Class 6 Investment Contract Flashcards
1933 Act section 2(a)(1)
definition of security
The term security means any note, stock … bond, debenture… investment contract, or instrument commonly known as a security
SEC v. W. J. Howey Co.
Facts:
Howey sold tracts of land with orange groves on each parcel to various investors. Howey would farm and sell the produce. About 85% of investors use Howey to manage. Services and produce were combined and sold. Money was disbursed to investors from Howey. Contracts were real estate sales combined with agreement for the service.
I: were the agreements investment contracts? Are real asset purchases included under securities laws (for some particular circumstances)? Are land purchases and service agreements separate, and hence, not investment contracts?
Holding: These agreements are investment contracts! They can be regulated under the 33 and 34 acts.
Reasoning: Investment contracts were defined in prior common law, enshrined by congress in the Acts
Investment contract is 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 third party. (formal certs not required)
Parties are offering an opportunity to contribute profit and to share in the profits.
Transfer of land is incidental.
The Howey case rejecting lower courts reasoning on the land sale: investment contract is necessarily missing where the enterprise is not speculative or promotional in character and where the tangible interests which is sold has intrinsic value independent of the success of the enterprise as a whole.
Was this not speculative? Not promotional?
Don’t any firms with assets have intrinsic value? Was this about direct ownership? Did the court misread the Court of Appeals?
Would a US government debt investment not have intrinsic value?
Don’t sophisticated investors need info?
How do sophisticated investors overcome info problems in contracting?
Intl. Brotherhood of Teamsters v. Daniel
Facts:
Collective bargaining led to an agreement with a compulsory and noncontributory pension.
Respondent (Daniel) needed 20 years of continuous service to get the pension. He took a break one year but worked 23 years. Pension was denied without continuous service. He sued under securities law alleging misstatements of fact and fraud.
I: was the pension interest an investment contract?
Holding: No, the pension investment was not part of an investment contract (but maybe other plans).
Reasoning: (following Howey)
Investment of money: Daniel did not actually do the investing/payment. The payments were not proportionate to the amount of work done.
Expectation of profits from common enterprise: the fund was reliant on the company for future contributions and to cover shortfalls.
Solely from efforts of promoter or third party. (Not addressed in this edited case).
Was it fair/reasonable for the court to rely on ERISA to displace the securities laws?
About expectation of profits, does it make a difference if the pension funds are managed by a professional (outside or in house) that generates substantial profits?
Or is this more of a pyramid scheme and that is what keeps it out of securities law?
What if a company just had a bank account that it contributed to and a policy of giving to employee retirements out of this (with no collective agreement or mention in employment agreements?
What if a company required all employees, as part of employment or collective agreement, to contribute to a mutual fund?
What if the employer paid the fund directly for each hour worked?
What if the fund was in-house?
SEC v. SG, Ltd.
Facts: SG had a game of investing in virtual stocks
The was all electronic/online
They disclosed about how money would come in and be distributed. An honest pyramid scheme.
There was a privileged company
10% monthly return
Drops in value would be covered by new money, fees from other virtual stocks, and spreads.
I: is this an investment contract?
Holding: this is an investment K
Reasoning (Howey again): Investment of money-yes
But this was a 12(b)(6) motion. Maybe defendants can factually argue they were simply selling games for enjoyment, not investment. (believable?)
In a common enterprise:
- horizontal commonality-investors pool funds, share profits/risks
-Broad vertical commonality-well-being of all investors be dependent upon the promoter’s expertise
-Just need to show investors profits are dependent on promoter/third party. SEC v. ETS
- Narrow Vertical Commonality-fortunes are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties. (so, can some investors not meet this while other can, within the same venture?)
This court adopted a horizontal standard. They are pooling, its a pyramid scheme. Hence, they are obviously sharing profits as well.
SG argued that there isn’t commonality because there isn’t a pyramid/Ponzi scheme, since they didn’t lie about the pyramid structure.
but they didn’t disclose that they would run out of new money and hence collapse eventually. There is no way to support 10% monthly forever. They didn’t disclose intent to keep investor money.
The court relies on the Howey case to adopt a horizontal standard, since investors pooled money in the orange groves. Couldn’t a vertical standard have been met by Howey? Weren’t they dependent of expertise?
