Opinion ID: 2610242
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Heading: the essential characteristics of an investment contract under the hawaii uniform securities act (modified).

Text: In arguing whether the interests represented by HMC's founder-member contracts constitute investment contract securities within the meaning of HRS § 485-1(12) both the appellant and the appellee rely for guidance principally upon the Supreme Court decision in Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). That case sought to formulate a test for the existence of an investment contract, such a contract being included within the definition of security under the Federal Securities Act. The Court concluded that an investment contract exists whenever 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. Securities & Exchange Commission v. W.J. Howey Co., supra at 299, 66 S.Ct. at 1103. The appellants urge us to adopt the Howey formula as the test to be applied in the present case. It is contended that under the Howey test the contracts in question are not investment contracts because founder-members in the HMC plan are expected to recruit new members and distribute purchase authorization cards in order to earn income; they do not, therefore, expect profits solely from the efforts of others. Gallion v. Alabama Market Centers, Inc., 282 Ala. 679, 213 So.2d 841 (Ala. 1968); Emery v. So-Soft of Ohio, Inc., 30 Ohio Op.2d 226, 199 N.E.2d 120 (Ohio Ct. App. 1964). The State also relies upon the Howey case but contends that the test enunciated therein is not to be taken literally. It argues that the efforts expected of the founder-members are minimal in nature and, as a practical matter, the founders are substantially dependent upon the management of the corporation for a successful return on their investment. Thus the State asserts, under the real meaning of the Howey rule, the disputed agreements are investment contracts. D.M.C of Colorado, Inc. v. Hays, 3 CCH Blue Sky L. Rptr., ¶ 70,897 at 67,042 (Colo.Dist.Ct. 2/26/71); see Florida Discount Centers, Inc. v. Antinori, 226 So.2d 693 (Fla. Dist. Ct. App. 1969), aff'd 232 So.2d 17 (Fla. 1970). We agree that the present agreements constitute securities within the coverage of the Hawaii Uniform Securities Act (Modified). We do not choose, however, to base this decision on the restrictive formula laid down by the Supreme Court in the Howey case. [2] The primary weakness of the Howey formula is that it has led courts to analyse investment projects mechanically, based on a narrow concept of investor participation. [3] See Gallion v. Alabama Market Centers, Inc., supra ; Emery v. So-Soft of Ohio, Inc., supra . Thus courts become entrapped in polemics over the meaning of the word solely and fail to consider the more fundamental question whether the statutory policy of affording broad protection to investors should be applied even to those situations where an investor is not inactive, but participates to a limited degree in the operation of the business. [4] In fulfilling the remedial purposes of our state act, we believe a sounder approach to securities regulation requires that courts focus their attention on the economic realities of security transactions: that is, [t]he placing of capital or laying out of money in a way intended to secure income or profit from its employment in an enterprise. State v. Gopher Tire & Rubber Co., 146 Minn. 52, 56, 177 N.W. 937, 938 (1920).
The salient feature of securities sales is the public solicitation of venture capital to be used in a business enterprise. Silver Hills Country Club v. Sobieski, 55 Cal.2d 811, 815, 13 Cal. Rptr. 186, 188, 361 P.2d 906, 908 (1961); Goodwin, Franchising in the Economy: The Franchise Agreement as a Security Under Securities Acts, Including 10b-5 Considerations, 24 Business Lawyer 1311, 1320-21 (1969). This subjection of the investor's money to the risks of an enterprise over which he exercises no managerial control is the basic economic reality of a security transaction. Coffey, The Economic Realities of a Security: Is There a More Meaningful Formula?, 18 W.Res.L.Rev. 367, 412 (1967); see Silver Hills Country Club v. Sobieski, supra ; see Securities & Exchange Commission v. Latta, 250 F. Supp. 170, 173 (N.D.Cal. 1965), aff'd per curiam, 356 F.2d 103 (9th Cir.1965), cert. denied, 384 U.S. 940, 86 S.Ct. 1459, 16 L.Ed.2d 539 (1966). Any formula which purports to guide courts in determining whether a security exists should recognize this essential reality and be broad enough to fulfill the remedial purposes of the Securities Act. Those purposes are (1) to prevent fraud, and (2) to protect the public against the imposition of unsubstantial schemes by regulating the transactions by which promoters go to the public for risk capital. HRS § 485-10(e). Therefore, we hold that for the purposes of the Hawaii Uniform Securities Act (Modified) an investment contract is created whenever: [5] (1) An offeree furnishes initial value to an offeror, and (2) a portion of this intial value is subjected to the risks of the enterprise, and (3) the furnishing of the initial value is induced by the offeror's promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of the operation of the enterprise, and (4) the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise. The above test provides, we believe, the necessary broad coverage to protect the public from the novel as well as the conventional forms of financing enterprises. Its utility is best demonstrated by its application to the facts in the instant case.