# Amicus Curiae Brief — SEC v. Edwards > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385014_0636%3A16 ## Record - **Collection:** Supreme Court brief - **Document type:** Amicus Curiae Brief - **Published:** January 1, 2004 - **Citation:** 540 U.S. 389 ## Text JUN 2 6 2093 Supreme © ou LS FILLED } 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 |! } 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).