Securities and Exchange Commission v. Edwards

FACTS Charles Edwards was the chairman, CEO, and sole shareholder of ETS Payphones, Inc. (ETS), which sold payphones to the public via independent distributors. The payphones were offered with a site lease, a five-year leaseback and management agreement, and a buyback agreement. The purchase price for the payphone packages was approximately $7,000. Under the leaseback and management agreement, purchasers received $82 per month, a 14 percent annual return. Purchasers were not involved in the day-to-day operation of the payphones they owned as ETS selected the site for the phone, installed the equipment, arranged for connection and long-distance service, collected coin revenues, and maintained and repaired the phones. Under the buyback agreement, ETS promised to refund the full purchase price of the package at the end of the lease or within one hundred and eighty days of a purchaser’s request.
In its marketing materials and on its website, ETS trumpeted the “incomparable pay phone” as “an exciting business opportunity,” in which recent deregulation had “open[ed] the door for profits for individual pay phone owners and operators.” According to ETS, very “few business opportunities can offer the potential for ongoing revenue generation that is available in today’s pay telephone industry.” Ten thousand people invested a total of $300 million in the payphone sale-and-leaseback arrangements.
The payphones did not generate enough revenue for ETS to make the payments required by the leaseback agreements, so the company depended on funds from new investors to meet its obligations. After ETS filed for bankruptcy protection, the Securities and Exchange Commission (SEC) brought this civil enforcement action. It alleged that Edwards and ETS had violated the registration requirements and antifraud provisions of the Securities Act of 1933, as well as Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 under that section.
The district court concluded that the payphone sale-and-leaseback arrangement was an investment contract and therefore was subject to the federal securities laws. The Court of Appeals reversed, holding that the respondent’s scheme was not an investment contract.

DECISION The judgment of the U.S. Court of Appeals is reversed, and the case is remanded.

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OPINION Congress’s 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. The 1993 Act and the 1934 Act define “security” to include any note, stock, treasury stock, security future, bond, debenture, investment contract, or any instrument commonly known as a security. “Investment contract” is not itself defined.
Under the Supreme Court decision in SEC v. W. J. Howey Co. the test for whether a particular scheme is an investment contract is “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” This definition “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.” “Profits” was used in the sense of income or return, to include, for example, dividends, other periodic payments, or the increased value of the investment.
There is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of the test. In both cases, the investing public is attracted by representations of investment income, as purchasers were in this case by ETS’s invitation to “watch the profits add up.” Moreover, investments pitched as low risk (such as those offering a “guaranteed” fixed return) are particularly attractive to individuals more vulnerable to investment fraud, including older and less sophisticated investors. An investment scheme promising a fixed rate of return can be an “investment contract” and thus a “security” subject to the federal securities laws.

INTERPRETATION An investment scheme promising a fixed rate of return can be an “investment contract” and thus a “security” subject to the federal securities laws.

How would you define a security? Explain.

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