Securities Law - Recent Developments Concerning SEC v. Howey, 328 U.S. 293 (1946)

SEC v. Howey, 328 U.S. 293 (1946) is one of the most important cases interpreting the securities laws.

The Defendants offered "units of a citrus grove development coupled with a contract for cultivating, marketing and remitting the net proceeds to the investor."

The SEC sued and alleged that the Defendants had failed to register the unit offering. The Defendants responded that they were not offering securities - rather they were offering the right to engage in citrus farming.

The Supreme Court held that the units were "investment contracts" under the Securities Law. 15 U.S.C. Section 77b(a)(1). The Court defined the investment contract as "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise." Id at 299.

The Supreme Court held that the interests in the citrus farm were investment contracts because the contracts were "an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise managed and partly owned by respondents." Moreover, the purchasers were not seeking to own land. They hoped to obtain a return on their investment. As the Court noted, "all the elements of a profit-seeking business venture are present here. The investors provide capital and share in the earnings and profits; the promoters manager, control and operate the enterprise."

The holding of Howey is crucial to the operation of the Securities Laws. Without this holding, promoters could design investment contracts that would be exempted from regulation under the Act.

Recent Developments:

Two recent decisions have reaffirmed the long-standing principles set forth in Howey.

In Warfield v. Alaniz, 569 F.3d 1015 (9th Cir. 2009), the Ninth Circuit held that certain charitable gift annuities were investment contracts under the federal securities laws.

The promoter, Robert Dillie, sold charitable annuities that promised an investment return to investors during their lifetimes and gifts to charities when the passed away. The Foundation raised $55 million from investors. Unfortunately it was a Ponzi scheme and had no investments. Ultimately, the Foundation collapsed. A receiver was appointed to recover assets for the victims. The receiver filed a lawsuit seeking the return of commissions paid to agents who sold the charitable annuities. After a trial the District Court entered judgment in favor of the receiver and against the agents.

The agents appealed on the ground that the charitable annuities were not investment contract and, thus, not securities.

The Ninth Circuit rejected their arguments and affirmed the judgment. The Court held that the annuities were investment contracts because there was "(1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others."

The annuities were investments because the promoter promised a substantial return on the investment to the participants.

The second decision we will review is Liberty Property Trust v. Republic Properties Corporation, 577 F.3d 335 (D.C. Cir. 2009).

The Plaintiffs brought claims under the securities laws against the Defendant Republic that marketed certain limited partnership units.

The two main defendants controlled the defendant and, in exchange for limited partnership units, transferred a valuable contract to the limited partnership. Later, as a result of a scandal, that contract was terminated by city of West Palm beach. The limited partnership interests became worthless.

The Defendants argued that the limited partnership interests were not investment contracts because they were on both sides of the transaction (they owned the Defendant and some of the limited partnership interests.) The court held that the limited partnership interests were securities because two of the defendants "expected to profit from the efforts of [others]." The two defendants lacked sufficient control over the limited partnership, so they were clearly trying to profit from the work of other people.

In sum, the Howey decision remains good law and is as relevant today as it was in 1946.

Edward X. Clinton, Jr.