Court Opinion

ID: 3000480
Source: CourtListenerOpinion
Date Created: 2015-09-24 20:05:24.599338+00
Date Added: 2024-06-11T15:03:13.107165
License: Public Domain

In the
 United States Court of Appeals
              For the Seventh Circuit
                         ____________

No. 05-4612
SECURITIES AND EXCHANGE COMMISSION,
                                             Plaintiff-Appellee,
                               v.

NATIONAL PRESTO INDUSTRIES, INC.,
                                         Defendant-Appellant.
                         ____________
       Appeal from the United States District Court for the
         Northern District of Illinois, Eastern Division.
          No. 02 C 5027—Charles R. Norgle, Judge.
                         ____________
   ARGUED SEPTEMBER 20, 2006—DECIDED MAY 15, 2007
                   ____________

 Before EASTERBROOK, Chief Judge, and POSNER and
EVANS, Circuit Judges.
  EASTERBROOK, Chief Judge. Most mutual funds and
other investment companies come within the scope of the
Investment Company Act of 1940 because they hold
themselves out “as being engaged primarily, or propos[ing]
to engage primarily, in the business of investing, reinvest-
ing, or trading in securities”. 15 U.S.C. §80a-3(a)(1)(A).
But firms can be dragged within the Act’s coverage kick-
ing and screaming, even though they depict themselves
as operating businesses rather than as managing other
people’s money. Any issuer that owns “investment securi-
ties” worth 40% of its total assets is an investment com-
2                                              No. 05-4612

pany under §80a-3(a)(1)(C) unless some other provision of
the Act takes it outside the definition. For this purpose,
however, “Government securities and cash items” are
omitted from both the numerator and the denominator.
  National Presto Industries, a seller of both consumer
goods (cookware, diapers, and other household items) and
munitions, used to make everything it sold. During the
1970s it began to divest its manufacturing facilities and to
contract production to third parties. In 1993 the Depart-
ment of Defense closed a facility that Presto had used to
make artillery shells. Presto was left with a pile of cash,
most of which it retained with a long-term plan to acquire
other businesses, and a shrunken book value of operating
assets. Financial instruments were 86% of its total assets
by 1994 and 92% in 1998. Since 2000 Presto has pur-
chased two manufacturers of military supplies and two
makers of diapers and puppy pads. But in 2003 financial
instruments still represented 62% of its physical and
financial assets. Intellectual property, although of consid-
erable value to Presto, is not carried on corporate books
at its full economic value, so this ratio overstates the
significance of its portfolio of securities, but Presto does
not argue that it could come under the 40% ratio by
marking its patents and trademarks to current market
value.
  All of Presto’s consumer products other than absorbent
products are made by subcontractors, so although it has
a substantial operating income it does not have operating
assets to match—and the Investment Company Act’s main
test is asset-based. The SEC concluded that Presto was
well past the 40% trigger. When the firm refused to
register as an investment company—and make the
changes to its corporate structure, management, and
financial reporting required of investment companies—or
request an administrative exemption, the SEC filed this
suit to seek an injunction that would require compliance.
No. 05-4612                                                 3

After preliminary maneuvering vindicated the SEC’s
choice of forum, see 347 F.3d 662 (7th Cir. 2003), the
district court granted summary judgment in the agency’s
favor, 397 F. Supp. 2d 943 (N.D. Ill. 2005), and issued an
injunction requiring Presto to register under the 1940 Act.
The firm has complied pending appeal.
  After suffering defeat on the merits, Presto replaced
enough of its existing portfolio with “Government securi-
ties and cash items” to bring investment securities under
the 40% threshold. The SEC had proposed an injunction
that would have allowed Presto the opportunity to do
this (or to seek an administrative exemption) in lieu of
registration; the firm thought to avail itself of the opportu-
nity even before the injunction was entered.
  Without inviting comment from the parties, however, the
district judge deleted these options from the SEC’s draft
and entered an injunction unconditionally requiring
Presto to register as an investment company. The judge
did not explain why. The result was a regulatory mis-
match: a firm that is today required (by statute) to be
organized and to report its financial position as an operat-
ing company is required (by injunction) to be organized
and report its financial position as an investment com-
pany. Instead of doing this, the district court would have
been well advised to craft an injunction commanding
registration only if Presto should revert to its old portfolio
design; obliging it to register as an investment company
even when its investments do not require this is hard to
fathom except as a form of punishment for Presto’s con-
duct in past years, and civil injunctions are not supposed
to punish litigants.
  The unconditional injunction has caused considerable
trouble. Investment companies are subject to many
governance requirements that do not apply to operating
companies. See, e.g., 15 U.S.C. §§ 80a-16, -17, -18, -19, -29,
4                                              No. 05-4612

-55, -56 (and the corresponding regulations). Presto’s
auditor, Grant Thornton, resigned because the SEC
questioned its certification of Presto’s financial state-
ments as those of an operating company. Now that Presto
is officially an investment company, Grant Thornton has
refused to allow the statements it certified to be used for
any purpose. This has disabled Presto from complying fully
with either the Investment Company Act or the Securities
Exchange Act of 1934. Without the financial statements,
it is unable to file quarterly and annual reports. It has
hired another auditor, but recreating and re-certifying
financial statements for many past years is expensive
and time consuming. Meanwhile stock exchanges have
threatened to delist its stock because Presto is out of
compliance with both statutory and exchange-based
financial-reporting requirements.
  At oral argument we inquired whether Presto’s financial
rearrangement has made the case moot. Now that it has
complied with the injunction by registering as an invest-
ment company, can’t it deregister and go back to its
preferred status as an operating company, subject to
registration under the Securities Exchange Act, no matter
what happens on appeal? Deregistration requires the
consent of the SEC, however, and although Presto filed the
appropriate papers with the agency in January 2006 the
SEC has failed to act on them.
  One senses from this prolonged silence, and the tenor
of the SEC’s brief and oral argument, that the agency (or
its senior staff) is in a snit because Presto declined to do
what many other firms with excess liquid assets have
done—apply to the agency for an exemption. See 15 U.S.C.
§80a-3(b)(2). (Microsoft, for example, holds more than 40%
of its assets in the form of investment securities but
received permission to operate outside the 1940 Act.) The
agency’s counsel implied at oral argument that an ex-
emption would have been forthcoming if sought. Yet a
No. 05-4612                                              5

firm’s refusal to kowtow to an agency is not a good reason
to force its investors to bear unnecessary costs—for it is
the investors who must pay to recreate the financial
statements, though they did not contribute to this
imbroglio—and keep a firm inappropriately registered, as
Presto now is. Why is the SEC bent on grinding down a
corporation that it appears to acknowledge would not
mislead or otherwise injure investors by using the gover-
nance and reporting devices appropriate to an operating
company?
  Because Presto remains registered as an investment
company while the SEC sits on its hands, there is a live
case or controversy, because a remedy is possible: we could
end its registration forthwith. Moreover, if we hold that
Presto’s former portfolio does not bring it within the
Investment Company Act, it will be free to rejigger its
investments; the old investments likely had a higher rate
of return, which is why Presto switched only after the
district court’s opinion.
  Let us begin, then, with Presto’s argument that even
before the recent changes to its portfolio, enough of its
investments were “Government securities and cash items”
to keep its “investment securities” under the 40% trigger.
  “Government securities” is a defined term. The phrase
“means any security issued or guaranteed as to principal
or interest by the United States, or by a person controlled
or supervised by and acting as an instrumentality of the
Government of the United States pursuant to authority
granted by the Congress of the United States; or any
certificate of deposit for any of the foregoing.” 15 U.S.C.
§80a-2(a)(16). According to Presto, pre-refunded municipal
bonds (“refunded bonds” for short) fit this definition.
Presto held these instruments in quantity.
 A refunded bond is a bond backed by U.S. securities as
well as the credit of the issuer. Suppose that a municipal-
6                                              No. 05-4612

ity issues long-term bonds for a project (say, an airport)
and that the market rate of interest later falls. The issuer
would like to take advantage of the lower rate, but the
bonds lack a call feature. The municipality can issue new
bonds at the current lower rate and use the proceeds to
buy Treasury bonds with the same maturity as the orig-
inal issue of municipal bonds. The Treasury securities
are held in trust to pay interest and principal on the
original issue. The municipality pays the interest on the
new issue; the Treasury securities may cover the old issue,
and if not the municipality can chip in the difference.
Refinancing in this way works because municipal bonds
are not subject to federal taxes, so they often pay lower
interest rates than Treasury securities. Bonds that can be
bought with the proceeds of the new municipal issue may
produce enough interest by themselves to cover the
interest on the old issue.
  The Treasury bonds held in trust lead Presto to call the
refunded bonds themselves “Government securities.” It
should be apparent, however, that they do not fit the
statutory definition. Refunded municipal bonds are still
municipal bonds, exactly as they were before the refunding
transaction. Municipal bonds are neither issued nor
guaranteed by the national government or any federal
instrumentality. If the municipality defaults, or a local
employee reaches into the till and makes off with the
Treasury securities, the national government will not cover
the loss. The bonds in trust make the municipal bonds
safer, but 15 U.S.C. §80a-2(a)(16) does not include in the
category of “Government securities” everything that a
company deems “almost as safe as” Treasury securities.
  The argument “X has the same economic attributes as Y,
so X must have the same legal attributes as Y” has a
history in securities law. It was the basis of the sale-of-
business doctrine that many courts accepted before
Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985). The
No. 05-4612                                                7

idea was that someone who bought all of the stock in a
closely-held corporation was buying the corporation’s
assets, as an economic matter, so the transaction should
not be governed by the securities laws. Landreth Timber
held, however, that someone who wants the legal treat-
ment of an asset acquisition must buy the assets rather
than the stock; people may choose between transacting
in securities and transacting in assets, and the law follows
the form—not only because that is what the statute says,
but also because trying to determine, one case at a time,
when a transaction “really” has the economic attributes
of a different form would lead to a great deal of uncer-
tainty for little purpose. Landreth Timber represents the
norm in securities law. Stock or bonds in a company that
invests the proceeds in land, or gold, or art, are still
regulated as securities rather than as land, or gold, or art.
Pooled interests in orange groves are regulated as invest-
ment contracts rather than as oranges. See SEC v. W.J.
Howey Co., 328 U.S. 293 (1946). And municipal bonds
issued by a city that plans to repay using U.S. bonds are
still municipal bonds.
  Securities laws regulate the form of financial transac-
tions, rather than looking through form to substance. See
Reves v. Ernst & Young, 494 U.S. 56 (1990) (demand notes
are regulated as securities even though they have many
economic attributes of exempt instruments). True enough,
§80a-2 begins, as several other definitional clauses in the
securities laws do, with the phrase, “unless the context
otherwise requires”. The Supreme Court used this in
Marine Bank v. Weaver, 455 U.S. 551 (1982), to hold that
a one-off transaction—a 50% interest in a neighbor’s
farm in exchange for a short-term loan, the sort of invest-
ment that could not even in principle be traded among
anonymous investors—should not be treated as a security.
 We know from Rowland v. California Men’s Colony, 506
U.S. 194 (1993), however, as well as from Landreth
8                                               No. 05-4612

Timber, that this use of the context clause cannot be
generalized into a norm that substance trumps form.
Rowland holds that context clauses refer to linguistic
rather than economic contexts, and even as so limited
should be employed—as they say—only when the context
of a phrase elsewhere in a statute “requires” a departure
from the definitional clause. Neither the interest in the
neighbor’s farm nor the bank account involved in Marine
Bank was a “security” under the Securities Exchange Act
because neither fit the model of homogenous instruments
that (at least potentially) could be traded among anony-
mous investors. The context clause prevented a need to
jam a square peg into a round hole. See Scott FitzGibbon,
What is a Security?—A Redefinition Based on Eligibility
to Participate in the Financial Markets, 64 Minn. L. Rev.
893 (1980). But nothing in §80a-3(a)(1)(C) similarly “re-
quires” a departure from the definition in §80a-2(a)(16).
The definition of the phrase “Government securities” in the
latter makes perfect sense when plugged into the former.
  Judge Friendly once remarked, with respect to the
definition of the term “note” in the securities laws: “So long
as the statutes remain as they have been for over forty
years, courts had better not depart from their words
without strong support for the conviction that, under the
authority vested in them by the ‘context’ clause, they are
doing what Congress wanted when they refuse to do what
it said.” Exchange National Bank of Chicago v. Touche
Ross & Co., 544 F.2d 1126, 1138 (2d Cir. 1976). That high
standard has not been met here. The Investment Company
Act has been with us for 67 years without giving problems
through the definition of “Government securities.” And
even if there were some wriggle room via the context
clause, Presto has not established that refunded bonds are
the economic equivalent of Treasury bonds. A report in
the record from Morgan Stanley shows that the yield for
Treasury bonds maturing in 2006 was 4.95%, while the
No. 05-4612                                                9

taxable equivalent yield for refunded bonds was 6.1% for
taxpayers in the 38% bracket. That’s a 23% premium over
Treasuries, which must reflect extra risk. (The nominal
interest rate for refunded bonds is below that for Treasury
bonds, because of the tax subsidy for municipal securities;
an adjustment must be made to find real returns and
implicit risks.)
   Mutual funds may treat refunded bonds as if they were
“Government securities” for the purpose of 15 U.S.C. §80a-
5, which says how an investment company’s portfolio must
be structured if it calls itself “diversified.” See 17 C.F.R.
§270.5b-3(b). How can refunded bonds be “Government
securities” for one purpose but not the other?, Presto asks.
Yet treating A as if it were B for one purpose does not
imply that A is B for every purpose. The regulation on
which Presto relies governs how investment companies
describe their portfolios; that’s a very different subject
from whether something is an investment company in the
first place. Equating refunded bonds with Treasury
securities for the purpose of diversification allows mutual
funds to offer tax advantages (which refunded bonds
supply) without any change in the covariance of risk
across a fund’s assets. Denying investors that opportunity
would injure them; it’s sensible for the SEC to look at the
economic attributes of instruments when determining
what counts as diversification (another economic inquiry)
while insisting that the statutory definition be used to
determine what entities are covered by the statute in the
first place.
  “Cash items” also are excluded when calculating the 40%
ratio, and Presto maintains that “variable-rate demand
notes” should be treated as “cash items.” A variable-rate
demand note is an instrument (usually a bond or deben-
ture) whose rate of interest is updated weekly (if not
more often) based on some index, such as the London
Interbank Offering Rate. Whenever the interest rate
10                                              No. 05-4612

changes, the note’s holder is entitled to redeem at par.
Usually this transaction is handled by a remarketing
agent, who buys the note from the holder and resells it
in the secondary market to another investor; the note’s
issuer is involved only if the note is trading for less than
par.
  In contrast to the detailed statutory definition of “Gov-
ernment securities,” the Investment Company Act does not
define “cash items.” Presto maintains that variable-rate
demand notes are equivalent to cash because of the weekly
opportunity to sell the instruments at par for cash. If
liquidity were enough, however, one would treat all shares
of stock in large issuers, and many bonds, as “cash items”
because they can be sold on liquid markets in a matter of
minutes. The reason that such investments are not treated
as cash or its equivalent, however, is that the market price
the instrument will fetch when sold is variable. Presto
thinks that the “redeem at par” feature of the variable-rate
demand note insulates them from that sort of risk, but
that’s not true. The investor is entitled to demand redemp-
tion at par, but whether the issuer will comply depends on
its financial health. A business reverse (or, for a municipal
issuer, a shortfall of taxes) will mean no redemption, or
redemption at a discount. That’s a kind of risk an investor
takes with any stock or bond—but does not take with cash.
  Although the statute does not define “cash item,” the
SEC gave this definition when adopting a safe-harbor rule
(17 C.F.R. §270.3a-1):
     For purposes of determining compliance with the
     proposed rule, cash, coins, paper currency, demand
     deposits with banks, timely checks of others
     (which are orders on banks to immediately supply
     funds), cashier checks, certified checks, bank
     drafts, money orders, traveler’s checks and letters
     of credit generally would be considered cash items.
No. 05-4612                                                11

    Certificates of deposit and time deposits typically
    would not be considered cash items absent con-
    vincing evidence of no investment intent.
Certain Prima Facie Investment Companies, Investment
Company Act Release No. IC-10937 (Nov. 13, 1979), at
n.29; regulation adopted in final form 46 Fed. Reg. 6879
(Jan 22, 1981). This definition applies only to Rule 3a-1,
but Presto does not contend that we should ignore it—or
that it is arbitrary or capricious. Agencies are entitled to
add detail to the statutes they administer, and their
resolution of ambiguities is entitled to respect. See Chev-
ron U.S.A. Inc. v. Natural Resources Defense Council, Inc.,
467 U.S. 837 (1984).
  A variable-rate demand note does not fit this definition.
Presto chose to invest in variable-rate demand notes
rather than, say, money-market funds (which are diversi-
fied portfolios of safe and liquid investments) because the
notes have higher rates of return. The higher return
stems from higher risk, which explains why the notes
differ from “cash items.” (Presto does observe that many
variable-rate demand notes are backed by letters of credit,
which the SEC is willing to treat as “cash items,” but
that’s a replay of the argument that refunded bonds are
“Government securities” because they are secured by
Treasury bonds.) Presto was making an investment in
these notes, along the lines of “time deposits” (which are
“cash items” only with “convincing evidence of no invest-
ment intent”), rather than holding them for liquidity.
  Presto therefore comes within the 40% test and is an
investment company unless one of the (many) statutory
exceptions applies. The one on which Presto relies is §80a-
3(b)(1): “Any issuer primarily engaged, directly or through
a wholly-owned subsidiary or subsidiaries, in a business
or businesses other than that of investing, reinvesting,
owning, holding, or trading in securities.” Presto is actively
12                                             No. 05-4612

engaged in several businesses. A visitor to its web site for
consumers (http://www.gopresto.com) will find sales
promotions, warranty information, and instruction manu-
als for pizza ovens and coffee makers but nary a hint that
someone would want to buy Presto’s stock as a means to
own a derivative interest in refunded municipal bonds or
variable-rate demand notes. But is Presto “primarily”
engaged in selling pressure cookers, deep fryers, popcorn
poppers, diapers, and ordnance rather than the business
of holding securities? The statute is unhelpful; “primarily”
is not a defined term. No regulation fills the gap.
  Sixty years ago the SEC announced that it would
consider five factors to decide whether a firm that sold off
its operating assets and chose not to distribute the pro-
ceeds to its stockholders had become what people today
call an “inadvertent investment company.” In re Tonopah
Mining Co., 26 S.E.C. 426 (1947). See also Sydney H.
Mendelsohn, Mark B. Goldfus & Mark J. Mackey, Status
Seeking: Resolving the Status of Inadvertent Investment
Companies, 38 Bus. Law. 193 (1982); Edmund H. Kerr,
The Inadvertent Investment Company: Section 3(a)(3) of the
Investment Company Act, 12 Stan. L. Rev. 29 (1959).
  According to Tonopah, what matter are the company’s
history, the way the company represents itself to the
investing public today, the activities of its officers and
directors, the nature of its assets, and the sources of its
income. Of these, all but the fourth favor Presto. Founded
in 1905, Presto was an active manufacturer of industrial,
consumer, and military products until the 1980s, when it
started to subcontract manufacturing activities. It re-
mains an active manufacturer of absorbent goods and
military ordnance and sells a line of kitchen goods under
its own trademarks.
  As far as we can see, this is the first time that the SEC
has argued that a firm with such a substantial ongoing
No. 05-4612                                              13

presence in product markets is an inadvertent investment
company. The model inadvertent investment company—of
which Tonopah Mining is the initial exemplar and Fifth
Avenue Coach Lines is perhaps the best-known, see SEC
v. Fifth Avenue Coach Lines, Inc., 289 F. Supp. 3 (S.D.
N.Y. 1968), affirmed, 435 F.2d 510 (2d Cir. 1970)—is one
in which the firm has sold all or almost all of its assets,
reduced its operations to a skeleton staff (Tonopah Mining
was down to one unprofitable mine and Fifth Avenue
Coach Lines to no busses at all), and purports to be look-
ing for acquisitions but never seems to find them. Per-
haps one could have applied the “purports to be looking
for acquisitions” label to Presto in the 1980s and 1990s,
but one could not say that Presto had withdrawn from
active business operations in the meantime. It continued
selling both consumer and military products. It changed
from a manufacturer to a firm that was (principally) a
designer and marketer of products assembled by others,
but this did not make Presto less an operating enterprise.
Many other firms have made a similar transition (Apple
comes to mind) without being thought to have evolved into
mutual funds.
  Presto presents itself to the public (and to investors) as
an operating company. That’s how its web site, its annual
reports, and its publicity all depict it. The contrast with
Tonopah Mining and Fifth Avenue Coach Lines is stark.
An investor in the market for a mutual fund, a hedge fund,
or any other investment pool would not dream of turning
to Presto, whose net income can increase or decrease
substantially as a result of business successes or reverses.
The price of Presto’s stock moves in response to changes
in its operating profits rather than the slight annual
changes in its investment income. The SEC has not
identified even one confused investor who bought stock in
Presto thinking that he was making an investment in a
closed-end mutual fund whose assets were the securities
that Presto holds.
14                                              No. 05-4612

  “Activities of Officers and Directors,” the third factor in
Tonopah, likewise favors Presto. Directors and senior
managers at Tonopah Mining and Fifth Avenue Coach
Lines spent most of their time managing the firms’
investment portfolios. Presto estimates that 95% of its
managers’ time is devoted to running its consumer-prod-
ucts and military-ordnance businesses. The SEC has not
offered any contrary evidence. Cf. First National Bank &
Trust Co. v. Beach, 301 U.S. 435 (1937) (a firm is “primar-
ily engaged in farming” under the Bankruptcy Code if its
officers and directors devote most of their time to farming).
  As for the fifth factor, income, Tonopah looked at both
gross and net figures, as well as at the firm’s expenditures
to produce income. (Looking at both gross and net is
essential; otherwise an operating loss, with negative net
income, would turn a firm into an “investment company”.)
Gross income at Presto is dominated by receipts from its
consumer and military sales. More than 90% of Presto’s
gross receipts for every year covered by the record (1994
through 2003) comes from its sales of products. In 2003,
for example, Presto recorded about $125 million in sales,
yielding a net profit of $18.9 million; total receipts from
investment securities that year were $4.2 million.
  Only net income helps the SEC’s position: the agency
calculates that, over the decade covered by the record,
50.22% of Presto’s net profits were derived from invest-
ments in securities. Presto’s calculations show that
operating profits exceed investment profits for the decade
as a whole. The SEC acknowledges that, in each of the
three years immediately preceding the district court’s
injunction requiring Presto to register as an investment
company, investments produced less than 40% of Presto’s
net profit. So even if we take the view most favorable to
the SEC, that a firm is “primarily” engaged in a business
other than investment management only if more than half
of its net profits come from non-investment sources,
No. 05-4612                                               15

Presto was “primarily” an operating business when the
injunction issued. Whatever classification may have been
appropriate in the 1990s (when more than half of net
profits came from investments) cannot support an injunc-
tion issued in 2005, when at least 60% of net profit was
coming from consumer and military sales. In Tonopah, by
contrast, “the company’s only source of net income con-
sists of interest, dividends and profits on the sale of
securities; and we find nothing to indicate that this
situation will be changed substantially in the foreseeable
future.” 26 S.E.C. at 431.
   This leaves the fourth Tonopah factor, the nature of
Presto’s assets. Here the picture at last favors the SEC, for
more than 60% of Presto’s assets were investment securi-
ties during every year covered by the record. In full flight
from the Commission’s multi-factor approach in Tonopah,
the SEC’s lawyer in this court urges us to give little
weight to any consideration other than Presto’s asset
structure. Yet looking primarily at accounting assets has
a potential to mislead. Imagine a firm that owns sub-
stantial assets such as patents and trademarks that do
not show up on its balance sheet as assets, and that
operates a business from a leased headquarters where
it designs, contracts for, and sells products. Such a firm
could have annual sales exceeding $100 million, and
profits exceeding $10 million as Presto does, with book-
value assets of only $1 million in office furniture. If that
firm stored even 10% of two years’ profits in refunded
bonds, as a hedge against business reverses (or to finance
expansion), instead of distributing all profits to investors
in dividends, it would become an investment company
under the approach the SEC urges in this litigation. Yet no
investor would perceive such a firm as a substitute for a
closed-end mutual fund; its stock returns would continue
to depend on its operating profits and losses.
16                                                No. 05-4612

  According to the SEC’s brief, Tonopah deemed assets
the “most important” of the five considerations. It would
be surprising if that were so, because it would make the
exclusion in §80a-3(b)(1) unavailable as a practical matter.
The only reason one turns to this exclusion is that the
40% asset test has been satisfied. If subsection (b)(2) does
nothing except raise the 40% test to 50% as a definition of
the firm’s “primary” engagement, it is an odd statutory
provision indeed. What sense would it make to enact a
law using 40% as the threshold in subsection (a)(1)(C), and
convert the “real” rule to 50% in subsection (b)(1) by using
words rather than numbers? Subsection (b)(1) has to be
about considerations other than assets (or at least in
addition to assets). And that’s what the SEC said in
Tonopah:
     More important . . . [is] the nature of the assets
     and income of the company, disclosed in the an-
     nual reports filed with the Commission and in
     reports sent to stockholders, was such as to lead
     investors to believe that the principal activity of the
     company was trading and investing in securities.
26 S.E.C. at 430 (emphasis added). In other words, the
Commission thought in Tonopah that what principally
matters is the beliefs the company is likely to induce in
investors. Will its portfolio and activities lead investors to
treat a firm as an investment vehicle or as an operating
enterprise? The Commission has never issued an opinion
or rule taking a different view, and its lawyers cannot
adopt a new approach by filing briefs. Only the Commis-
sion’s members may change established norms, and they
must do so by rulemaking or administrative adjudication.
See SEC v. Chenery Corp., 318 U.S. 80, 88-89 (1943); SEC
v. Chenery Corp., 332 U.S. 194, 196 (1947).
  Reasonable investors would treat Presto as an operating
company rather than a competitor with a closed-end
No. 05-4612                                              17

mutual fund. The SEC has not tried to demonstrate
anything different about investors’ perceptions or behavior.
It follows that Presto is not an investment company.
  The judgment of the district court is reversed. Presto,
which registered as an investment company only under
judicial compulsion, now is free to drop that registration
and operate under the Securities Exchange Act of 1934
whether or not the SEC gives its formal approach to that
step.

A true Copy:
      Teste:

                       ________________________________
                       Clerk of the United States Court of
                         Appeals for the Seventh Circuit

                   USCA-02-C-0072—5-15-07