest money in the hope of deriving a profit from

the work of others and hence the transaction did not involve

the sale of a security.

The United States Court of Appeals for the Fourth Circuit

reversed the district court’s decision and remanded the case for

further proceedings in an opinion entered April 25, 1979. The

circuit court found that when a transaction involves stock,

there is a strong presumption that the securities statutes apply.

The court stated that the question of whether an investor will

derive his profit partly from his own efforts is to be considered

only when there is some showing that ordinary corporate stocks

are Other than what they appear to be, such as interests not

easily recognized as securities in the capital market. Because the

alleged transferred interest involved ordinary corporate stock,

the court of appeals concluded no other inquiry was necessary

or permissible under the federal securities acts. Therefor, the

district court’s decision was reversed and the case was remanded.

ARGUMENT IN SUPPORT OF GRANTING THE WRIT

The decision of the United States Court of Appeals for the

Fourth Circuit in holding that the transaction in dispute is with-

in the purview of the Securities Act of 1933 and the Securities

Exchange Act of 1934, is a federal question decision made in a

way probably in conflict with applicable decisions oi the United

States Supreme Court.

In holding that the-transaction in question involved a

security, the circuit court ignored the definitions for a security

set forth in two decisions of this Court, namely, Securities and

Exchange Commission v. Howey Co., 328 U.S. 293 (1946) and

United Housing Foundation, Inc. v. Forman, 421 U.S. 837

(1975). Rather than apply the flexible approach enunciated by

this Court in Forman, the circuit court utilized the wooden

approach advanced by the respondent.

Mr. Coffin initially argued before both the district and

circuit courts that because the literal definition of “‘security”

includes “any .... stock” and because the stock sold to Mr. Coffin

has “all the characteristics one usually associates with stock”,

that the transaction set forth in the complaint clearly fell with-

in the purview of the federal legislation. This argument runs con-

trary to the rationale of Forman as well as numerous decisions

from other circuits.

In United Housing Foundation, Inc. v. Forman, supra, the

plaintiffs purchased shares of stock in a housing co-op as pre-

requisites to becoming tenants in the project. When certain false

and misleading representations were discovered in the information

bulletin used to attract the tenants, the tenants sought relief

from the federal courts under the same securities acts relied upon

by Mr. Coffin. This Court quickly rejected the argument that a

stock is a stock is a stock. A seganotion is not to be considered

a security transaction under the protection of the federal

securities acts simply because the transaction is evidenced by

the sale of shares called “stock” even though the statutory

definition of security includes the words “any ... stock.” 421 U.S.

at 848. Instead, in searching for the meaning and scope of the

word “security,” a court must disregard the form of the trans-

-9-

action and look to its substance.

The same principle was applied to a converse situation in

Securities & Exch. Com. v. Howey , Co., supra. In Howey, the

Securities and Exchange Commission sought to halt the offering

of units in a citrus development. Although the transaction did

not fall within the literal definition of a “‘security,” this Court

disregarded the name given to the transaction but looked to its

substance.

Contrary to the circuit court’s ruling, therefore, the mere

fact that the transaction set forth in Mr. Coffin’s complaint in-

volved the transfer of shares of the corporation’s stock does not

per se bring the transaction within the purview of the federal

acts. Mr. Coffin must demonstrate that the substance of the

transaction, and not its form, constitutes a sale of securities.

The district court carefully considered the allegations in

Mr. Coffin’s complaint, the agreement between the parties

dated February 15, 1976 and the descriptive report prepared by

the defendants and determined that the substance of the trans-

action alleged in the complaint removed it from the purview of

the federal legislation. To determine the appropriate standard

-10-

by which the substance of the transaction was to be measured,

the district court again looked to the decisions in Forman and

and Howey.

In Howey, the respondents owned large tracts of citrus

acreage which were planted annually. Approximately one-half

of the acreage was kept by the respondents and the other half

was Offered to the public. Each purchaser was offered a land

sales contract and a service contract for the harvesting and

marketing of the crops. Looking to the substance of the trans-

action to determine whether it was within the protection of

the federal securities acts, this Court stated: ‘The test is

whether the scheme involves an investment of money ina

common enterprise with profits to come solely from the efforts

of others.”” 328 U.S. at 301. In finding that the transaction

in Howey came within the spirit if not the letter of the federal

acts, this Court noted that the purchasers had no desire to

occupy the land or to develop it themselves. The purchasers

were attracted solely by the prospects of a return on their in-

vestment not a return on their own efforts. The purchasers

were to provide the capital and share in the earnings and profits;

the promoters were to manage, control and operate the

enterprise.

The same test was applied by this Court in Forman. Quoting

from its earlier opinion in Howey, this Court expanded the appli-

cation of the Howey test to situations other than investments

contracts.

We perceive no distinction, for present purposes,

between an “investment contract”’ and an “‘instru-

ment commonly known as a ,security’.” In either

case, the basic test for distinguishing the transaction

from the other commercial dealings is

“whether the scheme involves an investment

of money in a common enterprise with profits

to come solely from the efforts of others.”

{citation omitted]

The test, in shorthand form, embodies the essential

attributes that run through all of the Court’s de-

cisions defining a security. The touchstone is the

presence of an investment in a common venture

premised on a reasonable expectation of profits

to be derived from the entrepreneurial or man-

agerial efforts of others. 421 U.S. at 852.

In Forman, this Court found that the purchasers were attracted

solely by the prospect of acquiring a place to live, and not by

financial returns on their investment. The opinion noted:

What distinguishes a security transaction - and

what is absent [in the situation of Forman] is an

investment where one parts with his money in the

hope of receiving profits from the efforts of others,

and not where he purchases a commodity for

personal consumption or ... for personal use

421 U.S. at 858.

The key factor in both Howey and Forman was whether the pur-

chaser could be fairly characterized as an “investor,” attracted

by the prospects of a return on his investment of money and

looking to derive profits from the efforts of others or whether

the purchaser could be fairly characterized as a “participant,”

attracted by the prospects of a return on the investment of his

time and effort and looking to derive profits from his own efforts.

Accord. Emisco Industries, Inc. v. Pro’s Inc., 543 F.2d 38

(7th Cir. 1976). This Court has re-iterated on numerous occasions

that the purpose of the securities acts is to protect the interest of

investors. 421 U.S. at 850 (emphasis added). In judging situations

as presented in Howey, Forman and the instant case, courts must

look at the economic realities to determine whether the purchaser

is to be an “investor” or “participant.”

Applying this well-defined test to the facts in the instant case,

the district court easily determined that Mr. Coffin was not a mere

investor. Judge Warriner found that Mr. Coffin was not really buy-

ing shares of stock; he was buying a half interest in an ongoing

a.

business with a concurrent right and obligation to participate

in its management as an equal partner. Mem. op. at 3. The

Court reviewed extensively the agreement between the parties

dated February 15, 1976 which provided that Mr. Coffin was

to “share on an equal basis in the overall operation of Polishing

Machine Systems, Inc.,”” was to assume a position as officer of

the corporation and was to “‘use [his] best efforts and full time

in the day to day overall management of the company.”

Mr. Coffin in his complaint, concedes that the substance of the

transaction was a 50-50 partnership; he was “to become an active

participant in the business and affairs,of PMS, as required by the

Agreement.” In fact, Mr. Coffin assumed the duties of executive

vice president of PMS in May of 1976. From these facts, the

district court concluded that the transaction set forth by

Mr. Coffin did not come within the securities acts. The plain-

tiff was not seeking a profit or return solely from the “‘entre-

preneurial or managerial efforts of others.” Instead, he bought

himself a job with the company and assumed an official position

as executive vice president with 50-50 managerial right.

Mem. op. at 6.

i

An analysis similar to that being urged by the respondents

has been employed by various circuits in interpreting the term

“note” as contained in the securities acts. See e.g., Emisco

Industries Inc, v. Pro’s Inc., 543 F.2d 38 (7th Cir. 1976). See

also Romney v. Richard Prows, Inc., 289 F. Supp 313 (d. Utah

1968); Polikoff v. Levy, 55 Ill, App. 2d 229, 204 N.D. 2d 807,

cert. denied, 382 U.S. 903 (1965). Applying the test enuniciated

by this Court in Howey, these courts have looked to the sub-

stance of each transaction rather than merely accept at face

value that the instrument employed in the transaction comes with-

in the literal coverage under the securities acts. Clearly, the Howey

standard has been expanded beyond merely “investment contracts

and should be employed in this instance as was done by the district

court.

CONCLUSION

The failure of the circuit court to apply the Howey test in

the instant case runs contrary to the prior decisions of this Court

and other circuit courts and provides strong reason for the

granting of the writ requested by the petitioners. The issue raised

herein is of greater importance and requires further clarification by

a,

this Court. Accordingly, the petitioner requests that this matter

be given further consideration on writ of certiorari.

Respectfully submitted,

“W is at

W.H.C. Venable

Michael S. Shelton

COHEN, ABELOFF & STAPLES, P.C.

207 West Franklin Street

Richmond, Virginia 23220

Counsel for Petitioners

CERTIFICATE

I hereby certify that on the 24th day of July, 1979, a true

and correct copy of the foregoing Petition for Writ of Certiorari

was hand delivered to Stuart W. Settle, Esquire, 200 West

Franklin Street, Richmond, Virginia, 23220, counsel for

UY i (| AQ Won.

respondent.

Michael S. Shelton

-16-

IN THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF VIRGINIA

RICHMOND DIVISION

RICHARD E. COFFIN

v. : CIVIL ACTION

NO: 77-0318-R

JOHN A. TRICOLI, JR., et al

MEMORANDUM

This matter is before the Court on defendants’ motions

of 5 July 1977 pursuant to Fed. R. Civ. P. 12(b) (1), 12(b) (6)

to dismiss the above-styled action for lack of jurisdiction and for

failure to state a claim upon which relief can be granted. As

plaintiff has filed a responsive brief to these motions and defen-

dants have filed their rebuttal brief, the motions to dismiss are

ripe.

A summary of the facts relevant to this motion as alleged

in plaintiff’s complaint is substantially as follows: Defendant

Mr. Tricoli, president of defendant Polishing Machine Systems,

Inc., (hereinafter PMS) a Virginia corporation, approached

plaintiff in November 1975. Plaintiff at that time was operating

a service station in New York State. Defendant induced plain-

tiff to become an “‘area distributor” of PMS products. The fee

charged for the “distributorship” was $3,500.

A few months later defendant Mr. Tricoli, defendant

Mrs. Tricoli, and defendant Mr. Daniels, attorney for defendant

PMS, met with plaintiff for the purpose of inducing plaintiff

to purchase for $30,000 a 50% interest in the unregistered

common stock of PMS. Shortly afterward plaintiff entered

into an agreement with defendant Mr. Tricoli setting forth

the terms of the $30,000 stock purchase, one of which was that

plaintiff, as executive vice-president, was to share on an equal

basis in the overall operation of PMS. Some several months after

gaining access to the books and accounts of PMS, plaintiff

determined that the representations made to him had been

materially false and misleading and, in fact, PMS was in a

position of insolvency. Plaintiff is now suing for both compen-

satory and punitive damages. —

It is defendants’ position that the Court lacks jurisdiction

in this matter as the Securities Act of 1933 and the Securities

and Exchange Act of 1934 do not grant jurisdiction to federal

courts unless there has been a fraudulent sale of a security

- Two-

as defined by those Acts. Defendants argue that the transaction

described by the plaintiff does not fall within the definition

of a security and, hence, plaintiff’s complaint fails both for lack

of jurisdiction and for failure to state a claim upon which relief

pa be granted.

In support of their position, defendants cite the recent case

of United Housing Foundation, Inc. v. Forman, 421 U.S.837

(1975) in which the Supreme Court held that the mere sale of

shares called “stock”’ is not colachiaively a security transaction

within the coverage of the Security Acts simply because the

statutory definition of a security includes the words “any...

stock.” Instead, in searching for the meaning and scope of the

word “security” as used in the Securities Acts, courts should

disregard form and look to the substance of the transaction.

421 U.S. at 849. The High Court went on to state that a security

involved “the presence of an investment in a common venture

premised On a reasonable expectation of profits to be derived

from the entrepreneurial or managerial efforts, of others.”

421 U.S. at 853 (emphasis added).

Plaintiff argues that since what defendants sold to him

- Three -

was Clearly, unequivocally, completely, and without modi-

fication or limitation, shares of stock then the Act must apply

without regard to any other consideration. He points out that

the decision in Forman is inapposite since, though there the

instrument was called “stock” the reality was that it was not

stock since it lacked most or all the significant attributes of

stock. By contrast, the allegations of the complaint and the

undeniable fact is that in this case the investment by plain-

tiff is represented by shares of stock to which are attached

all or substantially all the attributes generally associated with

that term. The Court sia determine whether plaintiffs’

straightforward and direct reading of the statute is consonant

with the teaching of the decided cases.

Repeatedly, the law is laid down in this area that courts

are to look to substance and not to form. The substance

of the transaction alleged in the complaint is that plaintiffs

bought a half-interest in the business along with the right to

participate 50-50 in its management. Further, they proceeded

to exercise that ownership and management. The fact that the

transfer of the ownership interest and the management right

took the form of the sale of stock dves not alter the substance.

- Four -

Nor does it alter the fact that though the form of the sale was

through stock the investment was not made for the purpose of

seeking a profit or return solely through the work of others.

The offer of the sale of the stock was contained in language to

the effect that defendant Mr. Tricoli does, “hereby offer unto

Richard E. Coffin a 1/2 (one-half) interest of Polishing Machines

Systems, Inc. That is a full 50-50 agreement. The purchase

price for said interest, the sum of $30,000.”

The contract goes on to say that, “[u] pon acceptance of

this agreement, Mr. Coffin is to share on an equal basis in the

over-all operation of Polishing Machine Systems, Inc.. and all

other directly related and wholly owned subsidiaries.”

Paragraph six of the agreement provided “‘Tricoli and

Coffin will at all times use their best efforts and full time in the

day to day overall management of the company, following

through with agreed company plans, policy and standard

operation.

Paragraph seven provided for plaintiffs and Mrs. Coffin

to assume positions as officers of the corporation and, finally,

in paragraph ten the question of the issue of stock is dealt with.

- Five -

It reads as follows, ““Upon acceptance of this agreement, the

: shares representing this 50-50 agreement to be immediately

issued.”

The substance of the investment made by plaintiff is

as set forth in the agreement from which the excerpts above are

taken. Since the business was a corporation, the form of the

purchase of the one-half interest and the assumption of one-

half management rights was through the sale of stock. The law

must look to the substance and not to the form. The question,

then, is where the substance of a business transaction is the sale

of an interest in a corporation with a concomitant right and

obligation to participate in the management, are the certificates

of stock issued to represent the transfer of that ownership interest

“stock” within the meaning of Section 2(1) of the Securities

Act of 1933?

That the name given to the investment instrument is not to

be given a wooden meaning is made clear by Securities & Exch.

Com. v. Howey Co., 328 U.S. 293 (1946). Howey discusses and

defines an “investment contract” within the meaning of Section

2(1) of the Securities Act of 1933. On pages 297-299, in

- Six -

discussing the meaning, the Court points out that at common

law “an investment contract...came to mean a contract or

scheme for ‘the placing of capital or laying out of money in a

>

way intended to secure income or profit from its employment.

Omitting citations, the Court went on to say:

This definition was uniformly applied by

State courts to a variety of situations where

individuals were led to invest money in a

common enterprise with the expectation

that they would earn a profit solely through

the efforts of the promoter or of someone

other than themselves. [328 U.S. at 298

(emphasis added) }.

The Court defined an investment contract for purposes

of the Security Act as meaning:

[A] contract, transaction or scheme whereby

a person invests his money in a common enter-

prize and is led to expect profits solely from the

efforts of the promoter or a third party, it being

immaterial whether the shares in the enterprise

are evidenced by formal certificates or by nominal

interests in the physical assets employed in the

enterprise. [328 U.S. at 298, 299. ]

The Supreme Court observed that this definition:

{[P] ermits the fulfillment of the statutory purpose

of compelling full and fair disclosure relative to the

issuance of ‘the many types of instruments that in

our commercial world fall within the ordinary concept

of a security.... It embodies a flexible rather than a

static principle, one that is capable of adaptation to

- Seven -

meet the countless and variable schemes

devised by those who seek the use of the

money of others on the promise of profits.’

{328 U.S. at 299 (emphasis added) }.

Finally, the Supreme Court observes that:

{T]he test is whether the scheme involves

an investment of money in a common enter-

prise with profits to come solely from the

efforts of others. If that test be satisfied,

it is immaterial whether the enterprise is

speculative or nonspeculative or whether

there is a sale of property with or without

intrinsic value. [328 U.S. at 301].

Though the Supreme Court in Howey consistently used the

term “investment contract” it is clear that the definition used is

applicable to “a variety of situations,” “whether...evidenced

by formal certificates or by nominal interest,” for “many types

of instruments,” effectuating “‘countless and variable schemes.”

Thus, this Court is constrained to apply the definition to all

securities, all devices and schemes, all forms or manners in which

one may be induced to invest money in the hope of deriving a

profit from the work of others. Even though the security be

clearly, unequivocally and without quibble a share of stock never-

theless, if it does not represent an interest in an enterprise from

which the investor seeks to derive a profit solely from the work

of others then it is not “stock” for purposes of the Act no matter

- Eight -

what its efficacy as stock for other purposes may be.

The premise that in Howey the Supreme Court was not

defining the narrow concept of an “investment contract’’ but

was instead trying to define the “countless and variable schemes

parr by those who seek the use of money of others on the

promise of profits” is made clear by its further discussion in

Forman, supra. The Court held in Forman that the mere

naming of a piece of paper as “‘stock” did not make it stock

for the purposes of the Act. 421 U.S. at 848. This distinction

was emphasized when the Court said that previous decisions

had:

{M]ade clear that [the Court ] was not

establishing an inflexible rule barring

inquiry into the economic realities under-

lying a transaction. On the contrary,

the Court intended only to make the

rather obvious point that, in contrast

to the instrument before it which was not

included within the explicit statutory terms,

most instruments bearing these traditional

titles are likely to be covered by the statutes.

In holding that the name given to an instrument

is not dispositive, we do not suggest that the name

is wholly irrelevant to the decision whether it is a

security. There may be occasions when the use of

a traditional name such as “stocks” or “bonds” will

lead a purchaser justifiably to assume that the federal

securities laws apply. This would clearly be the case

when the underlying transaction embodies some of

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the significant characteristics typically

associated with the named instrument..

421 U.S. at 850-851

In further support of the view that a device, no matter

what its name, must meet the definition of “an investment of

money in a common enterprise with profits to come solely

from the efforts of others,” the Court in Forman said “we

perceive no distinction, for present purposes, between an

‘investment contract’ and an ‘instrument commonly known as a

security.””” 421 U.S. at 852. The Court goes on to say:

This test, in shorthand form, embodies the

essential attributes that run through all the

Court’s decisions defining a security. The

touchstone is the presence of an investment

in a common venture premised on a reason-

able expectation of profits to be derived

from the entrepreneurial or managerial

efforts of others.... In such cases the investor

is ‘attracted solely by the prospects of a return

on his investment .... By contrast, when a

purchaser is motivated by a desire to use or

consume the item purchased - ‘to occupy the

land or to develop it themselves,’ as the Howey

court put it, ibid. - the securities laws do not

apply. [421 U.S. at 852-853]. (emphasis added).

>’

By that definition and that discussion it is clear that the

investment made by the plaintiff in this case does not come

under the Act. He was not seeking a profit or return solely

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from the “‘entrepreneurial or managerial efforts of others.”

Instead, he bought himself a job with the company and

assumed an official position as executive vice-president with

a 50-50 managerial right. To use the phrase of the Supreme

Court in Forman, “the securities laws do not apply.”

Plaintiff points out that even though Howey stressed

the language “solely the work of others,” the Ninth Circuit

Court of Appeals in S.E.C. v. Glen W. Turner, Inc., 474 F. 2d

476 (9th Cir. 1973) refused to bar the plaintiffs from their

Securities Act claim merely because they had to exert sub-

stantial effort of their own to obtain a profit. The Court held

that the word “solely” should not be applied mechanistically so

that any effort or work by the investor, no matter how slight,

would remove the investment from the coverage of the Act. The

Ninth Circuit adopted what is considered a more realistic test:

“Whether the efforts made by those other than the investor are the

undeniably significant ones, those essential managerial efforts which

affect the failure or success of the enterprise.” 474 F.2d at 482.

This test may not be as easy to apply as it is to formulate. In

most business enterprises the managerial efforts of several persons,

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as a practical matter, “‘affect the failure or success of the

enterprise.”” An investor who also becomes a part of management

should not be able to claim the protection of the Act merely

because others in the common enterprise exert essential managerial

efforts which affect the failure or success of the enterprise. If the

investor-manager participates in those managerial efforts then even

the Turner gloss on the word “solely” would not bring the invest-

ment within the coverage of the Act.

Indeed, the facts in Turner show that the investor there had

no management duties at all. Each investor was a promotor of his

own pyramid empire but the money he invested was in a corpo-

ration controlled wholly by-others. A Chevrolet dealer who buys

stock in General Motors would not be precluded from protection

of the Act merely because his efforts (indeed managerial efforts)

affect the failure or success of General Motors. But one who

purchases a one-half interest in a corporation, who devotes his

full time and effort to its corporate affairs, who assumes and

accepts the position of executive vice-president and who serves

in that capacity for a substantial period of time cannot be said

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to be depending “solely” on the efforts of others to realize on

his investment.

1. The word “affect” has no life or death connotations. Every

sale of a Chevrolet (or failure to sell) affects the success

(or failure) of General Motors.

In the absence of federal question jurisdiction under the

securities laws the pendent jurisdiction over the remaining counts

of the complaint falls. It is appropriate, however, to paraphrase

the Supreme Court in part three of its Forman decision:

In holding that there is no federal jurisdiction,

we do not address the merits of [plaintiff's]

allegations of fraud. Nor do we indicate any

view as to whether the type of claims here

involved should be protected by federal

regulation. We decide only that the type of

transaction before us, in which the purchasers

{assumed a substantial and significant managerial

position in the enterprise], is not within the scope

of the federal securities laws. [421 U.S. at 859-860].

Accordingly, the complaint will be dismissed.

An appropriate order shall issue.

United States District Judge

Date: 28 July 1977

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Ss

<5 UNITED STATES COURT OF APPEALS

we FOR THE FOURTH CIRCUIT

SV NO. 77-2360

$

Richard E. Coffin,

Appellant,

v.

Polishing Machines, Inc.

John A. Tricoli, Jr., Helen Tricoli, Appellees.

and Nicholas Daniels, '

Appeal from the United States District Court for the Eastern

District of Virginia, at Richmond. D. Dortch Warriner, District

Judge.

Argued: February 6, 1979 Decided: April 25, 1979

Before HAYNSWORTH, Chief Judge, BUTZNER and WIDENER,

Circuit Judges.

Stuart W. Settle (John C. Moore, Coates, Comess, Settle, Moore

& Taylor on brief) for Appellant; Michael S. Shelton (W.H.C. Venable,

Cohen, Abeloff & Staples, P.C. on brief) for Appellees.

BUTZNER, Circuit Judge:

Richard E. Coffin sued in the district court to recover

compensatory and punitive damages for misrepresentations

allegedly made to him in connection with his purchase of

stock in Polishing Machines Systems, Inc. The district court

dismissed the action for lack of federal jurisdiction and for

failure to state a claim upon which relief could be granted. We

reverse and remand..

I

Coffin’s complaint alleges the following facts. Polishing

Machines is a Virginia corporation that sells commercial car

‘waxing and polishing equipment. John Tricoli, president of the

company, visited Coffin’s New York service station late in 1975

in order to interest Coffin in the company’s products. Asa

result of the visit, Coffin became an area distributor for the

company. Tricoli then gave Coffin a copy of a report describing

the company and encouraged him to consider purchasing stock

that the company wanted to sell in order to finance expansion.

After negotiations in Virginia and New York, the parties reached

an agreement. Their written contract provided that Coffin would

os

buy half of the outstanding shares in Polishing Machines, sell

his service station, move to Virginia, and devote his full time to

duties as executive vice president of the corporation.

Pursuant to the contract, Coffin sold his business and began work

at Polishing Machines in May, 1976. The stock that he purchased

had all of the attributes of ordinary common stock.

After gaining access to the company’s books, Coffin learned

that representations made to him in the report and during the

negotiations were materially fals and misleading . Specifically, he

discovered that Tricoli had converted corporate assets to his own

use and left Polishing Machines insolvent. Coffin then brought this

action in the district court to recover damages under the federal

securities acts, the Virginia blue sky statute, and the common law of

fraud.

The district court granted motions under Federal Rule of Civil

Procedure 12(b) (1) and (b) (6), dismissing the case on its pleadings.

_ The court relied on United Housing Foundation, Inc. v. Forman, 421

U.S. 837 (1975), for the proposition that not every sale of stock

falls within the coverage of the federal securities statutes. It then

reasoned that even ordinary corporate stocks are not securities within

the meaning of the federal statutes unless they “represent an interest

oa

in an enterprise from which the investor seeks to derive a profit

solely from the work of others... .’” See SEC v. Howey Co.,

328 U.S. 293, 298 (1946). Since Coffin wastto contribute

substantially to the management of Polishing Machines, the court

held that the substance of the transaction in this case was the

sale of a half interest in a business even though the transfer took

the form of a sale of stock.

II

We do not believe that Forman denies a purchaser of

ordinary corporate stock the protection of the federal securities

laws simply because he intends to participate in the management

of the corporation in which he invests. Both the Securities Act

of 1933, 15 U.S.C. § 77b(1), and the Securities Exchange Act

of 1934, 15 U.S.C. § 78c(a) (10), include “stock” within their

definitions of a “security.” Thus, when a transaction involves stock,

instrument.” See Forman, 421 U.S. 837, 850-51.

Absent some showing that ordinary corporate stocks are

other than what they appear to be, we need not consider

whether - investor will derive his profit partly from his own

efforts. That test, drawn from SEC v. Howey Co., 328 U.S. 293,

298 (1946), applies to interests not easily recognized as

securities in the capital market. It does not apply to stock that

comes within the clear language of the securities acts. The court

in Forman, for example, applied the Howey test only after deciding

that the shares under consideration were not like ordinary capital

stock. See Forman, 421 U.S. 837, 850-53; Bronstein v. Bronstein,

407 F. Supp. 925, 929-30 (E.D. Pa. 1976).

When ordinary corporate stock is involved in a transaction, we

likewise need not consider whether the parties could have structured

their arrangement in some other form. The parties in this case chose

to implement their plan for joint ownership by means of a stock

there is a strong presumption that the statutes apply. Occidental transfer rather than a partnership agreement or a sale of assets. Having

Life Insurance Co. v. Pat Ryan & Associates, Inc., 496 F.2d 1255, decided to deal in stock, they brought their transaction under the

1261 (4th Cir. 1974). Forman requires us to analyze the substance provisions of the federal securities statutes. Occidental Life Insurance

of a transaction only when the stocks involved do not have the Co. v. Pat Ryan & Associates, Inc., 496 F2d 1255, 1263 (4th Cir. 1974).

“significant characteristics typically associated with the named Indeed, the descriptive report supplied to Coffin during the negotiations

Me

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