SEC vs LIFE PARTNERS INC
investors; therefore, we do not reach LPI's
When attempting to ascertain whether to grant a
preliminary injunction, district court found that
minor interests in life insurance policies promoted
by LPI are considered securities, hence, must
comply with SEC procedures.
Based on the parameters set by Howey, Viatical
settlements are not considered securities.
LPI sells investment contracts where an investor
procures an interest in a terminally ill person’s life
(AIDS) insurance policy at a discount (20%-40%),
the discount being contingent on the insured’s life
expectancy. When the insured dies, the investor
receives the benefit of the insurance.
The investor's profit is the difference between the
discounted purchase price paid to the insured
and the death benefit collected from the insurer,
less transaction costs, premiums paid, and other
administrative expenses.
LPI organized these transactions and also
executes post-transaction assistance. SEC
asserts that fractional interests marketed by LPI
are considered securities hence a violation of the
Securities Act of 1933 and Securities Exchange
Act 1934. SEC requested that LPI cease (prelim
injunc) making additional sales until after
complying with SEC regulations.
LPI argues that:
(1) viatical settlements are exempt from the
securities laws because they are insurance
contracts within the meaning of the McCarran-
Ferguson Act,
(2) the fractional interests sold by LPI are not in
any event securities within the meaning of the
1933 and 1934 Acts. LPI asserts alternatively that
it could modify its program so as to come within a
safe harbor exemption for private offerings under
SEC Rule 506, 17 C.F.R. § 230.506.
We agree with the district court that viatical
settlements are not exempt from the securities
laws as insurance contracts. Contrary to the
district court, however, we conclude that LPI's
contracts are not securities subject to the federal
securities laws because the profits from their
purchase do not derive predominantly from the
efforts of a party or parties other than the
alternative argument that it might be able to alter
its operation in such a way as to be entitled to a
private offering exemption.
WoN the parameters set by Howey cover viatical
settlement as securities?
NO. According to Justice Ginsburg, viatical
settlements do not meet the third requisite of
Howey test – depends upon the efforts of others
HOWEY TEST: (1) expect profits from (2) a
common enterprise that (3) depends upon the
efforts of others.
The most important aspect to the viatical
settlements sold by LPI is the duration of the
insured’s life as opposed to the seller’s efforts.
The pre and post purchase services completed
by LPI were generally more clerical than
commercial.
However, Justice Wald’s dissent tackles that
when deciding if an investment fulfills Howey’s
third prong, focus needs to be in the manner and
amount of reliance between the investor’s profits
and the marketer’s undertakings. In this case,
WoN LPI pre-purchase managerial activities were
are successful determines whether the profits are
attained. It can be said that Howey’s third point is
met by LPI pre-purchase services.
As witnessed in this case, investment profits did
not come largely from others’ labors, meaning
that the pre-purchase events were not sufficient.
The Commission also notes that some firms have
sought and obtained an exemption from the
federal securities laws for their viatical contracts;
presumably a firm might also buy insurance
policies for its own account or act as an agent,
matching a single investor with a terminally ill
insured, without running afoul of the securities
laws.
That is not how LPI does business, however. LPI
sells fractional interests in insurance policies to
retail investors, who may pay as little as $650 and
buy as little as 3% of the benefits of a policy. In
order to reach its customers, LPI uses some 500
commissioned "licensees," mostly independent
financial planners. For its efforts, LPI's net
compensation is roughly 10% of the purchase
price after payment of referral and other fees.
Pardo claims that LPI is by far the largest of about
60 firms serving the rapidly growing market for
viatical settlements; in 1994 the company
accounted for more than half of the industry's
estimated annual revenues of $300 million. The
company is 95% beneficially owned by Pardo
through a trust, and 5% owned by Dr. Jack Kelly,
who performs medical evaluations of
policyholders on LPI's behalf.
LPI was also the first company to develop a plan
by which an investor could participate in a viatical
settlement through an Individual Retirement
Account. In order to circumvent the Internal
Revenue Code prohibition upon IRAs investing in
life insurance contracts, LPI structures the
purchase through a separate trust established for
that purpose. The IRA lends money to the trust,
for which it receives a non-recourse note; the trust
then uses the loan proceeds to purchase an
interest in a life insurance policy, the death
benefits of which collateralize the note. When the
insured dies and the benefits are paid, the
proceeds go to pay off the note held by the IRA.
Both LPI's program for individual investors and its
IRA program have gone through three iterations
during the course of this litigation. In each, LPI
performed or performs a number of pre-purchase
functions: Specifically, even before assembling
the investors, LPI evaluates the insured's medical
condition, reviews his insurance policy,
negotiates the purchase price, and prepares the
legal documents. The difference among the three
versions is that LPI performs ever fewer (and
ultimately no) post-purchase functions.
If viatical settlements are insurance contracts,
then they are altogether exempt from coverage
under the federal securities laws.
n this connection, the SEC suggests that
investors in LPI's viatical settlements are
essentially passive; their profits, the Commission
argues, depend predominantly upon the efforts of
LPI, which provides pre-purchase expertise in
identifying existing policyholders and, together
with Sterling, provides post-purchase
management of the investment. Meanwhile, LPI
argues that its pre-purchase functions are wholly
irrelevant and that the post-purchase functions,
by whomever performed, should not count
because they are only ministerial. On this view,
once the transaction closes, the investors do not
look to the efforts of others for their profits
because the only variable affecting profits is the
timing of the insured's death, which is outside of
LPI's and Sterling's control.
Summary and Conclusion
LPI advances two arguments in support of the
proposition that its viatical settlements are not
subject to the federal securities laws. First, the
company contends that its contracts are exempt
as insurance contracts under the Securities Act of
1933 and the McCarran-Ferguson Act. For the
reasons set forth in Part II.A, however, we
conclude that a viatical settlement is not an
insurance policy, and that the business of selling
fractional interests in insurance policies is not part
of "the business of insurance." We therefore
reject LPI's exemption argument.
Second, LPI maintains that the fractional interests
which it sells to investors are not securities within
the meaning of the 1933 Act, as controlled by the
Supreme Court's decision in Howey. In Parts
II.B(1) and II.B(2), respectively, we conclude that
LPI's contracts meet two parts of the Howey test:
investors purchase the contracts with an
expectation of profits; and they pool their funds,
then share any profits or losses that arise. In Part
II.B(3), however, we hold that fractional interests
in viatical settlements, in any of the three versions
marketed or proposed by LPI, are not securities.
The combination of LPI's pre-purchase services
as a finder-promoter and its largely ministerial
post-purchase services is not enough to satisfy
the third requirement in Howey: the investors'
profits do not flow predominantly from the efforts
of others. Finally, we hold that the notes issued to
IRAs by LPI-sponsored trusts are not securities
either. Looking to the substance of such
transactions, we see that the notes are used
solely for tax purposes, not as a means of raising
capital.
Accordingly, this case is remanded to the district
court with instructions to vacate the three
injunctions entered against LPI in August 1995,
January 1996, and March 1996.
POWER HOMES UNLIMITED CORP VS SEC &
NOEL MANERO
Power Homes is a domestic corporation
registered with SEC on Oct 2000.
Primary purpose: To engage in the transaction of
promoting, acquiring, managing, leasing,
obtaining options on, development, and
improvement of real estate properties for
subdivision and allied purposes, and in the
purchase, sale and/or exchange of said
subdivision and properties through network
marketing.
N. Manero requested SEC to investigate Power
Homes claiming that he attended a seminar
conducted by the latter claiming to sell properties
that were inexistent and had no broker’s license.
R. Munsayac inquired from SEC whether Power
Homes business involves LEGITIMATE
NETWORK MARKETING.
On this basis, SEC held a conference on Dec
2000 that was attended by Power Homes
incorporators – John Lim, Paul and Leonito
Nicolas.
Power Homes submitted to SEC copies of its
marketing course module and letter of
confirmation from Fil Estate, Crown Asia and
Pioneer. SEC visited the premises to gather
pertinent information.
Power Homes is engaged in the sale or offer for
sale or distribution of investment contracts, which
are considered securities under Sec. 3.1 (b) of
(R.A.) No. 8799 (The Securities Regulation
Code), but failed to register them in violation of
Sec. 8.1 of the same Act, SEC issued CDO.
Power Homes moved for the lifting of CDO but
SEC denied for lack of merit.
CA: imputing GADALEJ by SEC – favored SEC.
The issues for determination are: (1) whether
public respondent SEC followed due process in
the issuance of the assailed CDO; and (2)
whether petitioner's business constitutes an
investment contract which should be registered
with public respondent SEC before its sale or
offer for sale or distribution to the public.
On the first issue, Sec. 64 of R.A. No. 8799
provides: Sec. 64. Cease and Desist Order. —
64.1. The Commission, after proper investigation
or verification, motu proprio or upon verified
complaint by any aggrieved party, may issue a
cease and desist order without the necessity of a
prior hearing if in its judgment the act or practice,
unless restrained, will operate as a fraud on
investors or is otherwise likely to cause grave or
irreparable injury or prejudice to the investing
public.
Power Homes was not denied due process. SEC
properly examined Power Homes’ business
operations when it (1) called into conference
three of petitioner's incorporators, (2) requested
information from the incorporators regarding the
nature of petitioner's business operations, (3)
asked them to submit documents pertinent
thereto, and (4) visited petitioner's business
premises and gathered information thereat. All
these were done before the CDO was issued by
the public respondent SEC. Trite to state, a formal
trial or hearing is not necessary to comply with the
requirements of due process. Its essence is
simply the opportunity to explain one's position.
Public respondent SEC abundantly allowed
petitioner to prove its side.
The second issue is whether the business of
petitioner involves an investment contract that is
considered security and thus, must be registered
prior to sale or offer for sale or distribution to the
public pursuant to Section 8.1 of R.A. No. 8799,
viz: Section 8. Requirement of Registration of
Securities. — 8.1. Securities shall not be sold or
offered for sale or distribution within the
Philippines, without a registration statement duly
filed with and approved by the Commission. Prior
to such sale, information on the securities, in such
form and with such substance as the Commission
may prescribe, shall be made available to each
prospective purchaser.
SEC found the petitioner "as a marketing
company that promotes and facilitates sales of
real properties and other related products of real
estate developers through effective leverage
marketing."
It also described the conduct of petitioner's
business as follows: The scheme of the
[petitioner] corporation requires an investor to
become a Business Center Owner (BCO) who
must fill-up and sign its application form. The
Terms and Conditions printed at the back of the
application form indicate that the BCO shall mean
an independent representative of Power Homes,
who is enrolled in the company's referral program
and who will ultimately purchase real property
from any accredited real estate developers and
as such he is entitled to a referral
bonus/commission. Paragraph 5 of the same
indicates that there exists no employer/employee
relationship between the BCO and the Power
Homes Unlimited, Corp.
The BCO is required to pay US$234 as his
enrollment fee. His enrollment entitles him to
recruit two investors who should pay US$234
each and out of which amount he shall receive
US$92. In case the two referrals/enrollees would
recruit a minimum of four (4) persons each
recruiting two (2) persons who become his/her
own down lines, the BCO will receive a total
amount of US$147.20 after deducting the amount
of US$36.80 as property fund from the gross
amount of US$184. After recruiting 128 persons
in a period of eight (8) months for each Left and
Right business groups or a total of 256 enrollees
whether directly referred by the BCO or through
his down lines, the BCO who receives a total
amount of US$11,412.80 after deducting the
amount of US$363.20 as property fund from the
gross amount of US$11,776, has now an
accumulated amount of US$2,700 constituting as
his Property Fund placed in a Property Fund
account with the Chinabank. This accumulated
amount of US$2,700 is used as partial/full down
payment for the real property chosen by the BCO
from any of [petitioner's] accredited real estate
developers.
An investment contract is deDned in the
Amended Implementing Rules and Regulations
of R.A. No. 8799 as a "contract, transaction or
scheme (collectively 'contract') whereby a person
invests his money in a common enterprise and is
led to expect profits primarily from the efforts of
others."
Known as the Howey Test, it requires a
transaction, contract, or scheme whereby a
person (1) makes an investment of money, (2) in
a common enterprise, (3) with the expectation of
profits, (4) to be derived solely from the efforts of
others.
Although the proponents must establish all four
elements, the US Supreme Court stressed that
the Howey Test "embodies a flexible rather than
a static principle, one that is capable of adaptation
to meet the countless and variable schemes
devised by those who seek the use of the money
of others on the promise of profits." Needless to
state, any investment contract covered by the
Howey Test must be registered under the
Securities Act, regardless of whether its issuer
was engaged in fraudulent practices.
The business scheme of petitioner in the case at
bar is essentially similar. An investor enrolls in
petitioner's program by paying US$234. This
entitles him to recruit two (2) investors who pay
US$234 each and out of which amount he
receives US$92. A minimum recruitment of four
(4) investors by these two (2) recruits, who then
recruit at least two (2) each, entitles the principal
investor to US$184 and the pyramid goes on.
We reject petitioner's claim that the payment of
US$234 is for the seminars on leverage
marketing and not for any product. Clearly, the
trainings or seminars are merely designed to
enhance petitioner's business of teaching its
investors the knowhow of its multi-level marketing
business. An investor enrolls under the scheme
of petitioner to be entitled to recruit other
investors and to receive commissions from the
investments of those directly recruited by him.
Under the scheme, the accumulated amount
received by the investor comes primarily from the
efforts of his recruits.
We therefore rule that the business operation or
the scheme of petitioner constitutes an
investment contract that is a security under R.A.
No. 8799. Thus, it must be registered with public
respondent SEC before its sale or offer for sale or
distribution to the public. As petitioner failed to
register the same, its offering to the public was
rightfully enjoined by public respondent SEC. The
CDO was proper even without a finding of fraud.
As an investment contract that is security under
R.A. No. 8799, it must be registered with public
respondent SEC, otherwise the SEC cannot
protect the investing public from fraudulent
securities. The strict regulation of securities is
founded on the premise that the capital markets
depend on the investing public's level of
confidence in the system.
IN VIEW WHEREOF, the petition is DENIED. The
July 31, 2003 Decision of the Court of Appeals,
a8rming the January 26, 2001 Cease and Desist
Order issued by public respondent Securities and
Exchange Commission against petitioner Power
Homes Unlimited Corporation, and its June 18,
2004 Resolution denying petitioner's Motion for
Reconsideration are AFFIRMED. No costs.
SEC VS PROSPERITY.COM INC
This case involves the application of the Howey
test in order to determine if a particular
transaction is an investment contract.
PCI sold computer software and hosted websites
without providing internet service. To make profit,
PCI devised a scheme in which for the price of
$234 (increased to $294), buyer could acquire
from it an internet website of 15MB capacity. By
referring to PCI his own down-line buyers, a first-
time buyer could earn commissions, interest in
Real Estate in PH and US and insurance
coverage worth P50K.
To benefit from this scheme, PCI buyer must
enlist and sponsor at least 2 other buyers as his
down-lines. 2nd tier of buyers could build up their
own down-lines. For each pair of down-lines,
buyer-sponsor receives $92 commission but
referrals in a day by buyer-sponsor not to exceed
16 since commissions due from excess referrals
inure to PCI not to the buyer-sponsor.
PCI patterned its scheme from GOLONDA
VENTURES INC (GVI) to which it stopped
operations after SEC issued CDO. It was known
that same persons who ran GVI also directed
PCI’s actual operations.
In 2001, GVI filed a complaint with SEC against
PCI alleging that PCI had taken over GVI’s
operations. After hearing, SEC-CEB, issued CDO
against PCI. PCI schemes constitutes an
investment contract and accdg to SRC, it should
first register its contract and securities with SEC.
Instead of asking the SEC to lift its CDO in
accordance with Section 64.3 of Republic Act
(R.A.) 8799, PCI filed with CA a petition for
Certiorari against SEC with TRO. Since CA did
not promptly act on the case, PCI returned to SEC
and filed with it before lapse of the 5-day period
request to lift CDO. PCI withdrew its petition
before CA to avoid FS violation.
During the pendency of PCI's action before the
SEC, however, the CA issued a TRO, enjoining
the enforcement of the CDO. In response, the
SEC filed with CA an MtD on the ground of FS –
PCI guilty of FS as per CA. but on PCI’s motion,
CA reinstated the petition. CA granted PCI’s
petition and set aside the CDO of SEC – Howey
Test, PCI’s scheme did not constitute an
investment contract that needs registration
pursuant to SRC.
Issue: whether or not PCI's scheme constitutes
an investment contract that requires registration
under R.A. 8799.
The CA is right in ruling that the last requisite in
the Howey test is lacking in the marketing scheme
that PCI has adopted. Evidently, it is PCI that
expects profit from the network marketing of its
products. PCI is correct in saying that $234 it gets
from clients is merely a consideration for the sale
of websites it provides.

he Securities Regulation Code treats investment WHEREFORE, the Court DENIES the petition
contracts as "securities" that have to be and AFFIRMS the decision dated July 31, 2003
registered with the SEC before they can be and the resolution dated June 18, 2004 of the
distributed and sold. An investment contract is a Court of Appeals in CA-G.R. SP 62890.
contract, transaction, or scheme where a person
invests his money in a common enterprise and is
led to expect profits primarily from the efforts of
others.

: (1) a contract, transaction, or scheme; (2) an

investment of money; (3) investment is made in a
common enterprise; (4) expectation of profits and
(5) profits arising primarily from the efforts of
others – in order for SEC to win all these must
concur.

PCI's clients do not make such investments. They

buy a product of some value to them: an Internet
website of a 15-MB capacity. The client can use
this website to enable people to have internet
access to what he has to offer to them, say, some
skin cream. The buyers of the website do not
invest money in PCI that it could use for running
some business that would generate profits for the
investors. The price of $234 is what the buyer
pays for the use of website, a tangible asset that
PCI creates using its computer facilities and
technical skills.

Actually, PCI appears to be engaged in network

marketing, a scheme adopted by companies for
getting people to buy their products outside the
usual retail system where products are bought
from the store's shelf. Under this scheme,
adopted by most health product distributors, the
buyer can become a down-line seller. The latter
earns commissions from purchases made by new
buyers whom he refers to the person who sold the
product to him. The network goes down the line
where the orders to buy come.

The commissions, interest in real estate, and

insurance coverage worth P50,000.00 are
incentives to down-line sellers to bring in other
customers. These can hardly be regarded as
profits from investment of money under the
Howey test.
UNITED HOUSING FOUNDATION INC VS
FORMAN
Respondents are 57 residents of Co-op City, a
massive cooperative housing project in New York
City, organized, financed, and constructed under
the New York Private Housing Finance Law
(Mitchell-Lama Act).
They brought this action on behalf of all the
apartment owners and derivatively on behalf of
the housing corporation, alleging, inter
alia, violations of the antifraud provisions of the
Securities Act of 1933 and of the Securities
Exchange Act of 1934, in connection with the sale
to respondents of shares of the common stock of
the cooperative housing corporation.
Citing substantial increases in the tenants'
monthly rental charges as a result of higher
construction costs, respondents' claim centered
on a Co-op City Information Bulletin issued in the
project's initial stages, which allegedly
misrepresented that the developers would absorb
future cost increases due to such factors as
inflation.
Under the Mitchell-Lama Act, which was
designed to encourage private developers to
build low-cost cooperative housing, the State
provides large, long-term low-interest mortgage
loans and substantial tax exemptions,
conditioned on step-by-step state supervision of
the cooperative's development. Developers must
agree to operate the facilities "on a nonprofit
basis," and may lease apartments to only state-
approved lessees whose incomes are below a
certain level.
The corporate petitioners in this case built,
promoted, and presently control Co-op City:
United Housing Foundation (UHF), a nonprofit
membership corporation, initiated and sponsored
the project; Riverbay, a nonprofit cooperative
housing corporation, was organized by UHF to
own and operate the land and buildings and issue
the stock that is the subject of the instant action;
and Community Securities, Inc. (CSI), UHF's
wholly owned subsidiary, was the project's
general contractor and sales agent.
To acquire a Co-op City apartment, a prospective
purchaser must buy 18 shares of Riverbay stock
for each room desired at $25 per share. The
shares cannot be transferred to a non-tenant,
pledged, encumbered, or bequeathed (except to
a surviving spouse), and do not convey voting
rights based on the number owned (each
apartment having one vote).
On termination of occupancy, a tenant must offer
his stock to Riverbay at $25 per share, and, in the
unlikely event that Riverbay does not repurchase,
the tenant cannot sell his shares for more than
their original price, plus a fraction of the mortgage
amortization that he has paid during his tenancy,
and then only to a prospective tenant satisfying
the statutory income eligibility requirements.
Under the Co-op City Lease arrangement, the
resident is committed to make monthly rental
payments in accordance with the size, nature,
and location of the apartment. The Securities
Acts define a "security" as "any . . . stock, . . .
investment contract, . . . or, in general, any
interest or instrument commonly known as
a security.'" Petitioners moved to dismiss the
complaint for lack of federal jurisdiction,
maintaining that the Riverbay stock did not
constitute securities as thus defined. The District
Court granted the motion to dismiss. The Court of
Appeals reversed, holding that (1) since the
shares purchased were called "stock," the
definitional sections of the Securities Acts were
literally applicable, and (2) the transaction was an
investment contract under the Securities Acts,
there being a profit expectation from rental
reductions resulting from (i) the income produced
by commercial facilities established for the use of
Co-op City tenants; (ii) tax deductions for the
portion of monthly rental charges allocable to
interest payments on the mortgage; and (iii)
savings based on the fact that Co-op City
apartments cost substantially less than
comparable nonsubsidized housing.
Held: The shares of stock involved in this
Litigation do not constitute "securities" within the
purview of the Securities Acts, and since
respondents' claims are not cognizable in federal
court, the District Court properly dismissed their
complaint.
share in Riverbay does not constitute an
"investment contract" as defined by the Securities
Acts, a term which, like the term "any . . .
instrument commonly known as a security,'"
involves investment in a common venture
premised on a reasonable expectation of profits
to be derived from the entrepreneurial or
managerial efforts of others. Here, neither of the
kinds of profits traditionally associated with
securities were offered to respondents; instead,
as indicated in the Information Bulletin, which
stressed the "non-profit" nature of the project, the
focus was upon the acquisition of a place to live.
Although deductible for tax purposes, the portion
of rental charges applied to interest on the
mortgage (benefits generally available to home
mortgagors) does not constitute "profits," and, in
any event, does not derive from the efforts of third
parties.
Low rent attributable to state financial subsidies
no more embodies income or profit attributes than
other types of government subsidies.
uch income as might derive from Co-op City's
leasing of commercial facilities within the housing
project to be used to reduce tenant rentals (the
prospect of which was never mentioned in the
Information Bulletin) is too speculative and
insubstantial to bring the entire transaction within
the Securities Acts. These facilities were
established not for profit purposes, but to make
essential services available to residents of the
huge complex.
The issue in these cases is whether shares of
stock entitling a purchaser to lease an apartment
in Co-op City, a state subsidized and supervised
nonprofit housing cooperative, are "securities"
within the purview of the Securities Act of 1933
and the Securities Exchange Act of 1934.
Co-op City is a massive housing cooperative in
New York City. Built between 1965 and 1971, it
presently houses approximately 50,000 people
on a 200-acre site containing 35 high-rise
buildings and 236 town houses. The project was
organized, financed, and constructed under the
New York State Private Housing Finance Law,
commonly known as the Mitchell-Lama Act,
enacted to ameliorate a perceived crisis in the
availability of decent low income urban housing.
In order to encourage private developers to build
low-cost cooperative housing, New York provides
them with large long-term, low interest mortgage
loans and substantial tax exemptions. Receipt of
such benefits is conditioned on a willingness to
have the State review virtually every step in the
development of the cooperative.
The United Housing Foundation (UHF), a
nonprofit membership corporation established for
the purpose of "aiding and encouraging" the
creation of "adequate, safe and sanitary housing
accommodations for wage earners and other
persons of low or moderate income," was
responsible for initiating and sponsoring the
development of Co-op City.
In making this determination in the present case,
we do not write on a clean slate. Well-settled
principles enunciated by this Court establish that
the shares purchased by respondents do not
represent any of the "countless and variable
scheme devised by those who seek the use of the
money of others on the promise of
profits," Howey, 328 U.S. at 328 U. S. 299, and
therefore do not fall within "the ordinary concept
of a security."
We reject at the outset any suggestion that the
present transaction, evidenced by the sale of
shares called "stock," must be considered a
security transaction simply because the statutory
definition of a security includes the words "any . .
. stock." Rather, we adhere to the basic principle
that has guided all of the Court's decisions in
this area:
"[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."
The primary purpose of the Acts of 1933 and
1934 was to eliminate serious abuses in a
largely unregulated securities market. The focus
of the Acts is on the capital market of the
enterprise system: the sale of securities to raise
capital for profit-making purposes, the
exchanges on which securities are traded, and
the need for regulation to prevent fraud and to
protect the interest of investors. Because
securities transactions are economic in
character, Congress intended the application of
these statutes to turn on the economic realities
underlying a transaction, and not on the name
appended thereto. Thus, in construing these
Acts against the background of their purpose,
we are guided by a traditional canon of statutory
construction:
"[A] thing may be within the letter of the statute
and yet not within the statute, because not within
its spirit, nor within the intention of its makers."
In the present case, respondents do not contend,
nor could they, that they were misled by use of
the word "stock" into believing that the federal
securities laws governed their purchase.
Common sense suggests that people who intend
to acquire only a residential apartment in a state-
subsidized cooperative, for their personal use,
are not likely to believe that, in reality they are
purchasing investment securities simply because
the transaction is evidenced by something called
a share of stock. These shares have none of the
characteristics "that, in our commercial world fall
within the ordinary concept of a security."
H.R.Rep. No. 85, supra, at 11. Despite their
name, they lack what the Court
in Tcherepnin deemed the most common feature
of stock: the right to receive "dividends contingent
upon an apportionment of profits." 389 U.S.
at 389 U. S. 339. Nor do they possess the other
characteristics traditionally associated with stock:
they are not negotiable; they cannot be pledged
or hypothecated; they confer no voting rights in
proportion to the number of shares owned; and
they cannot appreciate in value. In short, the
inducement to purchase was solely to acquire
subsidized low-cost living space; it was not to
invest for profit.
LANDRETH TIMBER CO VS LANDRETH
Respondents father and sons, who owned all of
the common stock of a lumber business that they
operated, offered their stock for sale through
brokers. The company's sawmill was
subsequently damaged by fire, but potential
purchasers were told that the mill would be rebuilt
and modernized. Thereafter, a stock purchase
agreement for all of the stock was executed, and
ultimately petitioner company was formed by the
purchasers. Respondent father agreed to stay on
as a consultant for some time to help with the
daily operations of the mill. After the acquisition
was completed, the mill did not live up to the
purchasers' expectations. Eventually, petitioner
sold the mill at a loss and went into receivership.
Petitioner then filed suit in Federal District Court
for rescission of the sale of stock and damages,
alleging that respondents had violated the
registration provisions of the Securities Act of
1933 (1933 Act) and the antifraud provisions of
the Securities Exchange Act of 1934 (1934 Act).
The court granted summary judgment for
respondents, holding that, under the "sale of
business" doctrine, the stock could not be
considered a "security" for purposes of the Acts
because managerial control of the business had
passed into the hands of the purchasers, who
bought 100% of the stock. The court concluded
that the transaction thus was a commercial
venture, rather than a typical investment. The
Court of Appeals affirmed.
Held: The stock at issue here is a "security" within
the definition of the Acts, United Housing
Foundation, Inc. v. Forman, 421 U. S. 837,
distinguished, and the "sale of business" doctrine
does not apply.
a) Section 2(1) of the 1933 Act and § 3(a)(10) of
the 1934 Act define a "security" as including
"stock" and other listed types of instruments.
Although the fact that instruments bear the label
"stock" is not of itself sufficient to invoke the Acts'
coverage, when an instrument is both called
"stock" and bears stock's usual characteristics as
identified in Forman, supra, a purchaser
justifiably may assume that the federal securities
laws apply. The stock involved here possesses all
of the characteristics traditionally associated with
common stock. Moreover, reading the securities
laws to apply to the sale of stock at issue here
comports with Congress' remedial purpose in
enacting the legislation to protect investors.
(b) When an instrument is labeled "stock" and
possesses all of the traditional characteristics of
stock, a court is not required to look to the
economic substance of the transaction to
determine whether the stock is a "security" within
the meaning of the Acts. A contrary rule is not
supported by this Court's prior decisions involving
unusual instruments not easily characterized as
"securities." Nor were the Acts intended, as
asserted by respondents, to cover only "passive
investors," and not privately negotiated
transactions involving the transfer of control to
"entrepreneurs."
(c) An instrument bearing both the name and all
of the usual characteristics of stock presents the
clearest case for coverage by the plain language
of the definition. "Stock" is distinguishable from
most if not all of the other listed categories, and
may be viewed as being in a category by itself for
purposes of interpreting the Acts' definition of
"security."
(d) Application of the "sale of business" doctrine
depends on whether control has passed to the
purchaser. Even though the transfer of 100% of a
corporation's stock normally transfers control, the
purchasers here had no intention of running the
sawmill themselves. Moreover, if the doctrine
were applied here, it would also have to be
applied to cases in which less than 100% of a
company's stock was sold, thus inevitably leading
to difficult questions of line-drawing. As explained
in Gould v. Ruefenacht, post, p. 471 U. S. 701,
coverage by the Acts would in most cases be
unknown and unknowable to the parties at the
time the stock was sold. Such uncertainties
attending the applicability of the Acts would be
intolerable.
This case presents the question whether the sale
of all of the stock of a company is a securities
transaction subject to the antifraud provisions of
the federal securities laws (the Acts).
We now turn to the Court of Appeals' concern that
treating stock as a specific category of "security"
provable by its characteristics means that other
categories listed in the statutory definition, such
as notes, must be treated the same way.
Although we do not decide whether coverage of
notes or other instruments may be provable by
their name and characteristics, we do point out
several reasons why we think stock may be
distinguishable from most if not all of the other
categories listed in the Acts' definition.
Instruments that bear both the name and all of the
usual characteristics of stock seem to us to be the
clearest case for coverage by the plain language
of the definition. First, traditional stock
"represents to many people, both trained and
untrained in business matters, the paradigm of a
security." Daily v. Morgan, supra, at 500. Thus
persons trading in traditional stock likely have a
high expectation that their activities are governed
by the Acts. Second, as we made clear
in Forman, "stock" is relatively easy to identify
because it lends itself to consistent
definition. See supra, at 471 U. S. 686. Unlike
some instruments, therefore, traditional stock is
more susceptible of a plain meaning approach.
Professor Loss has agreed that stock is different
from the other categories of instruments. He
observes that it "goes against the grain" to apply
the Howey test for determining whether an
instrument is an "investment contract" to
traditional stock. L. Loss, Fundamentals of
Securities Regulation 211-212 (1983). As
Professor Loss explains:
"It is one thing to say that the typical cooperative
apartment dweller has bought a home, not a
security; or that not every installment purchase
'note' is a security; or that a person who charges
a restaurant meal by signing his credit card slip is
not selling a security, even though his signature
is an 'evidence of indebtedness.'
But stock (except for the residential wrinkle) is so
quintessentially a security as to foreclose further
analysis."
In sum, we conclude that the stock at issue here
is a "security" within the definition of the Acts,
and that the sale of business doctrine does not
apply. The judgment of the United States Court
of Appeals for the Ninth Circuit is therefore
Reversed.
PEOPLE OF THE PHILIPPINES, plaintiff-
appellee, vs. PRISCILLA BALASA, NORMITA
VISAYA, GUILLERMO FRANCISCO, NORMA
FRANCISCO and ANALINA FRANCISCO,
accused
COMMITTED WHEN THE APPELLANTS
OFFERED THE PUBLIC. AN INVESTMENT
PROGRAM CALLED "PONZI SCHEME"; CASE
AT BAR. — The testimonial evidence presented
by the prosecution proves that appellants
employed fraud and deceit upon gullible people
to convince them to invest in the foundation. It has
been held that where one states that the future
profits or income of an enterprise shall be a
certain sum, but he actually knows that there will
be none, or that they will be substantially less
than he presents, the statement constitutes
actionable fraud where the hearer believes him
and relies on the statement to his injury. That
there was no profit forthcoming can be clearly
deduced from the fact that the foundation was not
engaged nor authorized to engage in any
lucrative business to finance its operation. It was
not shown that it was the recipient of donations or
bequest with which to finance its "double or triple
your money" scheme, nor did it have any
operating capital to speak of when it started
operations. Parenthetically, what appellants
offered the public was a "Ponzi scheme," an
investment program that offers impossibly high
returns and pays returns to early investors out of
the capital contributed by later investors. Named
after Charles Ponzi who promoted the scheme in
the 1920s, the original scheme involved the
issuance of bonds which offered 50% interest in
45 days or a 100% profit if held for 90 days.
Basically, Ponzi used the money he received
from later investors to pay extravagant rates of
return to early investors, thereby inducing more
investors to place their money with him in the
false hope of realizing this same extravagant rate
of return themselves. This was the very same
scheme practiced by the Panata Foundation.
However, the Ponzi scheme works only as long
as there is an everincreasing number of new
investors joining the scheme. To pay off the 50%
bonds Ponzi had to come up with a one-and-a-
half times increase with each round. To pay 100%
pro@t he had to double the number of investors
at each stage, and this is the reason why a Ponzi
scheme is a scheme and not an investment
strategy. The progression it depends upon is
unsustainable. The pattern of increase in the
number of participants in the system explains
how it is able to succeed in the short run and, at
the same time, why it must fail in the long run.
This game is diJcult to sustain over a long period
of time because to continue paying the promised
pro@ts to early investors, the operator needs an
ever larger pool of later investors. The idea
behind this type of swindle is that the "con-man"
collects his money from his second or third round
of investors and then absconds before anyone
else shows up to collect. Necessarily, these
schemes only last weeks, or months at most.
CONSPIRACY; PRESENT WHEN THROUGH
ACTIVE COOPERATION, APPELLANTS
SHOWED A COMMUNITY OF DESIGN WITH
THE INCORPORATORS OF THE
FOUNDATION. — The evidence adduced by the
prosecution con@rms the existence of a
conspiracy among the appellants in committing
the crime charged. The fact that Guillermo
Francisco was not an incorporator of the
foundation does not make him any less liable for
the crime charged. By his own admission, he
participated in the foundation's activities by
serving as its paymaster. Because he is father
and husband to three of the organizers of the
foundation, it is not farfetched to presume that he
was aware of its operations. By his active
cooperation, he showed a community of design
with the incorporators of the foundation, thereby
making him a co-conspirator and equally liable for
the crime charged. His voluntary and
indispensable cooperation was a concatenation
of the criminal acts performed by his co-accused.
In this regard, appellant Guillermo Francisco is
not being implicated as a co-conspirator solely
because he is the father of the principal
proponent of the Ponzi scheme. He is held liable
as a conspirator because indispensable act of
being the paymaster of the foundation. Likewise,
Norma Francisco's bare denial cannot exempt
her from complicity. Aside from being the cashier,
Norma Francisco was also an incorporator of the
foundation. Likewise, the money invested in the
foundation was deposited in joint bank accounts
in Priscilla Balasa's name and hers. Norma
Francisco's activities would thus show a
community of design with the other accused
making her a co-conspirator and equally liable for
the crime charged. Her voluntary and
indispensable cooperation concurred with the
criminal acts performed by her co-accused.