Opinion ID: 76958
Heading Depth: 2
Heading Rank: 2

Heading: The Securities Acts

Text: 20 The Securities Act of 1933 and the Securities Exchange Act of 1934 both define the term security as including the catch-all term investment contracts. 15 U.S.C. § 77b(a)(1); 15 U.S.C. § 78c(a)(10). The phrase investment contract is not defined in either statute. In Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the Supreme Court provided a flexible test for determining whether a particular transaction qualified as 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 ... . 328 U.S. at 298-99, 66 S.Ct. at 1103. The Court stated that this approach embodies a flexible rather than a static principle, one that is capable of adaption to meet the countless and variable schemes devised by those who seek the use of the money of others on the promises of profits. 328 U.S. at 299, 66 S.Ct. at 1103. 21 In Securities & Exchange Commission v. Edwards, 540 U.S. 389, 124 S.Ct. 892, 157 L.Ed.2d 813 (2004), the Supreme Court reaffirmed the definition enunciated in Howey. The Court reiterated that `Congress' purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.' To that end, it enacted a broad definition of `security,' sufficient `to encompass virtually any instrument that might be sold as an investment.' 540 U.S. at 393, 124 S.Ct. at 896 (quoting Reves v. Ernst & Young, 494 U.S. 56, 110 S.Ct. 945, 108 L.Ed.2d 47 (1990)). 22 There is no genuine dispute here that there was (1) an investment of money, (2) in a common enterprise, 4 (3) involving an expectation of profits. The only real dispute concerns whether the investor's expectation of profits is based solely on the efforts of the promoter or a third party. MBC, relying on Securities & Exchange Commission v. Life Partners, Inc., 87 F.3d 536 (D.C.Cir.1996), argues that this element is a necessarily forward-looking inquiry. See Appellants' Br. at 13. MBC asks that we make a distinction between a promoter's activities prior to his having use of an investor's money and his activities after he has use of the money. This distinction was indeed made in Life Partners, a case involving facts similar to those presented here. 23 [W]e cannot agree that the time of sale is an artificial dividing line. It is a legal construct but a significant one. If the investor's profits depend thereafter predominantly upon the promoter's efforts, then the investor may benefit from the disclosure and other requirements of the federal securities laws. But if the value of the promoter's efforts has already been impounded into the promoter's fees or into the purchase price of the investment, and if neither the promoter nor anyone else is expected to make further efforts that will affect the outcome of the investment, then the need for federal securities regulation is greatly diminished.... 24 We see here no venture associated with the ownership of an insurance contract from which one's profit depends entirely upon the mortality of the insured... 25 Id. at 547-48. Because no significant post-purchase activity took place here, MBC argues, the expectation of profits is not based solely on the efforts of the promoter or a third party. 26 We decline to adopt the test established by the Life Partners court. We are not convinced that either Howey or Edwards require such a clean distinction between a promoter's activities prior to his having use of an investor's money and his activities thereafter. The rule set forth in Howey and reiterated in Edwards directs us to broadly apply the Security Acts of 1993 and 1994 to all schemes devised by those who seek the use of the money of others on the promise of profits. Howey, 328 U.S. at 299, 66 S.Ct. at 1103; see also Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967) ([I]n searching for the meaning and scope of the word `security' in the Act[s], form should be disregarded for substance and the emphasis should be on economic reality.). 27 While it may be true that the solely on the efforts of the promoter or a third party prong of the Howey test is more easily satisfied by post-purchase activities, there is no basis for excluding pre-purchase managerial activities from the analysis. See Life Partners, 87 F.3d at 551 (Wald, J., dissenting). Significant pre-purchase managerial activities undertaken to insure the success of the investment may also satisfy Howey. See id. Indeed, investment schemes may often involve a combination of both pre- and post-purchase managerial activities, both of which should be taken into consideration in determining whether Howey 's test is satisfied. Courts have found investment contracts where significant efforts included the pre-purchase exercise of expertise by promoters in selecting or negotiating the price of an asset in which investors would acquire an interest. See Sec. & Exch. Comm'n v. Eurobond Exch., Ltd., 13 F.3d 1334 (9th Cir.1994) (involving interests in foreign treasury bonds); Gary Plastic Packaging Corp. v. Merrill Lynch, Inc., 756 F.2d 230 (2d Cir.1985) (involving interests in certificate of deposit program); Glen-Arden Commodities, Inc. v. Costantino, 493 F.2d 1027 (2d Cir.1974) (involving investments in warehouse receipts for whiskey). 28 Furthermore, while the solely on the efforts of the promoter or a third party prong of the Howey test may not be met where an investment relies predominantly on market speculation, 5 that is not the case here. The investors' expectations of profits in this case relied heavily on the pre- and post-payment efforts of the promoters in making investments in viatical settlement contracts profitable. The investors selected the term of their investment, and submitted completed agreement forms and money. Thereafter, MBC selected the insurance policies in which the investors' money would be placed. MBC bid on policies and negotiated purchase prices with the insureds. MBC determined how much money would be placed in escrow to cover payment of future premiums. MBC undertook to evaluate the life expectancy of the insureds—evaluations critical to the success of the venture. If MBC underestimated the insureds' life expectancy, the chances increased that the investors would realize less of a profit, or no profit at all. And, investors had no ability to assess the accuracy of representations being made by MBC or the accuracy of the life-expectancy evaluations. They could not, by reference to market trends, independently assess the prospective value of their investments in MBC's viatical settlement contracts. There were important post-purchase managerial efforts of MBC as well. Often, life-expectancy evaluations were not completed until after closing. And, after closing on a policy, MBC assumed the responsibility of making premium payments. Escrow payments were collectively managed in such a manner that investors were not required to pay additional premiums. Thus, investors relied on both the pre- and postpurchase management activities of MBC to maximize the profit potential of investing in viatical settlement contracts. 29 MBC thus offered what amounts to a classic investment contract. Investors were offered and sold an investment in a common enterprise in which they were promised profits that were dependent on the efforts of the promoters. This is true regardless of which specific MBC purchase agreement form is at issue. Whether the investors were offered a longer or shorter window in which to withdraw funds from escrow, whether the life-expectancy evaluation was actually performed before or after closing, and despite certain differences in how premiums were paid, all investors here relied on the pre- and post-purchase managerial efforts of MBC to make a profit on the investment in viatical settlement contracts. The investors here relied on MBC to identify terminally ill insureds, negotiate purchase prices, pay premiums, and perform life expectancy evaluations critical to the success of the venture. The flexible test we are instructed to apply by Howey and Edwards covers these activities, qualifying MBC's viatical settlement contracts as investment contracts under the Securities Acts of 1933 and 1934.