Opinion ID: 1915619
Heading Depth: 1
Heading Rank: 3

Heading: Was the Sale/Leaseback Option a Security?

Text: With certain exemptions not relevant here, Iowa Code chapter 502 prohibits the offer or sale of any security in this state unless it is registered under this chapter. Iowa Code § 502.201. The statutory definition of security includes an investment contract. Id. § 502.102(19). Pursuant to his statutory authority, see id. § 502.607, the commissioner of insurance has adopted a definition of investment security that includes [a]ny investment in a common enterprise with the expectation of profit to be derived through the essential managerial efforts of someone other than the investor. In this rule, a common enterprise means an enterprise in which the fortunes of the investor are tied to the efficacy of the efforts and successes of those seeking the investment or of a third party. Iowa Admin. Code r. 191-50.15(1) (emphasis added). This definition is derived from the United States Supreme Court's decision in SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). [2] Pace asserts the COCOTS he sold were not investment contracts because there was not an expectation of profit derived from the managerial efforts of someone other than the investor. He relies on a case from the Eleventh Circuit Court of Appeals that considered the purchase and leaseback of payphones by one of the companies through which Pace sold COCOTS. See SEC v. ETS Payphones, Inc., 300 F.3d 1281 (11th Cir.2002), rev'd, SEC v. Edwards, 540 U.S. ___, 124 S.Ct. 892, 157 L.Ed.2d 813 (2004). In the ETS Payphones case, the circuit court held the fixed payments expected by the investors could not be considered participation in earnings and therefore the investors had no expectation of profits so as to render the sale/leaseback of payphones a security within the scope of federal securities law. Id. at 1283-84. Moreover, the court held, because the returns to investors were contractually guaranteed, those returns were not derived from the efforts of [others]. Id. at 1285. This decision was recently reversed by the United States Supreme Court. See Edwards, 540 U.S. at ___, 124 S.Ct. at 896, 157 L.Ed.2d at 819. The Supreme Court noted in its decision that the expectation of profit element of the Howey test referenced the profit or return anticipated by the investor, not the profit of the enterprise in which he or she invested. Id. at ___, 124 S.Ct. at 897, 157 L.Ed.2d at 820-21. Consequently, whether the investor participates in the profits of the underlying enterprise or is guaranteed a fixed rate of return is not determinative. Id. What is important is whether the investor's profit or return is dependent on the efforts of others. Id. at ___, 124 S.Ct. at 898, 157 L.Ed.2d at 821-22. When it is, the scheme is an investment contract notwithstanding the promise of a fixed rate of return. Id. The Court reversed the court of appeals' decision that the sale and leaseback of payphones was not a security within the scope of federal securities law. Id. at ___, 124 S.Ct. at 899, 157 L.Ed.2d at 822. We agree with the reasoning of the Supreme Court and find it consistent with our interpretation of the term investment contract under Iowa law. In State v. Tyler, 512 N.W.2d 552 (Iowa 1994), we held an investor expected a profit where the note evidencing her $2000 investment required a $20,000 payment. 512 N.W.2d at 556 (applying Howey test). We concluded the note was an investment contract regulated by chapter 502. Id. Thus, this court has not hesitated to hold that an investment with a promised fixed return falls within the scope of state securities law. Examining the facts of the present case, we agree with the district court that under the sale/leaseback option sold by the defendant, any return or profit anticipated by the investorsfixed or notwould necessarily result from the labor of others because the investors contributed no managerial efforts to the initial or ongoing operation of the payphone. Therefore, the COCOT was an investment contract and a security within the scope of chapter 502. See State v. Kraklio, 560 N.W.2d 16, 19 (Iowa 1997) (holding solicitation of $300 from each investor for defendant's preparation and pursuit of investor's claim in class action was the sale of a security because the investors had neither the desire nor the expertise to manage the investment [the claim] themselves). The trial court was correct in so ruling.