Opinion ID: 2610242
Heading Depth: 2
Heading Rank: 1

Heading: The Test Embodied in the Howey Case is Too Mechanical to Protect the Investing Public Adequately.

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).