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SEC vs LIFE PARTNERS INC efforts of a party or parties other than the

investors; therefore, we do not reach LPI's


When attempting to ascertain whether to grant a alternative argument that it might be able to alter
preliminary injunction, district court found that its operation in such a way as to be entitled to a
minor interests in life insurance policies promoted private offering exemption.
by LPI are considered securities, hence, must
comply with SEC procedures. WoN the parameters set by Howey cover viatical
settlement as securities?
Based on the parameters set by Howey, Viatical
settlements are not considered securities. NO. According to Justice Ginsburg, viatical
settlements do not meet the third requisite of
LPI sells investment contracts where an investor
Howey test – depends upon the efforts of others
procures an interest in a terminally ill person’s life
(AIDS) insurance policy at a discount (20%-40%), HOWEY TEST: (1) expect profits from (2) a
the discount being contingent on the insured’s life common enterprise that (3) depends upon the
expectancy. When the insured dies, the investor efforts of others.
receives the benefit of the insurance.
The most important aspect to the viatical
The investor's profit is the difference between the settlements sold by LPI is the duration of the
discounted purchase price paid to the insured insured’s life as opposed to the seller’s efforts.
and the death benefit collected from the insurer, The pre and post purchase services completed
less transaction costs, premiums paid, and other by LPI were generally more clerical than
administrative expenses. commercial.
LPI organized these transactions and also However, Justice Wald’s dissent tackles that
executes post-transaction assistance. SEC when deciding if an investment fulfills Howey’s
asserts that fractional interests marketed by LPI third prong, focus needs to be in the manner and
are considered securities hence a violation of the amount of reliance between the investor’s profits
Securities Act of 1933 and Securities Exchange and the marketer’s undertakings. In this case,
Act 1934. SEC requested that LPI cease (prelim WoN LPI pre-purchase managerial activities were
injunc) making additional sales until after are successful determines whether the profits are
complying with SEC regulations. attained. It can be said that Howey’s third point is
met by LPI pre-purchase services.
LPI argues that:
As witnessed in this case, investment profits did
not come largely from others’ labors, meaning
(1) viatical settlements are exempt from the
securities laws because they are insurance that the pre-purchase events were not sufficient.
contracts within the meaning of the McCarran- The Commission also notes that some firms have
Ferguson Act,
sought and obtained an exemption from the
federal securities laws for their viatical contracts;
(2) the fractional interests sold by LPI are not in presumably a firm might also buy insurance
any event securities within the meaning of the
policies for its own account or act as an agent,
1933 and 1934 Acts. LPI asserts alternatively that
it could modify its program so as to come within a matching a single investor with a terminally ill
safe harbor exemption for private offerings under insured, without running afoul of the securities
SEC Rule 506, 17 C.F.R. § 230.506. laws.

We agree with the district court that viatical That is not how LPI does business, however. LPI
settlements are not exempt from the securities sells fractional interests in insurance policies to
laws as insurance contracts. Contrary to the retail investors, who may pay as little as $650 and
district court, however, we conclude that LPI's buy as little as 3% of the benefits of a policy. In
contracts are not securities subject to the federal order to reach its customers, LPI uses some 500
securities laws because the profits from their commissioned "licensees," mostly independent
purchase do not derive predominantly from the financial planners. For its efforts, LPI's net
compensation is roughly 10% of the purchase
price after payment of referral and other fees. look to the efforts of others for their profits
Pardo claims that LPI is by far the largest of about because the only variable affecting profits is the
60 firms serving the rapidly growing market for timing of the insured's death, which is outside of
viatical settlements; in 1994 the company LPI's and Sterling's control.
accounted for more than half of the industry's
estimated annual revenues of $300 million. The
company is 95% beneficially owned by Pardo Summary and Conclusion
through a trust, and 5% owned by Dr. Jack Kelly,
who performs medical evaluations of LPI advances two arguments in support of the
policyholders on LPI's behalf. proposition that its viatical settlements are not
subject to the federal securities laws. First, the
LPI was also the first company to develop a plan company contends that its contracts are exempt
by which an investor could participate in a viatical as insurance contracts under the Securities Act of
settlement through an Individual Retirement 1933 and the McCarran-Ferguson Act. For the
Account. In order to circumvent the Internal reasons set forth in Part II.A, however, we
Revenue Code prohibition upon IRAs investing in conclude that a viatical settlement is not an
life insurance contracts, LPI structures the insurance policy, and that the business of selling
purchase through a separate trust established for fractional interests in insurance policies is not part
that purpose. The IRA lends money to the trust, of "the business of insurance." We therefore
for which it receives a non-recourse note; the trust reject LPI's exemption argument.
then uses the loan proceeds to purchase an
interest in a life insurance policy, the death Second, LPI maintains that the fractional interests
benefits of which collateralize the note. When the which it sells to investors are not securities within
insured dies and the benefits are paid, the the meaning of the 1933 Act, as controlled by the
proceeds go to pay off the note held by the IRA. Supreme Court's decision in Howey. In Parts
II.B(1) and II.B(2), respectively, we conclude that
Both LPI's program for individual investors and its LPI's contracts meet two parts of the Howey test:
IRA program have gone through three iterations investors purchase the contracts with an
during the course of this litigation. In each, LPI expectation of profits; and they pool their funds,
performed or performs a number of pre-purchase then share any profits or losses that arise. In Part
functions: Specifically, even before assembling II.B(3), however, we hold that fractional interests
the investors, LPI evaluates the insured's medical in viatical settlements, in any of the three versions
condition, reviews his insurance policy, marketed or proposed by LPI, are not securities.
negotiates the purchase price, and prepares the The combination of LPI's pre-purchase services
legal documents. The difference among the three as a finder-promoter and its largely ministerial
versions is that LPI performs ever fewer (and post-purchase services is not enough to satisfy
ultimately no) post-purchase functions. the third requirement in Howey: the investors'
profits do not flow predominantly from the efforts
If viatical settlements are insurance contracts, of others. Finally, we hold that the notes issued to
then they are altogether exempt from coverage IRAs by LPI-sponsored trusts are not securities
under the federal securities laws. either. Looking to the substance of such
transactions, we see that the notes are used
n this connection, the SEC suggests that solely for tax purposes, not as a means of raising
investors in LPI's viatical settlements are capital.
essentially passive; their profits, the Commission
argues, depend predominantly upon the efforts of Accordingly, this case is remanded to the district
LPI, which provides pre-purchase expertise in court with instructions to vacate the three
identifying existing policyholders and, together injunctions entered against LPI in August 1995,
with Sterling, provides post-purchase January 1996, and March 1996.
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
POWER HOMES UNLIMITED CORP VS SEC & On the first issue, Sec. 64 of R.A. No. 8799
NOEL MANERO provides: Sec. 64. Cease and Desist Order. —
64.1. The Commission, after proper investigation
Power Homes is a domestic corporation or verification, motu proprio or upon verified
registered with SEC on Oct 2000. 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,
Primary purpose: To engage in the transaction of
promoting, acquiring, managing, leasing, unless restrained, will operate as a fraud on
obtaining options on, development, and investors or is otherwise likely to cause grave or
irreparable injury or prejudice to the investing
improvement of real estate properties for
public.
subdivision and allied purposes, and in the
purchase, sale and/or exchange of said
subdivision and properties through network Power Homes was not denied due process. SEC
marketing. properly examined Power Homes’ business
operations when it (1) called into conference
three of petitioner's incorporators, (2) requested
N. Manero requested SEC to investigate Power
information from the incorporators regarding the
Homes claiming that he attended a seminar
nature of petitioner's business operations, (3)
conducted by the latter claiming to sell properties
that were inexistent and had no broker’s license. asked them to submit documents pertinent
thereto, and (4) visited petitioner's business
premises and gathered information thereat. All
R. Munsayac inquired from SEC whether Power these were done before the CDO was issued by
Homes business involves LEGITIMATE the public respondent SEC. Trite to state, a formal
NETWORK MARKETING. trial or hearing is not necessary to comply with the
requirements of due process. Its essence is
On this basis, SEC held a conference on Dec simply the opportunity to explain one's position.
2000 that was attended by Power Homes Public respondent SEC abundantly allowed
incorporators – John Lim, Paul and Leonito petitioner to prove its side.
Nicolas.
The second issue is whether the business of
Power Homes submitted to SEC copies of its petitioner involves an investment contract that is
marketing course module and letter of considered security and thus, must be registered
confirmation from Fil Estate, Crown Asia and prior to sale or offer for sale or distribution to the
Pioneer. SEC visited the premises to gather public pursuant to Section 8.1 of R.A. No. 8799,
pertinent information. viz: Section 8. Requirement of Registration of
Securities. — 8.1. Securities shall not be sold or
Power Homes is engaged in the sale or offer for offered for sale or distribution within the
sale or distribution of investment contracts, which Philippines, without a registration statement duly
are considered securities under Sec. 3.1 (b) of filed with and approved by the Commission. Prior
(R.A.) No. 8799 (The Securities Regulation to such sale, information on the securities, in such
Code), but failed to register them in violation of form and with such substance as the Commission
Sec. 8.1 of the same Act, SEC issued CDO. may prescribe, shall be made available to each
prospective purchaser.
Power Homes moved for the lifting of CDO but
SEC denied for lack of merit. SEC found the petitioner "as a marketing
company that promotes and facilitates sales of
CA: imputing GADALEJ by SEC – favored SEC. real properties and other related products of real
estate developers through effective leverage
marketing."
The issues for determination are: (1) whether
public respondent SEC followed due process in
the issuance of the assailed CDO; and (2) It also described the conduct of petitioner's
whether petitioner's business constitutes an business as follows: The scheme of the
investment contract which should be registered [petitioner] corporation requires an investor to
with public respondent SEC before its sale or become a Business Center Owner (BCO) who
offer for sale or distribution to the public. must fill-up and sign its application form. The
Terms and Conditions printed at the back of the the Howey Test "embodies a flexible rather than
application form indicate that the BCO shall mean a static principle, one that is capable of adaptation
an independent representative of Power Homes, to meet the countless and variable schemes
who is enrolled in the company's referral program devised by those who seek the use of the money
and who will ultimately purchase real property of others on the promise of profits." Needless to
from any accredited real estate developers and state, any investment contract covered by the
as such he is entitled to a referral Howey Test must be registered under the
bonus/commission. Paragraph 5 of the same Securities Act, regardless of whether its issuer
indicates that there exists no employer/employee was engaged in fraudulent practices.
relationship between the BCO and the Power
Homes Unlimited, Corp. The business scheme of petitioner in the case at
bar is essentially similar. An investor enrolls in
The BCO is required to pay US$234 as his petitioner's program by paying US$234. This
enrollment fee. His enrollment entitles him to entitles him to recruit two (2) investors who pay
recruit two investors who should pay US$234 US$234 each and out of which amount he
each and out of which amount he shall receive receives US$92. A minimum recruitment of four
US$92. In case the two referrals/enrollees would (4) investors by these two (2) recruits, who then
recruit a minimum of four (4) persons each recruit at least two (2) each, entitles the principal
recruiting two (2) persons who become his/her investor to US$184 and the pyramid goes on.
own down lines, the BCO will receive a total
amount of US$147.20 after deducting the amount We reject petitioner's claim that the payment of
of US$36.80 as property fund from the gross US$234 is for the seminars on leverage
amount of US$184. After recruiting 128 persons marketing and not for any product. Clearly, the
in a period of eight (8) months for each Left and trainings or seminars are merely designed to
Right business groups or a total of 256 enrollees enhance petitioner's business of teaching its
whether directly referred by the BCO or through investors the knowhow of its multi-level marketing
his down lines, the BCO who receives a total business. An investor enrolls under the scheme
amount of US$11,412.80 after deducting the of petitioner to be entitled to recruit other
amount of US$363.20 as property fund from the investors and to receive commissions from the
gross amount of US$11,776, has now an investments of those directly recruited by him.
accumulated amount of US$2,700 constituting as Under the scheme, the accumulated amount
his Property Fund placed in a Property Fund received by the investor comes primarily from the
account with the Chinabank. This accumulated efforts of his recruits.
amount of US$2,700 is used as partial/full down
payment for the real property chosen by the BCO
We therefore rule that the business operation or
from any of [petitioner's] accredited real estate the scheme of petitioner constitutes an
developers. investment contract that is a security under R.A.
No. 8799. Thus, it must be registered with public
An investment contract is deDned in the respondent SEC before its sale or offer for sale or
Amended Implementing Rules and Regulations distribution to the public. As petitioner failed to
of R.A. No. 8799 as a "contract, transaction or register the same, its offering to the public was
scheme (collectively 'contract') whereby a person rightfully enjoined by public respondent SEC. The
invests his money in a common enterprise and is CDO was proper even without a finding of fraud.
led to expect profits primarily from the efforts of As an investment contract that is security under
others." R.A. No. 8799, it must be registered with public
respondent SEC, otherwise the SEC cannot
Known as the Howey Test, it requires a protect the investing public from fraudulent
transaction, contract, or scheme whereby a securities. The strict regulation of securities is
person (1) makes an investment of money, (2) in founded on the premise that the capital markets
a common enterprise, (3) with the expectation of depend on the investing public's level of
profits, (4) to be derived solely from the efforts of confidence in the system.
others.
IN VIEW WHEREOF, the petition is DENIED. The
Although the proponents must establish all four July 31, 2003 Decision of the Court of Appeals,
elements, the US Supreme Court stressed that a8rming the January 26, 2001 Cease and Desist
Order issued by public respondent Securities and SEC VS PROSPERITY.COM INC
Exchange Commission against petitioner Power
Homes Unlimited Corporation, and its June 18, This case involves the application of the Howey
2004 Resolution denying petitioner's Motion for test in order to determine if a particular
Reconsideration are AFFIRMED. No costs. 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 The CA is right in ruling that the last requisite in
investment contract that needs registration the Howey test is lacking in the marketing scheme
pursuant to SRC. that PCI has adopted. Evidently, it is PCI that
expects profit from the network marketing of its
Issue: whether or not PCI's scheme constitutes products. PCI is correct in saying that $234 it gets
an investment contract that requires registration from clients is merely a consideration for the sale
under R.A. 8799. 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 pledged, encumbered, or bequeathed (except to
FORMAN a surviving spouse), and do not convey voting
rights based on the number owned (each
Respondents are 57 residents of Co-op City, a apartment having one vote).
massive cooperative housing project in New York
City, organized, financed, and constructed under On termination of occupancy, a tenant must offer
the New York Private Housing Finance Law his stock to Riverbay at $25 per share, and, in the
(Mitchell-Lama Act). unlikely event that Riverbay does not repurchase,
the tenant cannot sell his shares for more than
They brought this action on behalf of all the their original price, plus a fraction of the mortgage
apartment owners and derivatively on behalf of amortization that he has paid during his tenancy,
the housing corporation, alleging, inter and then only to a prospective tenant satisfying
alia, violations of the antifraud provisions of the the statutory income eligibility requirements.
Securities Act of 1933 and of the Securities
Exchange Act of 1934, in connection with the sale Under the Co-op City Lease arrangement, the
to respondents of shares of the common stock of resident is committed to make monthly rental
the cooperative housing corporation. payments in accordance with the size, nature,
and location of the apartment. The Securities
Citing substantial increases in the tenants' Acts define a "security" as "any . . . stock, . . .
monthly rental charges as a result of higher investment contract, . . . or, in general, any
construction costs, respondents' claim centered interest or instrument commonly known as
on a Co-op City Information Bulletin issued in the a security.'" Petitioners moved to dismiss the
project's initial stages, which allegedly complaint for lack of federal jurisdiction,
misrepresented that the developers would absorb maintaining that the Riverbay stock did not
future cost increases due to such factors as constitute securities as thus defined. The District
inflation. Court granted the motion to dismiss. The Court of
Appeals reversed, holding that (1) since the
shares purchased were called "stock," the
Under the Mitchell-Lama Act, which was
definitional sections of the Securities Acts were
designed to encourage private developers to
literally applicable, and (2) the transaction was an
build low-cost cooperative housing, the State
investment contract under the Securities Acts,
provides large, long-term low-interest mortgage
there being a profit expectation from rental
loans and substantial tax exemptions,
reductions resulting from (i) the income produced
conditioned on step-by-step state supervision of
by commercial facilities established for the use of
the cooperative's development. Developers must
Co-op City tenants; (ii) tax deductions for the
agree to operate the facilities "on a nonprofit
portion of monthly rental charges allocable to
basis," and may lease apartments to only state-
interest payments on the mortgage; and (iii)
approved lessees whose incomes are below a
savings based on the fact that Co-op City
certain level.
apartments cost substantially less than
comparable nonsubsidized housing.
The corporate petitioners in this case built,
promoted, and presently control Co-op City:
Held: The shares of stock involved in this
United Housing Foundation (UHF), a nonprofit
Litigation do not constitute "securities" within the
membership corporation, initiated and sponsored
purview of the Securities Acts, and since
the project; Riverbay, a nonprofit cooperative
respondents' claims are not cognizable in federal
housing corporation, was organized by UHF to
own and operate the land and buildings and issue court, the District Court properly dismissed their
complaint.
the stock that is the subject of the instant action;
and Community Securities, Inc. (CSI), UHF's
wholly owned subsidiary, was the project's share in Riverbay does not constitute an
general contractor and sales agent. "investment contract" as defined by the Securities
Acts, a term which, like the term "any . . .
instrument commonly known as a security,'"
To acquire a Co-op City apartment, a prospective
involves investment in a common venture
purchaser must buy 18 shares of Riverbay stock
premised on a reasonable expectation of profits
for each room desired at $25 per share. The
to be derived from the entrepreneurial or
shares cannot be transferred to a non-tenant,
managerial efforts of others. Here, neither of the The United Housing Foundation (UHF), a
kinds of profits traditionally associated with nonprofit membership corporation established for
securities were offered to respondents; instead, the purpose of "aiding and encouraging" the
as indicated in the Information Bulletin, which creation of "adequate, safe and sanitary housing
stressed the "non-profit" nature of the project, the accommodations for wage earners and other
focus was upon the acquisition of a place to live. persons of low or moderate income," was
responsible for initiating and sponsoring the
Although deductible for tax purposes, the portion development of Co-op City.
of rental charges applied to interest on the
mortgage (benefits generally available to home In making this determination in the present case,
mortgagors) does not constitute "profits," and, in we do not write on a clean slate. Well-settled
any event, does not derive from the efforts of third principles enunciated by this Court establish that
parties. the shares purchased by respondents do not
represent any of the "countless and variable
Low rent attributable to state financial subsidies scheme devised by those who seek the use of the
no more embodies income or profit attributes than money of others on the promise of
other types of government subsidies. profits," Howey, 328 U.S. at 328 U. S. 299, and
therefore do not fall within "the ordinary concept
uch income as might derive from Co-op City's of a security."
leasing of commercial facilities within the housing
project to be used to reduce tenant rentals (the We reject at the outset any suggestion that the
prospect of which was never mentioned in the present transaction, evidenced by the sale of
Information Bulletin) is too speculative and shares called "stock," must be considered a
insubstantial to bring the entire transaction within security transaction simply because the statutory
the Securities Acts. These facilities were definition of a security includes the words "any . .
established not for profit purposes, but to make . stock." Rather, we adhere to the basic principle
essential services available to residents of the that has guided all of the Court's decisions in
huge complex. this area:

The issue in these cases is whether shares of "[I]n searching for the meaning and scope of the
stock entitling a purchaser to lease an apartment word 'security' in the Act[s], form should be
in Co-op City, a state subsidized and supervised disregarded for substance and the emphasis
nonprofit housing cooperative, are "securities" should be on economic reality."
within the purview of the Securities Act of 1933
and the Securities Exchange Act of 1934. The primary purpose of the Acts of 1933 and
1934 was to eliminate serious abuses in a
Co-op City is a massive housing cooperative in largely unregulated securities market. The focus
New York City. Built between 1965 and 1971, it of the Acts is on the capital market of the
presently houses approximately 50,000 people enterprise system: the sale of securities to raise
on a 200-acre site containing 35 high-rise capital for profit-making purposes, the
buildings and 236 town houses. The project was exchanges on which securities are traded, and
organized, financed, and constructed under the the need for regulation to prevent fraud and to
New York State Private Housing Finance Law, protect the interest of investors. Because
commonly known as the Mitchell-Lama Act, securities transactions are economic in
enacted to ameliorate a perceived crisis in the character, Congress intended the application of
availability of decent low income urban housing. these statutes to turn on the economic realities
In order to encourage private developers to build underlying a transaction, and not on the name
low-cost cooperative housing, New York provides appended thereto. Thus, in construing these
them with large long-term, low interest mortgage Acts against the background of their purpose,
loans and substantial tax exemptions. Receipt of we are guided by a traditional canon of statutory
such benefits is conditioned on a willingness to construction:
have the State review virtually every step in the
development of the cooperative. "[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, LANDRETH TIMBER CO VS LANDRETH
nor could they, that they were misled by use of
the word "stock" into believing that the federal Respondents father and sons, who owned all of
securities laws governed their purchase. the common stock of a lumber business that they
Common sense suggests that people who intend operated, offered their stock for sale through
to acquire only a residential apartment in a state- brokers. The company's sawmill was
subsidized cooperative, for their personal use, subsequently damaged by fire, but potential
are not likely to believe that, in reality they are purchasers were told that the mill would be rebuilt
purchasing investment securities simply because and modernized. Thereafter, a stock purchase
the transaction is evidenced by something called agreement for all of the stock was executed, and
a share of stock. These shares have none of the ultimately petitioner company was formed by the
characteristics "that, in our commercial world fall purchasers. Respondent father agreed to stay on
within the ordinary concept of a security." as a consultant for some time to help with the
H.R.Rep. No. 85, supra, at 11. Despite their daily operations of the mill. After the acquisition
name, they lack what the Court was completed, the mill did not live up to the
in Tcherepnin deemed the most common feature purchasers' expectations. Eventually, petitioner
of stock: the right to receive "dividends contingent sold the mill at a loss and went into receivership.
upon an apportionment of profits." 389 U.S. Petitioner then filed suit in Federal District Court
at 389 U. S. 339. Nor do they possess the other for rescission of the sale of stock and damages,
characteristics traditionally associated with stock: alleging that respondents had violated the
they are not negotiable; they cannot be pledged registration provisions of the Securities Act of
or hypothecated; they confer no voting rights in 1933 (1933 Act) and the antifraud provisions of
proportion to the number of shares owned; and the Securities Exchange Act of 1934 (1934 Act).
they cannot appreciate in value. In short, the The court granted summary judgment for
inducement to purchase was solely to acquire respondents, holding that, under the "sale of
subsidized low-cost living space; it was not to business" doctrine, the stock could not be
invest for profit. 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 distinguishable from most if not all of the other
possesses all of the traditional characteristics of categories listed in the Acts' definition.
stock, a court is not required to look to the
economic substance of the transaction to Instruments that bear both the name and all of the
determine whether the stock is a "security" within usual characteristics of stock seem to us to be the
the meaning of the Acts. A contrary rule is not clearest case for coverage by the plain language
supported by this Court's prior decisions involving of the definition. First, traditional stock
unusual instruments not easily characterized as "represents to many people, both trained and
"securities." Nor were the Acts intended, as untrained in business matters, the paradigm of a
asserted by respondents, to cover only "passive security." Daily v. Morgan, supra, at 500. Thus
investors," and not privately negotiated persons trading in traditional stock likely have a
transactions involving the transfer of control to high expectation that their activities are governed
"entrepreneurs." by the Acts. Second, as we made clear
in Forman, "stock" is relatively easy to identify
(c) An instrument bearing both the name and all because it lends itself to consistent
of the usual characteristics of stock presents the definition. See supra, at 471 U. S. 686. Unlike
clearest case for coverage by the plain language some instruments, therefore, traditional stock is
of the definition. "Stock" is distinguishable from more susceptible of a plain meaning approach.
most if not all of the other listed categories, and
may be viewed as being in a category by itself for Professor Loss has agreed that stock is different
purposes of interpreting the Acts' definition of from the other categories of instruments. He
"security." observes that it "goes against the grain" to apply
the Howey test for determining whether an
(d) Application of the "sale of business" doctrine instrument is an "investment contract" to
depends on whether control has passed to the traditional stock. L. Loss, Fundamentals of
purchaser. Even though the transfer of 100% of a Securities Regulation 211-212 (1983). As
corporation's stock normally transfers control, the Professor Loss explains:
purchasers here had no intention of running the
sawmill themselves. Moreover, if the doctrine "It is one thing to say that the typical cooperative
were applied here, it would also have to be apartment dweller has bought a home, not a
applied to cases in which less than 100% of a security; or that not every installment purchase
company's stock was sold, thus inevitably leading 'note' is a security; or that a person who charges
to difficult questions of line-drawing. As explained a restaurant meal by signing his credit card slip is
in Gould v. Ruefenacht, post, p. 471 U. S. 701, not selling a security, even though his signature
coverage by the Acts would in most cases be is an 'evidence of indebtedness.'
unknown and unknowable to the parties at the But stock (except for the residential wrinkle) is so
time the stock was sold. Such uncertainties quintessentially a security as to foreclose further
attending the applicability of the Acts would be analysis."
intolerable.
In sum, we conclude that the stock at issue here
This case presents the question whether the sale is a "security" within the definition of the Acts,
of all of the stock of a company is a securities and that the sale of business doctrine does not
transaction subject to the antifraud provisions of apply. The judgment of the United States Court
the federal securities laws (the Acts). of Appeals for the Ninth Circuit is therefore
Reversed.
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
PEOPLE OF THE PHILIPPINES, plaintiff- the same time, why it must fail in the long run.
appellee, vs. PRISCILLA BALASA, NORMITA This game is diJcult to sustain over a long period
VISAYA, GUILLERMO FRANCISCO, NORMA of time because to continue paying the promised
FRANCISCO and ANALINA FRANCISCO, pro@ts to early investors, the operator needs an
accused ever larger pool of later investors. The idea
behind this type of swindle is that the "con-man"
COMMITTED WHEN THE APPELLANTS collects his money from his second or third round
OFFERED THE PUBLIC. AN INVESTMENT of investors and then absconds before anyone
PROGRAM CALLED "PONZI SCHEME"; CASE else shows up to collect. Necessarily, these
AT BAR. — The testimonial evidence presented schemes only last weeks, or months at most.
by the prosecution proves that appellants
employed fraud and deceit upon gullible people CONSPIRACY; PRESENT WHEN THROUGH
to convince them to invest in the foundation. It has ACTIVE COOPERATION, APPELLANTS
been held that where one states that the future SHOWED A COMMUNITY OF DESIGN WITH
profits or income of an enterprise shall be a THE INCORPORATORS OF THE
certain sum, but he actually knows that there will FOUNDATION. — The evidence adduced by the
be none, or that they will be substantially less prosecution con@rms the existence of a
than he presents, the statement constitutes conspiracy among the appellants in committing
actionable fraud where the hearer believes him the crime charged. The fact that Guillermo
and relies on the statement to his injury. That Francisco was not an incorporator of the
there was no profit forthcoming can be clearly foundation does not make him any less liable for
deduced from the fact that the foundation was not the crime charged. By his own admission, he
engaged nor authorized to engage in any participated in the foundation's activities by
lucrative business to finance its operation. It was serving as its paymaster. Because he is father
not shown that it was the recipient of donations or and husband to three of the organizers of the
bequest with which to finance its "double or triple foundation, it is not farfetched to presume that he
your money" scheme, nor did it have any was aware of its operations. By his active
operating capital to speak of when it started cooperation, he showed a community of design
operations. Parenthetically, what appellants with the incorporators of the foundation, thereby
offered the public was a "Ponzi scheme," an making him a co-conspirator and equally liable for
investment program that offers impossibly high the crime charged. His voluntary and
returns and pays returns to early investors out of indispensable cooperation was a concatenation
the capital contributed by later investors. Named of the criminal acts performed by his co-accused.
after Charles Ponzi who promoted the scheme in In this regard, appellant Guillermo Francisco is
the 1920s, the original scheme involved the not being implicated as a co-conspirator solely
issuance of bonds which offered 50% interest in because he is the father of the principal
45 days or a 100% profit if held for 90 days. proponent of the Ponzi scheme. He is held liable
Basically, Ponzi used the money he received as a conspirator because indispensable act of
from later investors to pay extravagant rates of being the paymaster of the foundation. Likewise,
return to early investors, thereby inducing more Norma Francisco's bare denial cannot exempt
investors to place their money with him in the her from complicity. Aside from being the cashier,
false hope of realizing this same extravagant rate Norma Francisco was also an incorporator of the
of return themselves. This was the very same foundation. Likewise, the money invested in the
scheme practiced by the Panata Foundation. foundation was deposited in joint bank accounts
However, the Ponzi scheme works only as long in Priscilla Balasa's name and hers. Norma
as there is an everincreasing number of new Francisco's activities would thus show a
investors joining the scheme. To pay off the 50% community of design with the other accused
bonds Ponzi had to come up with a one-and-a- making her a co-conspirator and equally liable for
half times increase with each round. To pay 100% the crime charged. Her voluntary and
pro@t he had to double the number of investors indispensable cooperation concurred with the
at each stage, and this is the reason why a Ponzi criminal acts performed by her co-accused.
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