Amicus Curiae Brief — SEC v. Edwards

JUN 2 6 2093

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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.

OnA yee From the United States

Court ofz ppeals 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

June 26, 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 A , aes From the United States

Court of ppeals 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

June 26, 2003

MOTION FOR LEAVE TO FILE BRIEF

FOR PUBLIC INVESTORS ARBITRATION

BAR ASSOCIATION, INC. AS AMICUS CURIAE

IN SUPPORT OF THE UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

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 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 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,

Joseph C. Long

Counsel for the Public Investors

Arbitration Bar Association, Inc.

2609 Acacia Court

Norman, OK 73072

(405) 364-5471

June 26, 2003

TABLE OF CONTENTS

Page

Statement of Interest of the Public Investor’s

Arbitration Bar Association, Inc. ................. l

IDs Seeebcwdtdcvuddadsdusdctésnons 2

PE etcndnncdeddndéedadétddeesdscadssadncanies 6

Point I

United Housing Does Not Justify the

Exclusion of Payment of Interest and Other

Fixed Amounts From the “Profits” Element

EET dkvlonededucsceadodecsskanses 7

A. The Language of United Housing

Does Not Demand Such Result ............ 7

B. Earlier Supreme Court Cases Do Not

Support the Exclusion of Fixed-Return

or Interest Bearing Instruments From

Coverage Under the Investment

cs ccdcceuabesdeesccece 10

c. Exclusion of Fixed Payments or

Interest From “Profits” Under the

Howey Test Finds No Support in the

State Law Origins of the Concept

of “Investment Contracts” ............... 13

D. The Public Policy Behind the Securities

Act of 1933 Does Not Support the

Exclusion of Fixed Payments or

Interest from “Profits” Under the

Dt Dieses cenkhoedsicaseunéee 16

iv

E. Exclusion of Fixed Payments or Interest

From “Profits” Under the Howey Test

Is Contrary to the Holdings in Many

Other Lower Federal Court Decisions ...... 19

F. Exclusion of Fixed Payments or Interest

From “Profits” Under the Howey Test is

Contrary to the Position Taken by the SEC .. 21

G. Exclusion of Fixed Payments or Interest

From “Profits” Under the Howey Test is

Contrary to the Position Taken by Many

PEED ccncccdecceccecseenecesces 22

H. \ Exclusion of Fixed Payments or Interest

\From “Profits” Under the Howey Test is

ontrary to the Position Taken by State

ecurities Agencies ...........-.++0005: 23

Point I

In Reversing the Eleventh Circuit, the

Court Should Conduct an Overall Review

GOT n cc cccccccccccccucecesccusces 25

A. The Court Should Not Simply

Redefine “Profits” to Include

Interest and Fixed Payments ............. 26

B. The Court Should Undertake a

Reconsideration of the Whole Concept

of What is a Security and Identify the

Elements of “Securitiness” .............. 26

DOE oo ccccccccccccscsscececcececcoecccooenes 29

SLE PEPE SG

Vv

TABLE OF AUTHORITIES

Cases:

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

ER Ge eae ep 22

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

a 9,21

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

te 20

Department of Banking and Finance v.

Mehl, 2002 WL 31452438 (Fla. Sec.

Div., Final Order, Oct. 17, 2002) ......... 24

Fidelity Inv. Ass'n v. Emmerson, 318 Ill. 548,

i 15

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

1969 WL 95369 (1969) ...........000... 21

In re ETS Payphones, Inc., 2001 WL 422179

(Ala. Sec. Comm’n Feb. 6, 2001) .......... 3

In re ETS Payphones, Inc., 2002 WL 1586379

(Ind. Div. Sec. June 7, 2002) .............. 3

In re Ellsworth, 2003 WL 21207816 (Mo.Div.

BR, FE BOD oc cccccccccccccccces 25

dn re Mack, 2003 WL 21269563 (Ohio

Dept.Comm., May 30, 2003) ............. 25

In re National Communications Marketing, Inc.,

2001 WL 236889 (Wash. Sec. Div.

PD Sete d din cud o bacndeeuene de 3

vi

In re Ray, 2003 WL 21269561 (Ohio

Dept.Comm., May 22, 2003) ............. 25

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

1982 WL 522493 (Dec. 16, 1982) ......... 21

Kerst v. Nelson, 171 Minn. 191,

213 N.W. 904 (1927) ... 0... 0... eee eee 15

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

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

PEED. vn eceéddenkecedesneessecuecs 21

King v. Pope, 91 S.W.3d 314 (Tenn. 2002) ...... 4,22

Landreth Timber Co. v. Landreth,

re eh Oe occ ececececescccecsa 28

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

GUE, BA, TED cc ccccccccccccccecccess 22

McCormick v. Shively, 267 Ill. App. 99 (1932) ..... 15

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

550, N. 17 (5 Cir. 1981) .............. 9, 20

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

560 S.E.2d 305 (2002) ............645. 4,22

Payable Accounting Corp. v. McKinley,

667 P.2d 15, 19 (Utah 1983) ............. 23

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

199 Cal. Rptr. 253 (App. 1983) ........... 23

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

P.2d 680, 224 Cal. Rptr. 7119 (1986) ...... 23

Vii

People v. White, 12 P.2d 1078 (Cal. App. 1932) . 12, 14

Rasch v. State, 579 S.E.2d 817

SE ED 20 ceseescesescévvececes 22

Reves v. Ernst & Young,

494 U.S. 56 (1990) .... 0... 6.0045. 12, 19, 26

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

SN EL MED co cehocenccceeccecues 20

SEC v. C. M. Joiner, 320 U.S. 344 (1943) ...... 10, 22

SEC v. Capital Holdings, L.L.C., CA No. 03-RB-0923

(D. Colo., filed May 21, 2003)............ 22

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

Supp.2d 1349 (N.D. Ga. 2000) ........... 19

SEC v. Herula, C.A. No. 02-154-ML

Ss Ges SU A ED oc cceeccececececes 21

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

PEED ccccncveccesvccccusce 20

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

503 F.Supp. 1066 (M.D.N.C. 1980) ....... 21

SEC v. Phoenix Telecom, LLC, 2000

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

PT cc veeusedebaheesceesesees 20

SEC v. Ralston Purina Co., 346 U.S. 119 (1953) ... 16

SEC v. SG, Ltd., 265 F.3d 42, 54 (1* Cir. 2001) .... 22

SEC v. United Benefit Ins. Co.,

ee ED ok kctcccusecsacecces 9

Vili

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

2, 5, 6, 7, 8, 9, 11, 12, 13, 14, 16, 17, 18, 19, 20,

22, 24, 25, 26, 27, 29

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

1243-1244 (S.D. Tenn. 1980) ............ 21

SEC v. Yoder, No. #:03-CV-0418AF

(N.D. Ind., filed June 19, 2003) ........... 21

State v. Evans, 154 Minn. 95,

FG Fi ee SPEND cc cccccceveccccesse 15

State v. Gerisch, 49 P.3d 392 (Idaho 2002) ...... 4, 22

State v. Gopher Tire & Rubber Co.,

146 Minn. 52, 177 N.W. 937 (1920) .... 14, 15

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

Pe PE hb oe dececccvecedesess: 22

State of New York v. Justin, 237 F.

Supp.2d 368 (W.D.N.Y. 2002) ........... 24

Stevens v. Liberty Packing Corp., 161 A.

893, 195 COEF. Ci, ISSR) cc cccccccess 12, 14

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

18727 Final Decision

(Ga. Sec. Div. Sept. 6, 2002) ............ 24

Szpunar v. State, 783 N.E.2d 1213

ek ie BE oa ci nesdiccdivcedns 4, 22

United Housing Foundation v. Forman,

421 U.S. 837 (1975) . 2, 4, 5, 6, 7, 13, 20, 21, 26

ix

United States v. Carman, 577 F.2d

556, 563 (9 Cir. 1978) ...........00000. 20

United States v. Farris, 614 F.2d

GOO, GOR Ge, TOFD onc cc cccccccccecs 20

United States v. Jones, 712 F.2d

1316 (9" Cir.), cert. denied

464 US. 986 (1983) .................. 3, 20

Webster v. U.S.I. Realty Co., 170 Minn. 360,

ok re eee 15

Statutes:

Cahill’s Revised Statutes 1931, Ch. 12, 9259(1) .... 15

Miscellaneous:

12, Joseph C. Long,

Blue Sky Law §1:16 (2002) .............. 14

12, Joseph C. Long,

Blue Sky Law §1:17-1:18 (2002) ....... 12, 14

12, Joseph C. Long,

Blue Sky Law §2:58 (2002) .............. 8

Cal. Corp. Comm’n, Press Release 00-16 (2000) ....3

7 ee. oe

vs.

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 Appeal From the United States Court

of Appeals for the Eleventh Circuit

Brief for the Public Investor's Arbitration

Association, Inc., as Amicus Curiae

STATEMENT OF INTEREST OF THE

PUBLIC INVESTOR'S ARBITRATION BAR

ASSOCIATION, INC.

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. -

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

2

interests in payphones offered by other companies. The decision

of this Court will strongly influence the outcome of these actions.

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. There are

similar investment plans presently being offered to the general

public involving 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

PIABA believes the SEC has greatly understated the true

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. The Eleventh Circuit 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

a contract fixed-return obligation. It reached this conclusion

based upon its reading of United Housing requiring that the

investor's profit must come from the earnings of the company.

Interest or fixed return contract obligations may or may not come

from the earnings of the enterprise 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

1SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

Aomaae

3

agencies spend a great deal of their enforcement resources dealing

with novel or unusual securities. By far the most used portion of

the Statutory definition of a security in these cases is that of

“investment contracts.” Virtually all these novel securities cases

also involve either Ponzie schemes or fraudulent conduct, often

aimed 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 included, the number of

state enforcement actions soars to over 200.2 The State of

California alone has issued 143 Desist and Refrain Orders against

54 such entitles.‘

This is, 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 railroad 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).

These problems will also continue into the future. Ads are

presently running on national television offering similar contracts

on both Internet site locations and credit card confirmation

*See e.g., In re ETS Payphones, Inc., 2002 WL 1586379 (Ind. Div.

Sec. June 7, 2002); In re ETS Payphones, Inc., 2001 WL 422179 (Ala. Sec.

Com. Feb. 6, 2001); and In re National Communications Marketing, Inc., 2001

WL 236889 (Wash. Sec. Div. Feb. 26, 2001).

*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.

4

machines. Many 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 international banking transaction

frauds. 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) The

states have also been faced with the fraudulent sale of viatical

settlement contracts.

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, 783 N.E.2d 1213 (Ind: App. 2003), could not be brought.

Nor would the state agencies be able to bring administrative

actions and civil injunctive proceedings, such as King v. Pope, 91

S.W.3d 314 (Tenn. 2002).

This brief will attempt to accomplish two things. First, it

will address why the Eleventh Circuit's position in the present

case is wrong and should be overruled. Then, it will outline the

two approaches the Court can take in overruling the Eleventh

Circuit and establishing a meaningful and consistent public policy

in this area.

There are numerous reasons why this Court should reverse

the decision of the Eleventh Circuit. PIABA will demonstrate

that the Eleventh Circuit's reading of United Housing was

mechanical and unwarranted. It will also show that the United

:

f

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}

ee

5

Housing restrictions on "profits" are not supported by this Court's

prior cases and the origins of the “investment contract” concept.

Finally, PLABA will show that the United Housing restriction, as

interpreted by the Eleventh Circuit, is inconsistent with the

decisions of the other federal courts, the SEC, the state courts,

_ and the state securities agencies.

Assuming that the Court is willing to overturn the

Eleventh Circuit's decision, PLABA will then outline how the

Court can accomplish this result. PIABA believes that the Court

can accomplish this task in either of two ways.

The easiest and simplest approach would be to rule that

interest or any fixed income can be considered a "profit" under

the third element of the Howey test. While this approach will

accomplish the appropriate result and is attractive because of its

simplicity, PLABA would urge the Court to follow the second

approach.

The Court should use this case as a vehicle for a broad

rethinking of the elements of an investment contract and of a

security in general. During the last fifty years, since the decision

in SEC v. W.J. Howey Co., the Court has dealt with the

definition of an investment contract and that of a security in

general on a piece-meal basis. Time is overdue for the Court to

take the time to harmonize its various pronouncements as to what

is a security and develop a single logical approach te this issue

which is consistent with the intent of Congress in passing the

Securities Act of 1933. In other words, in a logical and consistent

manner, the Court needs to identify the elements of "securitiness"

as well as of investment contracts.

In performing this task, the Court should determine the

true nature of "securitiness" and a number of artificial tests which

have grown up in the lower federal courts. The cases are largely

the result of the Court’s imprecision in its past pronouncement on

the subject. The test should not be burdened with restrictions or

6

\

limitations which have no relevance to defining that which

Congress sought to regulate in passing the Securities Act of 1933.

This Court, in many other areas, has sought to return to

the original intent of Congress as determined by the language of

the statute itself, its legislative history, and historical development

as gleaned from similar statutes which Congress sought to use as

a drafting model. The need is for a test to identify in a consistent

and rational way, what are the elements of “securitiness.”

In summary, PIABA urges the Court to reverse the

decision in the present case and undertake the task of identifying

the appropriate elements of "securitiness”.

ARGUMENT

Technically, there is only one issue before the Court. This

question is whether the Eleventh Circuit was correct in holding

that an obligation to pay a fixed monthly amount for the use of

payphones under a purchase and service contract prevents that

agreement from being an investment contract. The Eleventh

Circuit concluded that “the expectation of profits” element of the

Howey test is not met by any interest-bearing agreement or

contract requiring the payment of a fixed return. In doing so, the

Eleventh Circuit interpreted United Housing Foundation v.

Forman, 421 U.S. 837 (1975), which defined the "profit"

element of Howey test to exclude either the payment of interest

or a fixed-return. This conclusion was based upon its reading of

United Housing to require that the investor's profit must come

from the earnings of the company or enterprise. Interest bearing

or fixed-return obligations may or may not come from such

earnings because these debts must be paid without regard to the

enterprise’s profit.

-

7

POINT I

UNITED HOUSING DOES NOT JUSTIFY THE

EXCLUSION OF PAYMENT OF INTEREST AND

OTHER FIXED AMOUNTS

FROM THE "PROFITS" ELEMENT

OF THE HOWEY TEST

The language of United Housing does not require the

exclusion of fixed-return or interest-bearing instruments from

being investment contracts. Nor do the prior decisions of this

Court. Further, such exclusion finds no support in either the

policy behind the Securities Act of 1933 or the state law origins

of the "investment contracts" concept.

AL THE LANGUAGE OF UNITED HOUSING

DOES NOT DEMAND SUCH RESULT

The language of United Housing Foundation, Inc. v.

Forman, 421 U.S. 837 (1975), does not require the interpretation

given to it by the Eleventh Circuit. The thrust of United Housing

was to distinguish those cases where the receiving of 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. In attempting to make this distinction, the Court

made the following statement about the "profits" element of the

Howey test, which the Eleventh Circuit relied to exclude interest-

bearing and fixed-return contracts from coverage as investment

contracts.

[The Howey] test, in shorthand form, embodies

the essential attributes that run through all of

the Court's decisions 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 management efforts of

8

others. 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.... In such

cases the investor is ‘attracted solely by the

prospect of a return’ on his investment. Id.

[Emphasis added. ]

The first example of "profits," capital appreciation, does

not cause any problem. It is the second clause "a participation in

the earnings resulting from the use of the investor's funds" which

causes the problem. Read out of context, the phrase "earnings

resulting from the use of investor's funds" could lend support to

the Eleventh Circuit exclusion of debt and fixed payment

instruments, if earnings are defined as gross or net profits of the

enterprise. These obligations as debts must be paid regardless of

profits or earnings. However, the Eleventh Circuit’s

interpretation is not the only possible interpretation. PIABA

suggests that it is not the best interpretation for two reasons.”

First, the language must be put in context. When this is

done, several things are clear. It is evident that the Court believes

the Howey test, including its profits element, to be the litmus test

for securities in general. If this is true, debt instruments can not

be excluded because notes, bonds, debentures, and evidences of

indebtedness are specifically included within the statutory

definition. Thus, there would seem to be no intent to exclude

interest or other fixed-payment instruments. Also, the

questionable language is followed by the last sentence which

reads: “In such cases the investor is ‘attracted solely by the

prospect of a return’ on his investment.” The emphasis here

5See a more detailed discussion of these reasons, in the Author's

treatise, Blue Sky Law §2:58 (2002).

eg sO A IO IE

9

is on the expectation of a return to the investor. “Return”

includes interest, dividends, and fixed-return payments.

Finally, it is clear that the language used was an example

based upon the prior cases of the Court. 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

this fact, the Fifth Circuit in Meason v. Bank of Miami, 652 F.2d

542, 550, N.17 (Sth Cir. 1981), commented that the quoted

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

. These three factors, taken together, mitigate against an

intent to exclude some types of returns such as interest or fixed

payments.

Second, if read the way the Eleventh Circuit did, the focus

of the "profits" element would be reversed. The Howey test

focuses on the expectation of a profit to the investor. It does

not focus on the enterprise in which the investment is made

making a profit. The investor doesn’t care whether the

enterprise makes a profit so long as his expectation of a return is

fulfilled.

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

(Sth Cir. 1977), the investor was to receive ten dollars off the cost

of his vacuum for every referral made. The ten dollars was paid

whether the referral bought a vacuum or not. All that was

required to receive the ten dollars was for the referral to allow a

demonstration of the vacuum. The Fifth Circuit held the

agreement to be an investment contract, despite the fact that the

ene cleaner company might not make a profit because no sale

is e.

*The Court has considered variable annuity contracts in SEC v. United

Benefit Ins. Co., 387 U.S. 202 (1967) which have a fixed-return floor on the

investment. The focus of the case, however, for investment contract purposes,

was on the variable annuity feature.

10

The basis for the Eleventh Circuit's exclusion of fixed-

return or interest-bearing debt securities on the other hand is that

the enterprise must pay these obligations, so long as it is solvent,

without regard to whether it makes a profit.

B. EARLIER SUPREME COURT CASES DO

NOT SUPPORT THE EXCLUSION OF

FIXED-RETURN OR INTEREST BEARING

INSTRUMENTS FROM COVERAGE

UNDER THE INVESTMENT CONTRACT

ANALYSIS

This Court's first decision 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 were

definitions by enumeration. Some of the instruments named in

the definition were "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.

It also recognized that:

[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.

Finally, the Court 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

. ead

mansicegney Fest. +

11

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.

The Court found the oil and gas interests offered by Joiner

were investment contracts. In doing so, it refrained from

providing a test to identify “investment contracts.” Nothing,

however, 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. The Court made two important observations in Howey.

First, it noted that the term "investment contracts" was not

a defined term either in the statute itself or the legislative history.

However, the term had been in use under the state securities or

Blue Sky laws where "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

| This statement is particularly important in the present case because

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

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

phone. From the perspective of many investors, they were making an

investment which would receive a return on that investment, and would not

participate in the management of the investment. They were buying an

investment contract, not a contract for the payment of rent on a payphone.

12

countless and variable schemes devised by those

who seek the use of the money of others on the

promise of profits. Jd. at 299.

Finally, the Court 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. Jd. at 298-299.

Based on this discussion, the Court concluded the scheme

in Howey was an investment contract. Again, there is nothing in

the language used or the Court's discussion which suggests that

the profit can not be in the form of fixed payments or interest on

debt securities. In fact, the SEC notes that two of the state cases

relied upon by the Court in Howey involved fixed income or

"guaranteed" returns. 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).°

The only support for the Eleventh Circuit's position is the

dicta in Reves v. Ernst & Young, 494 U.S. 56 (1990). In Reves,

the Court established when promissory notes would be securities.

In footnote 4, the Court discussed the concept of “profits.” It first

said: “We emphasize that by ‘profits’ in the context of notes, we

mean ‘a valuable return on an investment,’ which undoubtedly

includes interest.”

Then it added the following dicta:

For a detailed discussion of these cases and the other state and lower

federal court cases cited in Howey, see the Author's treatise, Joseph C. Long,

Blue Sky Law §§1:17-1:18 (2002).

ae 6 A ae 9 gag Mem OA 5

ek et EL TE TS aN TL sete

13

We have, of course defined "profit" more

restrictively in applying the Howey test to what

are claimed to be investment contracts. [Citing

Forman] To apply this restrictive definition to the

determination whether an instrument is a "note"

would be to suggest that notes paying a rate of

interest not keyed to the earnings of the enterprise

are not "notes" within the meaning of the

Securities Acts. 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.

The first part of this dicta appears to confirm the Eleventh

Circuit's interpretation of United Housing. The Court, however,

makes clear that its statement is dicta because the issue was not

before the Court. Further, the last part of the dicta indicates that

the Court might re-consider the definition of "profits" in respect

to investment contracts in an appropriate case. The present case

presents the Court with such an opportunity.

Cc. EXCLUSION OF FIXED PAYMENTS OR

INTEREST FROM "PROFITS" UNDER THE

HOWEY TEST FINDS NO SUPPORT IN

THE STATE LAW ORIGINS OF THE

CONCEPT OF "INVESTMENT

CONTRACTS"

In Howey, the Court indicated that Congress had taken the

definition of a security from previous state statutes. That

definition, as were many sections of the originally proposed

Securities Act of 1933, was drawn from the Uniform Sale of

Securities Act adopted by the National Conference of

Commissioners on Uniform State Laws. In turn, the Uniform

Sale of Securities Act incorporated features of earlier state

14

securities. The words "investment contract" first appeared in the

Arkansas Securities Act of 1913.’

Because of this incorporation of state law, the Howey

Court indicated that it was appropriate to look to state law case

for the definition of "investment contracts," since no definition

was included in either the Securities Act of 1933 or the Uniform

Sale of Securities Act. The Court said:

By including an investment contract within the

scope of §2(1) of the Securities Act, Congress was

using a term the meaning of which had been

crystalized by this prior judicial interpretation. It

is therefore reasonable to attach that meaning to

the term as used by Congress, especially since

such a definition is consistent with the statutory

aims.

Howey, 328 U.S. at 298.

The Court then proceeded to examine some eight state

cases decided prior to the enactment of the Securities Act of

1933.'° As noted above, SEC pointed out that two of these cases,

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

Liberty Packing Corp., 161 A. 193, 195 (NJ. Ch. 1932),

involved a fixed income or "guaranteed" return. Clearly, these

cases do not support the exclusion of fixed-return or interest-

bearing instruments from coverage under investment contracts.

As the Howey Court noted, the first case to attempt to

define "investment contract" was State v. Gopher Tire &

91913 Ark. Acts 214, at 904. See the Author's treatise, 12 Joseph C.

Long, Blue Sky Law §1:16 (2002).

For a discussion of those eight cases, see the Author's treatise, 12

Joseph C. Long, Blue Sky Law §1:17 (2002).

<p SRE SR TNE alae

15

Rubber Co., 146 Minn. 52, 177 N.W. 937 (1920). The court in

Gopher concluded that an investment contract was a contract

involving "[t}he placing of capital or laying out of money in a way

intended to secure income or profit from its employment..."

[Emphasis added.] The use of the word “income” clearly would

cover the receipt of interest or a fixed-return payment.

Subsequent Minnesota cases affirm this conclusion.

State v. Evans, 154 Minn. 95, 191 N.W. 425 (1922),

involved the sale of an interest in land under an installment plan.

The contract provided that the investor could surrender his

interest in the land and be paid a bonus of seventy dollars per

each thousand invested over and above the return of his

investment. The court found the arrangement to be an investment

contract under the Gopher test. Five years later, Webster v.

U.S.I. Realty Co., 170 Minn. 360, 212 N.W. 806 (1927), a

similar land sale contract with a cash out option which paid

interest was found to be an investment contract. See also Kerst

v. Nelson, 171 Minn. 191, 213 N.W. 904 (1927).

Examples of interest bearing or fixed-return contracts

being held to be investment contracts was not confined to

Minnesota. For example, both Fidelity Inv. Ass'n v. Emmerson,

318 Ill. 548, 149 N.E. 530 (1925) and McCormick v. Shively,

267 Ill. App. 99 (1932) involve such agreements.''

From these cases and other pre-1933 state cases, it

becomes abundantly clear that the Eleventh Circuit's restriction on

**In fact, the Illinois Act of that period defined investment contract.

It indicated that a contract involving:

a sum of money [to be paid] at a future date, either with or

without interest, in consideration of a payment or payments

made or contemplated to be made by such purchaser or

holder, ... are hereinafter referred to as investment contracts.

Cahill's Revised Statutes 1931, Ch.12, 9259(1).

16

"profits" does not find support in the early state cases. Investment

contract, prior to 1933, involved the expectation of the receipt of

income in the form of profits, interest, or the payment of a fixed

return.

D. THE PUBLIC POLICY BEHIND THE

SECURITIES ACT OF 1933 DOES NOT

SUPPORT THE EXCLUSION OF FIXED

PAYMENTS OR INTEREST FROM

"PROFITS" UNDER THE HOWEY TEST

Probably the most important argument against adopting

the Eleventh Circuit's exclusion of fixed-payments and interest

from a "profit" comes from the purpose and public policy behind

the Securities Act of 1933. The purpose of the Act was to ensure

that the investing public had the necessary information to make

an informed decision whether to purchase the security. The public

policy behind the Act should be to define a definition of a

"security" in such a way that all investors who need such

information are covered by the Act, and those who do not are

excluded. Cf SEC v. Ralston Purina Co., 346 U.S. 119 (1953).

The Court in Howey properly identified the category of

investors who need the protection of the Act, when it said: “[AJll

the elements of a profit-seeking business venture are present here.

The investors provide the capital and share in the earnings

and profits; the promoters manage, control and operate the

enterprise.” Jd. at 299. [Emphasis added. ]

Put another way, a security is 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 and control of the

operation. The investor needs to be supplied information about

the company, its product, and the company's success in the

marketing of the product. Further, the investor needs information

about the people to whom he is entrusting his money.

EN a ee

17

Finally, the investor needs to be informed about his

investment. Does it carry the right to vote in the entities affairs

and to what extent? What return does the investment yield and

does that yield vary, or is it fixed? Will this return be paid as

long as the entity is solvent or is it dependent upon the profits of

the enterprise? Where does the investment rank in bankruptcy

and liquidation? What are the chances that investor will actually

receive his return?

There are two types of investments where the investor

does not need this information. As the above quoted language

from Howey points out, the first example is where the investor

actively engages in the operation or management of the enterprise.

An example of this active participation is the general partnership

where all partners exercise their statutory partnership rights to

manage the partnership. Under this scenario, the investor, by

participating in management, is in control of his own destiny.

Further, the investor, by virtue of his participation, has access to

the information necessary to make an informed investment

decision.

The second type of investment is where the investment is

totally passive. An example of this type of investment is where

the investor, himself,'? purchases a piece of raw land. He does

not plan to develop the land or use it for agricultural purposes.

The land is to remain idle. The investor hopes, however, that the

land will appreciate in value. However, such appreciation is not

related to anyone's concerted effort.

The above quoted language from Howey serve to

eliminate the first situation where there is no need for investor

protection. It indicates that there must be an investment with the

expectation of a profit and the investor is passive. These are the

*?If he hires someone to exercise his special expertise in selecting the

land, then an investment contract results because the selection process is the

necessary active element.

18

first and third elements of the Howey test, investment with the

expectation of a profit to come from the efforts of others.

The passive investment scenario is eliminated by the

Howey common enterprise element. When properly construed,

it requires nothing more than two people joining together to

accomplish a common goal of making a profit for the investor.

To accomplish this goal, someone other than the investor must

actively generate the expected profits.

Thus, the Howey test is designed to meet the public policy

of eliminating those persons who do not need the protection of the

securities acts under “the investment contract” portion of the

definition of a security. Or, as will be developed below, it

identifies the elements of "securitiness" which should be applied

to all parts of the definition.

In construing the various parts of the Howey definition,

this public policy must be the pole star. No artificial element or

requirement should be added which does not aid in identifying

those people the Act was intended to cover.

A prime example of such an artificial test is the division

over the meaning of “common enterprise.” The Sixth and

Seventh Circuits, based upon the facts of Howey, claim that

there must be multiple investors. The Ninth Circuit requires the

promoter or third party to share in the profits of the enterprise.

Neither of these requirements furthers the goal of

identifying persons to be protected. A single investor buying

what otherwise would be an investment contract needs the same

protection as when two or more investors buy the same

investment. Likewise, the investor who receives all the profits

generated by the promoter or third party needs the protection of

the Act, if he is passive, as does a similar investor who only

receives part of the profits.

19

PIABA submits that the Eleventh Circuit's elimination of

interest and fixed-returns from the definition of profit is merely

another artificial restriction. The Court in Reves in the footnote

quoted above recognized that for the purposes of promissory

notes "profits" should include interest. The same is obviously

true for bonds, debentures, and other evidences of indebtedness

contained in the statutory definition.

The question then becomes whether there is something

inherent in the nature of an "investment contract" that requires

different treatment. PIABA submits that the answer to this

question is “no.”

PIABA believes the Howey test outlines the elements of

“securitiness.". PIABA also believes that these elements are

found in all the enumerated terms in the definition of a security.

Therefore, "profit" should not be treated differently under the

"investment contract" portion of the definition than it is when

dealing with other portions of the definitions such as notes,

bonds, debentures, or other evidences of indebtedness. A "profit"

for the purpose of identifying those persons needing the

protection of the securities is a "profit" whether it takes the form

ofa dividend, interest, or payment under a fixed-return obligation.

The Eleventh Circuit, by excluding interests and payment

under fixed-return obligations, has simply created another

irrelevant artificial test which does not help accomplish the

purpose and public policy behind the Securities Act of 1933.

This Court should strongly reject such effort.

E. EXCLUSION OF FIXED PAYMENTS OR

INTEREST FROM "PROFITS" UNDER THE

HOWEY TEST IS CONTRARY TO THE

HOLDINGS IN MANY OTHER LOWER

FEDERAL COURT DECISIONS

Two federal district courts, in addition to the trial court in

the present case, SEC v. ETS Payphones, Inc., 123 F. Supp.2d

20

1349 (N.D.Ga. 2000), rev’d _ F.3d__ (11 Cir. 2002), have

held that payphone schemes similar to that in the present case are

investment contracts. SEC v. Phoenix Telecom, LLC, 2000

U.S. Dist. LEXIS 22314 (N.D. Ga. Aug. 2, 2000) and SEC v.

Alpha Telecom, Inc., 187 F. Supp.2d 1250 (D. Ore. 2002).

Since the United Housing decision, both the Third and

the Ninth Circuits have rejected the exclusion of interest or fixed

payments from the Howey definition of profit. In doing so, they

have held 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. The contracts provided that the return on

these student loans carry a fixed interest return. Further, the

interest was guaranteed by the federal government. The Ninth

Circuit held these contracts to be investment contracts. 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).

Finally, the Eleventh Circuit decision in the present case

is in conflict with other binding decisions by the Fifth Circuit

prior to the creation of the Eleventh Circuit. 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.

Immediately before the creation of the Eleventh Circuit,

the Fifth Circuit in Meason v. Bank of Miami, 652 F.2d 542,

550, N.17 (Sth Cir. 1981) recognizing that this Court had never

21

had a note case before it, rejected the district court's holding that

an investment was not a security, merely because the investor

received a fixed-return on the investment.” It stated the

definition of "profits" in the United Housing case "seems to us

to be dubious value in [the note] context." Similarly, in Bell v.

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

found an investment contract where the purchaser of a vacuum

cleaner was to receive ten dollars for every referral made. The ten

dollars was payable, if the referral allowed a demonstration of the

vacuum whether or not a sale was made.

F. EXCLUSION OF FIXED PAYMENTS OR

INTEREST FROM "PROFITS" UNDER THE

HOWEY TEST IS CONTRARY TO THE

POSITION TAKEN BY THE SEC

. As the SEC notes in its Brief Seeking Certiorari, 23-24,

and its brief on the merits, both the exclusion of interest and fixed

payments from the definition of "profit" runs contrary to the long

standing position of the SEC in its administrative actions. See

e.g., In re Abbett, Sommer & Co., 44 S.E.C. 104, 1969 WL

95369 (1969) and In re Union Home Loans, 26 S.E.C. Dkt

1517, 1982 WL 522493 (Dec. 16, 1982).

Further, the Commission has argued in its enforcement

cases involving "Prime Bank" and various other schemes that

such schemes are investment contracts. This position is taken in

spite of the fact that most of the schemes provide the investor

with a guaranteed rate of return. See also SEC v. Herula, C.A.

No. 02-154-ML (D. R.I. June 20, 2003)(Prime Bank); SEC v.

Yoder, No. #:03-CV-0418AF (N.D. Ind., filed June 19, 2003);

**Meason indicates other courts have not accepted the idea

{ that a

fixed return disqualifies the finding of an investment contract., citing Khadem

v. Equity Sec. Corp., 494 F.2d 1224, 1229 (9th Cir.), cert. denied, 419 U.S.

pnd may SEC v. Nat'l Executive Planners, Ltd., 503 F.Supp. 1066

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

(S.D. Tenn. 1980). ” castes

22

SEC v. Capital Holdings, L.L.C., CA No. 03-RB-0923 (D.

Colo., filed May 21, 2003).

This argument appears to have been accepted by the

courts. For example, SEC v. SG, Ltd., 265 F.3d 42, 54 (1st Cir.

2001) involved virtual reality shares. Relying heavily upon

Joiner, the First Circuit found the shares to be investment

contracts. In discussing the "profits" element of Howey, the court

noted: “SG flatly guaranteed that investments in the shares of the

privileged company would be profitable, yielding monthly returns

of 10% and annual returns of 25%. In our view, these profit-

related guarantees constitutes not-very-subtle form of economic

inducement....”

G. EXCLUSION OF FIXED PAYMENTS OR

INTEREST FROM "PROFITS" UNDER THE

HOWEY TEST IS CONTRARY TO THE

POSITION TAKEN BY MANY STATE

COURTS

Many state courts have rejected the idea that fixed fee

agreements and debt securities can not be investment contracts.

These courts have construed the definition of "investment

contracts” under the state 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), 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). The most recent of this series,

Rasch v. State, 579 S.E.2d 817 (Ga. App. 2003), was decided

while the petition for certiorari was pending before this Court.

More specifically, two state cases, King v. Pope, 91 S.W.3d 314

(Tenn. 2002)(a payphone case with fixed monthly payments

similar to ETS), and Szpumar v. State, 783 N.E.2d 1213 (Ind.

Qh STS

23

App. 2003)(another payphone scheme), have held that payphone

sales involve the sale of an investment contract.

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.”

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 1 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. ]

H. EXCLUSION OF FIXED PAYMENTS OR

INTEREST FROM “PROFITS” UNDER THE

HOWEY TEST IS CONTRARY TO THE

POSITION TAKEN BY STATE SECURITIES

AGENCIES

Likewise, the state securities agencies themselves have

rejected the idea that an instrument calling for either the payment

24

of interest or a fixed fee can not be investment contracts. As

noted in Point I, 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 a

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, DOAH Case No. 02-0526, 2002 WL 31452438 (Fla. Sec.

Div., Final Order, Oct. 17, 2002), the Florida Comptroller

rejected the Eleventh Circuit approach under the Act. The

Comptroller said "Florida law does not use such a narrow

construction of ‘profits,’ it has not distinguished between fixed or

variable returns to the investor." As outlined in Point I, sixteen

other state securities agencies have also taken action against ETS

under the investment contract analysis. A number of new orders

25

have been entered during this Court’s deliberation whether to

grant certiorari.’

In summary, there is no basis in the language of the

Securities Act, the prior case law from this Court, the history of

the concept of “investment contract,” or the public policy and

purpose behind the Act to support the Eleventh Circuit's

exclusion of interest and payment under a fixed-return contract

from the definition of "profits" under the Howey test. Further,

such limitation runs contrary to the holdings of other federal

courts, the SEC, the state courts, and the state securities agencies

which have held that interest may constitute a profit for

investment contracts purposes.

POINT I

IN REVERSING THE ELEVENTH CIRCUIT,

THE COURT SHOULD CONDUCT AN

OVERALL REVIEW OF "SECURITINESS"

Assuming that the Court is willing to overturn the

Eleventh Circuit's decision, PIABA suggests that the Court can

accomplish the result of assuring that interest and payments under

fixed-return contracts are included in the definition of "profits" in

either of two ways. The easiest and simplest approach would be

to rule that interest or any fixed income can be considered a

"profit" under the "profit" element of the Howey test. The second

way is for the Court to use this case as a vehicle for a broad

rethinking of the elements of an “investment contract” and of a

“security” in general. PIABA urges the Court to follow the

second choice.

4Seee.g., Inre Mack, 2003 WL 21269563 (Ohio Dept.Comm., May

30, 2003); In re Ray, 2003 WL 21269561 (Ohio Dept.Comm.,, May 22, 2003);

and In re Ellsworth, 2003 WL 21207816 (Mo.Div. Sec., April 29, 2003).

26

A. THE COURT SHOULD NOT SIMPLY

REDEFINE "PROFITS" TO INCLUDE

INTEREST AND FIXED PAYMENTS

As noted above, the simplest way to resolve the present

case is to reverse the Eleventh Circuit. It can, at the same time,

disaffirm the dicta in both United Housing and Reves. Then, the

Court can make crystal clear that "profits" under Howey includes

both interest bearing agreements and fixed-return contracts. In so

doing, the Court would bring the definition of "profits" under the

investment contract portion of the definition in line with the

definition "profits" used in the Reves case for promissory notes.

While this approach will accomplish the appropriate result

and is attractive because of its simplicity, PLABA would urge the

Court not to limit its pronouncement in this way. This approach

is merely applying another band-aid to an area where prior case

law by this Court, as well as the other federal courts, is in serious

confusion. This confusion has resulted in losing sight of the

purpose of, and policy goals behind the Securities Acts.

B. THE COURT SHOULD UNDERTAKE A

RECONSIDERATION OF THE WHOLE

CONCEPT OF WHAT IS A SECURITY AND

IDENTIFY THE ELEMENTS OF

"SECURITINESS"

PLABA urges the Court to use the present case as a vehicle

for a broad re-thinking of the elements of an investment contract

and of a security in general. It has been almost sixty years since

the landmark decision in SEC v. W.J. Howey Co. During this

period, the Court has dealt with the definition of a security as well

as the definition of an investment contract on a piece-meal basis.

This approach has resulted in a great of uncertainty in an area

where predictability is extremely important.

PIABA believes that time is overdue for the Court to take

the time to re-think the entire concept of what is a security. In

27

doing so, the Court can harmonize its various pronouncements

and develop a single logical approach to this issue. The result

should be a definition of investment contracts, and "securitiness"

in general, which is consistent with the intent of Congress in

passing the Securities Act of 1933.

a In performing this task, the Court should strive to

eliminate a number of artificial tests which have grown up under

various elements of the Howey test. These artificial or

mechanical tests do not help identify the people which Congress

intended to have the protection of the Securities Act. These tests

have developed largely because of the imprecision of the Court in

its past pronouncements. These tests merely burden the definition

of investment contracts, and securities in general, with restrictions

or limitations which has no relevance to defining that which

Congress sought to regulate by passing the Securities Act of 1933.

This Court, in many other areas, has sought to return to

the original intent of Congress as determined by the language of

the statute itself, its legislative history, and historical development

as gleaned from similar statutes which Congress sought to use as

4 drafting model. The Court needs to undertake such a re-analysis

in the securities area and develop, in a consistent and rational

way, what are the elements of “securitiness.”

PIABA believes the Court in Howey long ago identified

the four proper elements of a security. As discussed above in

Point ID, these are an investment in active enterprises motivated

by the expectation of a profit or return to the investor where some

one other than the investor will perform the managerial and

~—ecagare functions necessary to generate that profit or

The investment should not be limited to money, but

should include services performed or the use of property given to

the enterprise.

28

The enterprise must be actively doing something to

generate the expected profit. Further, it should make no

difference whether there is only one investor or many. Likewise,

it is irrelevant whether the promoter or third person participates

in the profits or return.

The profits or return should include interest, dividends,

and fixed payments. Further, it should not be limited to the

payment of money, but should include the distribution of other

securities or property.

Finally, to be excluded under the efforts of others test, the

right to participate in management must come from the ownership

of the securities and not the holding of an office such as an officer

or director of a corporation. Also, the right to participate in

management must be a right to directly participate in the

management of the enterprise, and not be indirect management as

in the case of election of the directors of a corporation.

To confirm these elements of "securitiness", the Court

should apply the above elements to stock in a corporation. The

Court in Landreth Timber Co. v. Landreth, 471 U.S. 681, 105

S.Ct. 2297 (1985), held that stock was the quid essential example

of a security.

To obtain stock in a corporation, the shareholder must

invest money, property, or services in the corporation. The

corporation is actively doing something, such as manufacturing

goods or performing services, to generate a profit. The investor

has made his investment in the corporation in the expectation that

he will receive a profit in the form of dividends or an appreciation

in the value of his stock.

Finally, his stock ownership may or may not give him the

right to participate in the election of the board of directors and on

certain extraordinary events such as merger or sale of assets. Yet

this right is a derivative right. It does not allow the shareholder

to direct the day-to-day operations, merely elect the directors who

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——_ OL CLE ce

29

are responsible for such operations. Stock then has all the

essential elements of "securitiness" identified by Howey.

A similar result will be reached, if the elements are

applied to bonds and debentures. The active enterprise element

will eliminate from coverage under the Act of those notes and

evidences of indebtedness used to fund the purchase of car, boat,

or home where the purchaser is consuming the goods for his own

personal use rather than employing them in an active enterprise

to generate a profit.

After over ninety years of securities regulation, it is time

to positively identify the elements of the interests to be regulated

rather than relying upon a laundry list of items which might or

might not carry the elements of a security. PIABA urges the

a to use the present case to undertake such an identification

SUMMARY

Based upon the above outlined cases and agreements,

PIABA urges the Court to reverse the Eleventh Circuit and find

the ETS interest to be investment contracts. In doing so, PIABA

urges the Court to reject the idea that a "profit" under the Howey

test can not be interest or the payment of a fixed return. Finally,

PIABA urges the Court to undertake a re-thinking of the area of

what is a security. In doing so, the Court should isolate the

elements of "securitiness" common to all securities: PIABA

believes that these elements are found in the Howey test as

interpreted above.

Dated: June 26, 2003

Norman, OK 73072

30

Respectfully submitted,

e Public Investors

Arbitration Bar Association

2609 Acacia Ct.

Norman, OK 73072

(405) 364-5471