Opinion ID: 2632290
Heading Depth: 1
Heading Rank: 7

Heading: Reasonable expectation of profits to be derived from the entrepreneurial or management efforts of others

Text: Under this prong of the Howey-Forman test, profits are generally defined as either capital appreciation resulting from the development of the initial investment ... or a participation in earnings resulting from the use of investors' funds. Forman, 421 U.S. at 852, 95 S.Ct. at 2060, 44 L.Ed.2d at 632. Those profits are derived from the efforts of others, and the third prong is therefore satisfied, if the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise. S.E.C. v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973). Here, Gertsch's efforts were essential ones affecting the failure or success of the enterprise, and the investors were expecting a participation in earnings resulting from the use of their funds in some account or business. Gertsch again stresses, as to this prong, the view that the transactions in question were more akin to bank loans than capital investments. Specifically, she argues that the combination of an unconditional promise to repay and a promise of a fixed rate of return absolutely precludes a finding that the investors sought profits. However, in United States v. Carman, 577 F.2d 556, 563 (9th Cir.1978), the court held that investment contracts existed despite the fact that the transactions carried unconditional promises to repay and fixed rates of return. In that case, a trade school sold Federally Insured Student Loan (FISL) notes to a credit union, accompanied by promises to service the loans and to buy back some of the notes upon adequate notice. There was no argument that the notes themselves were securities under the note component of the federal act's definition of a security. Id. Instead, the court focused on the transactions between the trade school and the credit union in their entireties, including the service and buyback promises, in order to determine whether they constituted investment contracts. Id. The court held that the transactions were investment contracts, noting that the transactions placed the credit union in a passive role and that the credit union's success was dependent upon the trade school's ability to maintain its accreditation for FISL packages and its continued ability to pay loan refunds to students who dropped out prior to completing their schooling. Id. Observing the economic realities of the transactions at hand, the investors expected a return on their money akin to an investment return. The investors testified that they never employed their own management skills to the funds. They testified that they were never under the impression that the funds were commercial loans or loans for Gertsch's personal use. The investors relied upon Gertsch's efforts, and they were completely passive with regard to attracting new investors and securing payment from those who had promised to invest. They incurred substantial risk, despite the promise of a fixed rate of return. Although the promise of a fixed rate of return could preclude a finding of an investment in some circumstances, the extremely high rate promised by Gertschthe equivalent of one hundred percent annually in some casesdemonstrates that these transactions were something more than loans or savings account deposits. At best, the extremely high rates of return promised by Gertsch can be viewed as some sort of limit or cap on the profits that could be expected from the venture. The record contains sufficient evidence to support the jury's finding that the investors sought the return of profits to be made from the entrepreneurial or managerial efforts of others.