Amicus Curiae Brief — SEC v. Edwards

mm

/ \

MOTION FILED WV

MAR 17 2003 ~~ REPRINTED COP

No. 02-1196

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 2002

THE UNITED STATES SECURITIES AND EXCHANGE

COMMISSION,

Appellant,

AGAINST

ETS PAYPHONES, INC.

AND

CHARLES L.. EDWARDS,

Appellees.

On Petition for Writ of Certiorari to

the United States Court of Appeals

for the Eleventh Circuit

BRIEF FOR PUBLIC INVESTORS

ARBITRATION BAR

ASSOCIATION, INC. AS

AMICUS CURIAE IN SUPPORT OF

THE UNITED STATES SECURITIES

AND EXCHANGE COMMISSION

JOSEPH C. LONG

COUNSEL FOR

PUBLIC INVESTORS

ARBITRATION BAR

ASSOCIATION, INC.

2609 Acacia Ct.

Norman, OK 73072

(405) 364-5471

March 14, 2003

No. 02-1196

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 2002

THE UNITED STATES SECURITIES AND EXCHANGE

COMMISSION,

Appellant,

AGAINST

ETS PAYPHONES, INC.

AND

CHARLES E. EDWARDS,

Appellees.

On Petition for Writ of Certiorari to

the United States Court of Appeals

for the Eleventh Circuit

BRIEF FOR PUBLIC INVESTORS

ARBITRATION BAR

ASSOCIATION, INC. AS

AMICUS CURIAE IN SUPPORT OF

THE UNITED STATES SECURITIES

AND EXCHANGE COMMISSION

JOSEPH C. LONG

COUNSEL FOR

PUBLIC INVESTORS

ARBITRATION BAR

ASSOCIATION, INC.

2609 Acacia Ct.

Norman, OK 73072

405) 364-5471

arch 14, 2003

MOTION FOR LEAVE TO FILE BRIEF

AMICUS CURIAE IN SUPPORT OF THE

SEC'S PETITION FOR WRIT OF CERTIORARI

AND BRIEF AMICUS CURIAE IN SUPPORT THEREOF

The Public Investors Arbitration Bar Association, Inc.

("PIABA") is a national non-profit voluntary public bar

association with a membership of some 550 attorneys. In order

to be a member of PIABA, an attorney must devote a significant

portion of his or her practice to representing public investors

(non-industry members) in private arbitrations involving

securities matters. PLABA hereby respectfully moves for leave to

file the attached brief, as Amicus Curiae, in the present case.

Permission of the appellant, the United States Solicitor General,

has been obtained. Permission of Charles E. Edwards, appellee,

was sought and denied.

The interest of PLABA in this case arises from the fact that

a number of members are involved in private arbitrations where

hundreds of investors purchased ETS investments or similar

interests in payphones offered by other companies. The decision

of this Court could strongly influence the outcome of these future

arbitrations.

Beyond the issue of whether payphones schemes involve

the sale of securities in the form of investment contracts, this

Court's decision will impact a number of other similar

investments presently being offered to the public. These

investments include automated teller machines, credit card

processing units, and Internet access terminals, among others.

None of the interests in these schemes are registered as securities

and many are fraudulent. If the decision of the Eleventh Circuit

is allowed to stand, the payphone and the other major schemes

will go largely unregulated. Further, the public investors will be

denied in the information and protection which the state and

federal securities acts were designed to provide.

The focus of the brief of the Solicitor General on behalf

of the Securities and Exchange Commission accompanying the

petition for certiorari is limited to the Eleventh Circuit's analysis

of the ETS payphone operation and its implications decision on

the federal securities acts. The brief, which PIABA as Amicus

Curiae seeks permission to file, will, however, have a wider

focus. It will address the impact of this Court's decision on

arbitration, state securities laws, and other types of similar

schemes. It will provide the Court with an understanding of the

potential impact that the Court's decision will have in these

broader areas.

Respectfully submitted,

CounseMor the Public Invée$tors

Arbitration Bar Association, Inc.

2609 Acacia Court

Norman, OK 73072 ~

(405) 364-5471

March 14, 2003

ili

TABLE OF CONTENTS

Page

Interest of the Amicus Curiae ............000 eee eeeee l

Summary of Argument ...........cccccccccccceccccces 2

AGUTAGEE 0 cc ccccccccccccccccscvccccsevcceccoseces 3

Point I

The Issue in This Case Involves Great

National Public Interest and, Therefore,

Should be Reviewed by This Court ............... 3

Point Il

The Controlling Authorities From This

Court are Ambiguous and Should

DGD sin cccuvdecbouttedcciscsetecsdeet 6

Point Ill

The Decisions of the Courts of Appeals

on the Issue of “Profits” Under the Howey

Dest Asm MO GUMED 0 oc cc ccdesccccccccévccscces 11

Point IV

The Eleventh Circuit’s Decision is in

Conflict with the Interpretation of the SEC,

the State Courts, and the State Securities

Agencies on the Issue of “Profits” ............... 14

Cem oc cc cv ciceccecéueccesencccecesccccecees 16

Cases:

iV

TABLE OF AUTHORITIES

American Fletcher Mortgage Co. v. U.S.

Steel Credit Corp., 635 F.2d 1247

(7 Cir. 1980), cert. denied,

i

Bayhi v. State, 629 So.2d 782 (Ala. Crim.

CS ee

Bell v. Health-Mor, Inc., 549 F.2d 342

a 10,

Bonner v. City of Prichard, 661 F.2d 1206

LR a ee

Cameron v. Outdoor Resorts of America, Inc.,

G0 P28 CEP EP Gie, BBTED wo cc cccccccesss

Department of Banking and Finance v.

Mehl, 2002 WL 31452438 (Fla. Sec.

Div., Final Order, Oct. 17, 2002) ..... weooe

First Fin. Fed. Sav. & Loan v. E.F.

Hutton, Mortgage Co., 834 F.2d 685,

I ii colt Ls cuddesces

Gary Randolph Hayden, 2002 WL 1575117

(Tex. St. Sec. Bd. July 9, 2002) ...........

Hunssinger v. Rockford Business Credits,

Inc., 745 F.2d 484 (7 Cir. 1984) ..........

In re Abbett, Sommer & Co., 44 S.E.C. 104,

RE

Vv

In re Arbitration: Daughterty and Sowers,

2002 WL 1944487 (NASD 2002) .......... 6

In re Arbitration: Womble and Locust

Street Sec., Inc., 2001 WL 1636341

I ca, er et 6

In re ETS Payphones, Inc., 2001 WL 422179

(Ala. Sec. Comm’n Feb. 6, 2001) .......... 4

In re ETS Payphones, Inc., 2002 WL 1586379

(Ind. Div. Sec. June 7, 2002) .............. 4

In re Union Home Loans, 26 S.E.C. Dkt 1517,

1982 WL 522493 (Dec. 16, 1982) ......... 14

Jerome Alex Zanowski, 2000 WL 1847107

(Anz. Corp. Com. Nov. 30, 2000) .......... 4

Jerry Klemp, 1999 WL 20390 (Wis. Com.

ES a eee 4

Khadem v. Equity Sec. Corp., 494 F.2d 1224,

1229 (9" Cir.), cert. denied, 419 U.S.

I i a 12

King v. Pope, 91 S.W.3d 314 (Tenn. 2002) ........ 14

Linda L. Eberly, 2002 WL 1151509 (Pa. Sec.

IIE dc eunctetdsacoenckeve 4

Manns v. Skolnik, 666 N.E.2d 1236

Sn ENG ba ddnoddnecécccoes ce 14

Meason v. Bank of Miami, 652 F.2d 542,

550, N. 17 (5" Cir. 1981) ............. 10, 11

vi

Mosley v. State, 253 Ga. App. 710,

Se PEED occccccosvcceces 5,14

National Communications Marketing, Inc.,

1998 WL 704697 (Kan. Sec. Com.

PURSE GED + cc cvasavdcsccecccccveces 4

National Communications Marketing, Inc.,

2001 WL 236889 (Wash. Sec. Div.

PE A Anhedecndentecsiecevaccas 4

Payable Accounting Corp. v. McKinley,

667 P.2d 15, 19 (Utah 1983) ............. 14

People v. Coster, 151 Cal. App.3d-1188,

199 Cal. Rptr. 253 (App. 1983) ........... 15

People v. Figueroa, 41 Cal. 3d 714, 715

P.2d 680, 224 Cal. Rptr. 7119 (1986) ...... 15

People v. Milne, 690 P.2d 629 (Colo. 1984) ....... 14

People v. White, 12 P.2d 1078 (Cal. App. 1932) ..... 9

Philip L. Helton, 2001 WL 1193030

(Mo. Div. Sec. Oct. 2, 2001) .............. 4

Resolution Trust Corp. v. Stone, 998 F.2d 1534

Pate Tne ssogbdivehuhbicesceees 12

Reves v. Ernst & Young, 494 U.S. 56 (1990) ....... 10

Robert L. Scott, 2002 WL 31089631

(Ohio Dept. Com. Aug. 29, 2002) .......... 4

SEC v. Alpha Telecom, Inc., 187 F. Supp.2d

EEE 4 deidontecedeesecess 13

Vii

SEC v. C. M. Joiner, 320 U.S. 344 (1943) ....... 6, 10

SEC v. ETS Payphones, Inc., 123 F.

Supp.2d 1349 (N.D. Ga. 2000) ........... 13

SEC v. Infinity Group Co., 212 F.3d 180,

PED ekeeetécececosescsces 13

SEC v. Marino, 2000 WL. 33678041

(D. Utah Oct. 6, 2000) .............00005. 5

SEC v. Nat'l Executive Planners, Ltd.,

503 F.Supp. 1066 (M.D.N.C. 1980) ....... 12

SEC v. Phoenix Telecom, LLC, 2000

U.S. Dist. LEXIS 22314 (N.D. Ga.

CE EE 9 865 dh ceubeesicccocecess 13

SEC v. Pinckney, 923 F. Supp. 76

SS DUE Ghee ness ncddcccececcese 5

SEC v. W.J. Howey Co., 328 U.S.

SOE Cac cunseoutes 3, 7, 8,9, 10, 11, 15

SEC v. Weeks Sec. Inc., 483 F.Supp. 1239,

1243-1244 (S.D. Tenn. 1980) ............ 12

Siporin v. Carrington, 200 Ariz. 97,

23 P.3d 92 (App. 2001)...............4.. 5

State v. Gerisch, 49 P.3d 392 (Idaho 2002) ...... 5,14

State v. Philips, 108 Wash.2d 627,

Pe Ce shes dibetcccecccdccs 14

State of New York v. Justin, 237 F.

Supp.2d 368 (W.D.N.Y. 2002) ........... 15

Vili

Stevens v. Liberty Packing Corp., 161 A.

193, 195 (N.J. Ch. 1932) 2... 0... c eee eee 9

Stigall v. Sec. of State, Case No:EN-

18727 Final Decision

(Sept. 6, 2002)... ceccvcccccceccess 4,15

Szpunar v. State, 2003 Ind. App. LEXIS

298 (Ind. App. Feb. 27, 2003) .......... 5,14

Union Planters Nat'l Bank of Memphis

v. Commercial Credit Business Loans,

Inc., 651 F.2d 1174 (6" Cir.), cert.

denied, 454 U.S. 1124(1981) ............ 12

United Housing Foundation v. Forman,

421 U.S. 837 (1975) ..........0500e- 3, 9, 12

United States v. Carman, 577 F.2d

556, 563 (9 Cir. 1978) ....... 0.66.0 eee 13

United States v. Farris, 614 F.2d

634, 641 (9 Cir. 1979) ....... 0.6.0 e eee. 13

United States v. Jones, 712 F.2d

1316 (9" Cir.), cert. denied

Statutes:

464 U.S. 986 (1983)... 0... cee cee eens 4,13

ISUBC. STIOMA) ... 0c cccccccccccccccccscces 3

15 U.S.C. §78(c)a10) 0... cece eee ceeeceueees 3

ix

Miscellaneous:

12 and 12A, Joseph C. Long,

Blue Sky Law §1:15 (2002) ............... 6

12 and 12A, Joseph C. Long,

Blue Sky Law §1:17-1:18 (2002) ........... 9

12 and 12A, Joseph C. Long,

Blue Sky Law §2:58 (2002) ............5. 10

Cal. Corp. Comm’n, Press Release 00-16 (2000) ....4

In the

Supreme Court of the United States

~ October Term, 2002

The United States Securities and Exchange Commission,

Appellant,

against

ETS Payphones, Inc.

and

Charles E. Edwards,

Appellees.

On Petition for Wnit of Certiorari to

the United States Court of Appeals

for the Eleventh Circuit .

Brief for the Public Investors Arbitration

Bar Association, Inc., as Amicus Curiae

INTEREST OF THE AMICUS CURIAE

The Public Investors Arbitration Bar Association, Inc.

("PIABA") is a national non-profit voluntary public bar

association with a membership of some 550 attorneys.’ In order

to be a member of PIABA, an attorney must devote a significant

portion of his or her practice to representing public investors

(non-industry members) in private arbitrations involving

securities matters.

‘Joseph C. Long, a member of PIABA and the undersigned counsel for

PIABA, wrote the entire brief. No one other than PIABA, the amicus cunae,

has made a monetary contribution to the preparation or submission of this

brief.

2

The interest of PLABA in this case arises from the fact that

a number of members are involved in private arbitrations where

hundreds of investors purchased ETS investments or similar

interests in payphones offered by other companies. The decision

of this Court could strongly influence the outcome of these future

arbitrations.

Beyond the issue of whether payphones schemes involve

the sale of securities in the form of investment contracts, this

Court's decision will impact a number of other similar

investments presently being offered to the public. These

investments include automated teller machines, credit card

processing units, and Internet access terminals, among others.

None of the interests in these schemes are registered as securities

and many are fraudulent. If the decision of the Eleventh Circuit

is allowed to stand, the payphone and the other major schemes

will go largely unregulated. Further, the public investors will be

denied the information and protection which the state and federal

securities acts were designed to provide.

SUMMARY OF ARGUMENT

The Wnit of Certiorari should be granted for four reasons.

First, the question of national public interest in that it effects the

definition of profits under the investment contract test in the

federal and state securities acts. Second, the present decisions of

this Court on this issue are ambiguous and need to be clarified.

Third, the decisions of the various Courts of Appeals on the issue

of “profits” are badly divided. Finally, the decision of the

Eleventh Circuit is in conflict with the position of the SEC, the

state courts under similar definitions in the state securities acts,

and the state securities agencies themselves.

3

ARGUMENT

POINT I

THE ISSUE IN THIS CASE INVOLVES GREAT

NATIONAL PUBLIC INTEREST AND, THEREFORE,

SHOULD BE REVIEWED BY THIS COURT

PIABA believes the SEC has greatly understated the issue

in the present case. The real issue is whether any debt security or

contract requiring the payment of a fixed return can be an

investment contract under the statutory definition of a “security”

in either the Securities Act of 1933 or the Exchange Act of

1934.° The Eleventh Circuit, in the present case, interpreted this

Court's decision in United Housing Foundation v. Forman, 421

U.S. 837 (1975), defining the "profit" element of Howey’ test for

investment contracts to exclude either the payment of interest or

contract fixed return obligations. It reached this conclusion based

upon its reading of United Housing to require that the investor's

profit must come from the earnings of the enterprise. Interest or

fixed return contract obligations may or may not come from these

earnings because these obligations must be paid without regard to

whether the enterprise earns a profit.

The correctness of this interpretation is a matter of

national public interest. Both the SEC and the state securities

agencies spend a great deal of their enforcement resources dealing

with novel or irregular securities. By far the most litigated

portion of the statutory definition of a security is “investment

contracts.” Virtually all of these novel securities cases also

involve either Ponzie schemes or fraudulent conduct, often aimed

715 U.S.C. §77(6\(1).

*15 U.S.C. §78(c\aX 10).

*“SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

4

at the unsophisticated and the elderly. The losses to the general

public are enormous.

To understand the size of the problem, it should be noted

that, in addition to the SEC, at least 18 state securities agencies

have taken action against ETS.° When enforcement activities

against other payphone operations are added, the number of state

enforcement actions rises to over 200.° The State of California

alone has issued 143 Desist and Refrain Orders against 54 such

entities.’

These payphone cases are, however, merely the tip of the

iceberg. In the past, the agencies have had to deal with similar

schemes involving automatic teller machines and other sale and

lease-back promotions ranging from rail cars to trailer trucks. See

e.g., United States v. Jones, 712 F.2d 1316 (9th Cir.), cert. denied,

464 U.S. 986 (1983)(trailer trucks).

*ETS Payphones, Inc., 2002 WL 1586379 (Ind. Div. Sec. June 7, 2002);

National Communications Marketing, Inc., 1998 WL 704697 (Kan. Sec. Com.

Sept. 25, 1998); Jerry Klemp, 1999 WL 20390 (Wis. Com. Sec. Jan. 8, 1999);

Jerome Alex Zanowski, 2000 WL 1847107 (Ariz. Corp. Com. Nov. 30, 2000);

ETS Payphones, Inc., 2001 WL 422179 (Ala. Sec. Com. Feb. 6, 2001);

National Communications Marketing, Inc.,2001 WL 236889 (Wash. Sec. Div.

Feb. 26, 2001); Phillip L. Helton, 2001 WL 1193030 (Mo. Div. Sec. Oct. 2,

2001); Linda L. Eberly, 2002 WL 1151509 (Pa. Sec. Com. May 9, 2002);

Gary Randolph Hayden, 2002 WL 1575117 (Tex. St. Sec. Bd. July 9, 2002);

Robert L. Scott, 2002 WL 31089631 (Ohio Dept. Com. Aug. 29, 2002);

Department of Banking and Finance v. Mehl, 2002 WL 31452438 (Fla. Sec.

Div., Final Order, Oct. 17, 2002); and Stigall v. Sec. of State, Case No:EN-

18626 Final Decision (Sept. 6, 2002). The New York and California decisions

are reported on the Internet at

www.oag.state ny.us/press/2002/jun/juniI2C 02.html, and

www.corp.ca.gov/pressrel/nr00 1 6.htm.

“Westlaw search, MSEC-CS, payphones /s securities. The search was done

on March 11, 2003.

Cal. Corp. Comm'n, Press Release 00-16 (2000), available at

WWW.COIP.Ca. gov.

5

This problem will also continue into the future. Ads are

presently running on national television, offering similar contracts

on both Internet site locations and credit card processing

machines. Many of these schemes are advertising that they are

the successor to the payphone opportunities!

Beyond the sale and lease-back cases, the SEC and state

agencies have had to deal with wide-spread Ponzi schemes

involving promissory notes and prime bank frauds. See e.g. , State

v. Gerisch, 49 P.3d 392 (Idaho 2002) and Mosley v. State, 253 Ga.

App. 710, 560 S.E.2d 305 (2002)(promissory notes); SEC v.

Marino, 2000 WL 33678041 (D. Utah Oct. 6, 2000) and SEC v.

Pinckney, 923 F.Supp.76 (E.D.N.C. 1996)(prime bank cases). The

states have also been faced with the fraudulent sale of viatical

settlement contracts. See e.g., Siporin v. Carrington, 200 Ariz.

97, 23 P.3d 92 (App. 2001). All these investments involve either

debt interests or fixed return contracts and would not be

investment contracts under the Eleventh Circuit’s decision.

If the Eleventh Circuit decision is upheld, the SEC will

lose its most effective weapon to control and combat these

schemes. Further, while the state courts are not obligated to

follow federal decisions, they often do. Thus, a huge gap in both

the federal and state agency enforcement programs will result.

The white collar criminals will have carte blanche to conduct

these various schemes with impunity.*

The problem will also hamper criminal prosecutions and

civil recovery. If the interests are not investment contracts or

securities, criminal enforcement actions such as Szpunar v. State,

2003 Ind. App. LEXIS 298 (Ind. App. Feb. 27, 2003) can not be

brought. Many victims are now able to bring civil securities

actions or arbitrations to recover their losses. For example, there

*It is true that many of these schemes are not presently structured to provide

a fixed return or the payment of interest. However, such programs can easily

be altered to include these features, especially where there is no intent by the

promoter to meet these payment obligations.

6

are presently a number of NASD arbitrations where the defrauded

investors have sought to recover their money !ost in payphone

investments. See e.g., In re Arbitration: Daugherty and Sowers,

2002 WL 1944487 (NASD 2002) and Jn re Arbitration: Womble

and Locust Street Sec., Inc., 2001 WL 1636341 (NASD

2001)(both ETS cases). If the Eleventh Circuit position is upheld,

using the investment contract theory under the federal securities

acts will be foreclosed to them.

Because of the impact of the Eleventh Circuit's decision

on both state and federal enforcement activities as well as its

impact upon investor recovery, this Court should grant certiorari

to review the Eleventh Circuit’s decision.

POINT II

THE CONTROLLING AUTHORITIES

FROM THIS COURT ARE AMBIGUOUS

AND SHOULD BE CLARIFIED

A major reason that the Court should grant certiorari in

the present case is that the controlling decisions of this Court

appear to be ambiguous. The first case to deal with the concept

of an investment contract was SEC v. C.M. Joiner, 320 U.S. 344

(1943). The Court in Joiner recognized that the definitions of a

security found in both the Securities Act of 1933 and the

Exchange Act of 1934 are not true definitions.’ Instead, they are

definitions by enumeration. Some of the instruments named in

the definition are "pretty much standardized and the meaning

alone carries well settled meaning.” 320 U.S. at 351. "Others are

of a more variable character and were necessarily designated by

more descriptive terms, such as ... ‘investment contract’...." Jd.

Joiner recognized that:

*Nor do the state securities acts which preceded them have true definitions.

See the Author's Treatise, 12 and 12A, Joseph C. Long, Blue Sky Law §1:15

(2002\(Hereinafter “Blue Sky Law § __”) for a discussion of the

development of the statutory definition.

7

[T}he reach of the Act does not stop with the

obvious and commonplace. Novel, uncommon, or

irregular devices, whatever they appear to be, are

also reached if it be proved as a matter of fact that

they were widely offered or dealt in under terms

or courses of dealing [that] established [them] as

‘investment contracts.’ Id.

The Court then suggested that whether a device comes

within or is excluded from one category of the definition does not

prevent it from being included in another portion of the definition.

Id. at 352.

The Court finally concluded:

The test rather is what character the instrument is

given in commerce by the terms of the offer, the

plan of distribution, and the economic

inducements held out to the prospect. In the

enforcement of an act such as this it is not

inappropriate that promoters’ offering be judged as

being what they were represented to be.'°

Id. at 352-353. Nothing in the Court's decision hints that fixed

return or debt securities should be excluded from classification as

“investment contracts.”

Three years later, in SEC v. W.J. Howey Co., 328 U.S. 293

(1946), again considered what constituted an investment contract.

*°This statement is particularly important in the present case because it

emphasizes what the investors thought they were getting. In the present case,

the contracts were technically cast in the form of fixed payments for rent of the

phone. Many of the investors in the present case were elderly. From their

prospective, they were making an investment, would receive a return on that

investment, and would not participate in the management of the investment.

From their prospective, they were buying an investment contract, not a

contract for the payment of rent on a payphone.

Initially, the Court made two important observations. First, it

noted that the term "investment contracts” was not a defined term

either in the statute itself or the legislative history. However, it

pointed out the term had been in use for a number of years under

the state securities or Blue Sky laws. The Court also pointed out

“it had been broadly construed by state courts so as to afford the

investing public, a full measure of protection.” Then, the Court

went on to note that "investment contracts”:

[E}mbodies a flexible rather than static principle,

one that is capable of adaptation to meet the

countless and variable schemes devised by those

who seek the use of the money of others on the

promise of profits. Id. at 299.

The Court, then, announced the now famous test for an

investment contract:

[A]n investment contract for purposes of the

Securities Act means a contract, transaction or

scheme whereby a person invests his money in a

common enterprise and is led to expect profits

solely from the efforts of the promoter or a third

party. Id. at 298-299."

Finally, the Court concluded the scheme in Howey was an

investment contract. In doing so, the Court stated the essence of

both investment contracts and securities in general:

Thus all the elements of a profit-seeking business

venture are present here. The investors provide

the capital and share in the earnings and profits;

**The Court restated this test slightly differently:

The test is whether the scheme involves an investment of

money in a common enterprise with profits to come solely

from the efforts of others. Id at 301.

9

the promoters manage, control and operate the

enterprise. Id. at 299.

A security will be present when the capital providing function is

separated from the management function. The investor supplies

at least part of the capital, the promoter or a third party supplies

the management, control, and operation. The remaining two

elements of Howey further refine the idea. The common

enterprise element requires that the enterprise be active rather

than passive (such as holding but not developing raw land). The

expectation of profits element requires that the investment be

motivated by his expectation that he will receive a return on his

investment.

Again, nothing in the language used or the discussion in

the Howey case suggests that the profit can not be in the form of

fixed payments or interest paid on debt securities. In fact, as the

SEC notes in its brief in support of the petition, SEC Brief, p.12,

two of the state cases relied upon by the Court in Howey involved

fixed income or a “guaranteed” return. See People v. White, 12

P.2d 1078 (Cal. App. 1932) and Stevens v. Liberty Packing Corp.,

161 A. 193, 195 (N.J. Ch. 1932).”

In 1975, in United Housing Foundation, Inc. v. Forman,

423 U.S. 837 (1975), the Court muddied the waters. The thrust of

United Housing was to distinguish those cases where receiving a

true "profit" was the motivating force behind the investor's

investment from those cases where the purchaser of the property

was motivated by "the desire to use or consume the item

purchased...." 423 U.S. at 852. The Court recognized the Howey

test and then made the statement which led the Eleventh Circuit

astray:

“See Blue Sky Law §1:17. For a discussion of the lower federal cases

cited in Howey, see id. §1:18.

10

By profits, the Court has meant either capital

appreciation resulting from the development of

the initial investment as in Joiner, supra, ... or a

participation in the earnings resulting from the use

of investor's funds, as in Tcherepnin v.

Knight...Id.

This statement does not support the exclusion of all fixed rate

investments or debt securities from coverage by "investment

contracts" for two reasons."’ First, it is clear from the language

used that the Court was referring to its past decisions. As it

happens, the Court, at that time, had never considered an

investment contract case involving either a fixed return or a debt

security. Recognizing that the Court had never had the note -

problem before it, the Fifth Circuit in Meason v. Bank of Miami,

652 F.2d 542, 550, N.17 (Sth Cir. 1981) stated that the quoted

language "seems to us to be dubious value in [the note] context."

Second, the words "the earnings resulting from the use of

investor's funds” turns the Howey test on its head. The focus of

Howey was on the expectation of a profit to the investor, not

necessarily to the enterprise in which the investment was made."

In the case of fixed rate or debt securities, the investor makes a

profit, even if the enterprise in which he invests does not.

The Court further muddied the waters in Reves v. Ernst &

Young, 494 U.S. 56 (1990).'* Reves established the test for when

promissory notes are securities. However, in footnote 4, the

Court made the concept of "profits" more ambiguous by saying:

“See Blue Sky Law §2:58.

“*See, for example, Bell v. Health-Mor, Inc., 549 F.2d 342 (Sth Cir. 1977)

where the investor was to receive a $10 rebate on the cost of his vacuum for

every referral made whether the referral bought or not.

‘See Blue Sky Law §2:58, N.11.

11

We emphasize that by "profits" in the context of

notes, we mean "a valuable return on an

investment,” which undoubtedly includes interest.

We have, of course defined "profit" more

restrictively in applying the Howey test to what

are claimed to be investment contracts. [Citing

Forman}. ... Because the Howey test is irrelevant

to the issue before us..., we decline to extend its

definition of "profits" beyond the realm in which

that definition applies. 494 U.S. at 953, N.4.

In summary, the Court should grant certiorari in the

present case to clear up the ambiguity as to its intent as to the

profits element of the Howey test. This ambiguity needs to be

resolved.

POINT Ill

THE DECISIONS OF THE COURTS OF APPEALS ON

THE ISSUE OF "PROFITS" UNDER THE HOWEY

TEST ARE IN CONFLICT

With the decisions of this Court ambiguous over the

proper interpretation of "profits" under the Howey test, it is not

surprising that the decisions of the various Court of Appeals are

in conflict. Further, the Eleventh Circuit decision in the present

case is also in conflict with other decisions by the Fifth Circuit

prior to the creation of the Eleventh Circuit." See Meason v.

Bank of Miami, 652 F.2d 542 (Sth Cir. 1981 (rejecting the district

court’s hoiding that an investment was not an investment because

the investor was paid a fixed return);'’ Cameron v. Outdoor

**In Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981)(en banc),

the Eleventh Circuit adopted as precedent all decisions of the former Fifth

Circuit decided prior to October 1, 1981.

*” Meason indicates other courts have not been restricted by a concept of a

fixed return disqualifying the finding of an investment contract., citing

12

Resorts of America, Inc., 61 F.2d 187 (Sth Cir. 1979); Bell v.

Health-Mor, Inc., 549 F.2d 342 (Sth Cir. 1977).

The Sixth, Seventh, Eighth, and Tenth Circuits also

appear to have accepted the Eleventh Circuit's position. See

Union Planters Nat'l Bank of Memphis v. Commercial Credit

Business Loans, Inc., 651 F.2d 1174 (6th Cir.), cert. denied, 454

U.S. 1124 (1981); American Fletcher Mortgage Co. v. U.S. Steel

Credit Corp., 635 F.2d 1247 (7th Cir. 1980), cert. denied, 451

U.S. 911 (1981); First Fin. Fed. Sav. & Loan v. E.F. Hutton,

Mortgage Co., 834 F.2d 685, 689 (8th Cir. 1987); and Resolution

Trust Corp. v. Stone, 998 F.2d 1534 (10th Cir. 1993).

The Seventh Circuit, however, appears to be willing to

reconsider its position in Hunssinger v. Rockford Business

Credits, Inc., 745 F.2d 484 (7th Cir. 1984). Of the above quoted

language from United Housing, the court said “at the time of the

Forman decision, the Court had not yet considered a debt

instrument.” 745 F.2d at 491. The court then went on to say:

As a matter of original principles, however, one

may question the wisdom of excluding fixed

interest payments from the definition of ‘profits.’

Congress listed a large number of terms, including

the seemingly broad term ‘investment contract,’ in

the definitional sections of the securities acts

apparently in order to prevent imaginative

promoters from avoiding regulation by inventing

nonconventional instruments. [Citation omitted].

It is arguable that giving a restrictive definition to

the term ‘profits’ would be in frustration of

Congress’s intention. It is of course true that the

Supreme Court has strongly indicated that the

Khadem v. Equity Sec. Corp.;494E.2d 1224, 1229 (9th Cir.), cert. denied, 419

U.S. 900 (1974); SEC v. Nat'l Executive Planners, Ltd., 503 F Supp. 1066

(M.D.N.C, 1980); and SEC v. Weeks Sec. Inc., 483 F.Supp. 1239, 1243-1244

(S.D. Tenn. 1980).

13

term ‘profits’ should exclude fixed interest

payments, and decisions of this court contain

language following the path set by the Court. Jd.

However, both the Third and the Ninth Circuits have

rejected the Eleventh Circuit's position. They hold that fixed

return or debt securities can be investment contracts. The Third

Circuit in SEC v. Infinity Group Co., 212 F.3d 180, 189 (3d Cir.

2000), stated "the definition of security does not turn on whether

the investor receives a variable or fixed rate of return." Similarly,

in United States v. Carman, 577 F.2d 556, 563 (9th Cir. 1978),

the court rejected the defendant’s argument that the student loans

involved in that case were not investment contracts because the

return was in the form of fixed interest and guaranteed by the

federal government. See also United States v. Farris, 614 F.2d

634, 641 (9th Cir.1979)(promissory notes on real estate) and

United States v. Jones, 712 F.2d 1316 (9th Cir.), cert. denied, 464

U.S. 986 (1983)(sale and lease back of semi-trailer).

More specifically, two federal district courts, one from the

Ninth Circuit, in addition to the trial court in the present case,

have found payphone schemes to be investment contracts. SEC v.

Phoenix Telecom, LLC, 2000 U.S. Dist. LEXIS 22314 (N.D. Ga.

Aug. 2, 2000); SEC v. Alpha Telecom, Inc., 187 F. Supp.2d 1250

(D.Ore. 2002); and SEC v. ETS Payphones, Inc., 123 F. Supp.2d

1349 (N.D.Ga. 2000). The Phoenix Telecom case had the same

type of fixed rental fee agreement as in the present case. As was

seen in Point I, the arrangement involved in the Alpha Telecom

case could have easily been converted to a fixed return agreement.

The Court should grant certiorari to resolve the split

between the Courts of Appeals and the inconsistency in the

opinions of the Eleventh Circuit.

14

PCINT IV

THE ELEVENTH CIRCUIT'S DECISION IS IN

CONFLICT WITH THE INTERPRETATION OF THE

SEC, THE STATE COURTS, AND THE STATE

SECURITIES AGENCIES ON THE ISSUE OF

"PROFITS"

As the SEC notes in its Brief, 23-24, the Eleventh Circuit's

decision in the present case runs contrary to the long standing

position of the SEC. See e.g., In re Abbett, Sommer & Co., 44

S.E.C. 104, 196° WL 95369 (1969) and Jn re Union Home Loans,

26 S.E.C. Dkt 1517, 1982 WL 522493 (Dec. 16, 1982).

The Eleventh Circuit's holding also runs contrary to the

decisions of many state courts construing the definition of

"investment contracts" under the states securities acts to cover

both fixed payment agreements and promissory notes. See e.g.,

State v. Gerisch, 49 P.3d 392 (Idaho 2002); Mosley v. State, 253

Ga. App. 710, 560 S.E.2d 305 (2002); Bayhi v. State, 629 So.2d

782 (Ala. Crim. App. 1993); State v. Philips, 108 Wash.2d 627,

741 P.2d 24 (1987); and People v. Milne, 690 P.2d 629 (Colo.

1984), all promissory note cases. See also Manns v. Skolnik, 666

N.E.2d 1236 (Ind. App. 1996), a contractual obligation to pay

fixed return case, King v. Pope, 91 S.W.3d 314 (Tenn. 2002), a

payphone case with fixed monthly payments similar to ETS, and

Szpunar v. State, 2003 Ind. App. LEXIS 298 (Ind. App. Feb. 27,

2003), another payphone case.

Several of these state decisions speak directly to the

question of whether fixed fees or interest can qualify as “profits.”

In Payable Accounting Corp. v. McKinley, 667 P.2d 15, 19 (Utah

1983), the court said “the critical factor is not whether the rate of

return is fixed, but whether the ‘investment transaction’ is so

structured that the money to pay off the investor eventually will

be generated by the venture or enterprise.”

15

In People v. Figueroa, 41 Cal. 3d 714, 715 P.2d 680, 224

Cal. Rptr. 7119 (1986)(en banc) also addressed the issue of fixed

payments, saying:

Many "investment contracts” ...contemplate both a

variable and a fixed return. The investment

contracts in [People v. Coster, 151 Cal. App.3d

1188, 199 Cal. Rptr. 253 (App. 1983)], for

example purported to give the investor a 20

percent "fixed" return on principal and | percent

of the gross company income. [Citation omitted. ]

Both kinds of return, as well as a recoupment of

principal depended on the success of the

business... It would be illogical to [to exclude] a

promissory note transaction simply because the

promised return ... is to take the form of interest at

a "fixed" rate. Id. at 740, 715 P.2d at 698, 224 Cal.

Rptr. at 737. [Emphasis added. ]

Likewise, the state securities agencies themselves have

rejected the Eleventh Circuit's approach. As noted in Point 1, at

least 18 state securities agencies have brought administrative

enforcement actions against ETS. New York has also brought an

action against another company offering a similar fixed return

plan. State of New York v. Justin, 237 F. Supp.2d 368 (W.D.N.Y.

2002). At least two of these state ETS cases were contested

cases, and both were decided after the Eleventh Circuit's opinion

in the present case. Both rejected the Eleventh Circuit's position.

In Stigall v. Sec. of State, Case No:EN-18727 Final Decision

(Sept. 6, 2002), slip op. at 13, the Georgia Commissioner said:

The Commissioner rejects the Eleventh Circuit's

analysis of the third element of Howey as being

inextricably intertwined with its narrow view of

“profits.” ... [T]he fact that there is a contractual

guarantee of payment which might be satisfied

from the capital of the enterprise is as irrelevant in

this case as it would be in a case involving 4

16

promissory note. "The statutory policy of

affording broad protection to investors is not to be

thwarted by unrealistic and irrelevant formulae.”

Likewise, in Department of Banking and Finance v. Mehl,

2002 WL 31452438 (Fla. Sec. Div., Final Order, Oct. 17, 2002),

the Florida Comptroller rejected the Eleventh Circuit approach as

representing the law of Flonda. He said, "Florida law does not

use such a narrow construction of ‘profits,’ it has not

distinguished between fixed or variable returns to the investor.”

In summary, since the Eleventh Circuit's position runs

contrary to the positions held by the SEC, the state courts, and the

State securities agencies, this Court should grant certiorari to

examine the issue.

CONCLUSION

For the above outlined reasons, PIABA urges the Court to

grant the SEC’s petition for Wnt of Certiorari.

Dated: March 14, 2003

Norman, OK 73072

lly submitted,

ad

Counsel for the Public Invest

Arbitration Bar Associati

2609 Acacia Court

Norman, OK 73072

(405) 364-5471