SECURITIES AND EXCHANGE COM'N v. Continental Com. Corp.

Citation497 F.2d 516
Decision Date17 July 1974
Docket NumberNo. 73-2429.,73-2429.
PartiesSECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. CONTINENTAL COMMODITIES CORPORATION et al., Defendants-Appellees.
CourtU.S. Court of Appeals — Fifth Circuit

Wayne M. Whitaker, Robert F. Watson, S. E. C., Ft. Worth, Tex., Thomas Taylor, Richard E. Nathan, Gen. Counsel, S. E. C., Washington, D. C., for plaintiff-appellant.

Sam N. Vilches, Jr., Fletcher Yarbrough, Martin Frost, Temporary Receivers, Dallas, Tex., for defendants-appellees.

Before RIVES, GEWIN and RONEY, Circuit Judges.

GEWIN, Circuit Judge:

This appeal is taken from a district court order denying a preliminary injunction sought by the Securities and Exchange Commission (SEC) against Continental Commodities Corporation (Continental Commodities), Charles Long, and Continental Commodities Trading Company.1 The complaint filed by the SEC sought to enjoin Continental Commodities from committing alleged violations of various registration provisions of the Securities Act of 1933, 15 U.S.C. §§ 77e(a), 77e(c), and 77q(a) (1970),2 and of the anti-fraud provisions of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970) and Rule 10b-5 thereunder, 17 CFR § 240.10b-5 (1973),3 and petitioned for the appointment of a receiver of all assets and property belonging to or in its possession. The district court deemed jurisdiction of the subject matter to be lacking, reasoning that none of the transactions engaged in by Continental Commodities involved a security within the meaning of the two aforementioned Acts. In view of our disagreement with this conclusion, we reverse and remand for consideration by the district court of the propriety of granting the relief requested by the SEC.4

I

According to the verified complaint, Continental Commodities, a Texas corporation incorporated in November of 1972, Charles Long, its President, and Continental Commodities Trading Company, a partnership formed in California by Long in mid-January 1973, offered to sell and sold to public investors interests denominated options on commodities futures contracts.5 Headquartered at a Los Angeles office in which all options were written, the trading enterprise was a member firm of the West Coast Commodity Exchange and hence subject to rulings of the California Commissioner of Corporations. On February 22, 1973, the Commissioner issued notice that the West Coast Commodities Exchange had classified all commodity options as securities and suspended trading in these options pending their registration as such. Compliance with this ruling dictated that Continental Commodities and Continental Commodities Trading Company cancel each option that they had underwritten and take steps to mollify their disappointed customers. Since from its inception until February 22, 1973, the Dallas office had attracted approximately 80 customers with 40 open accounts and the Los Angeles office had attracted approximately 40 customers with 20 open accounts, the appeasement efforts required of Continental Commodities were substantial. The failure of these efforts left disgruntled customers whose affidavits appear in the abbreviated record.

The complaint filed by the SEC asserted that jurisdiction could be grounded upon one of two bases. The first base was the trading enterprise itself, the second, promissory notes issued as partial reimbursement to customers who held open accounts with Continental Commodities at the time trading was suspended.

The trading enterprise extended the opportunity to invest in commodities futures contracts. Continental Commodities undertook to recommend certain commodities futures contracts to its customers. An interested customer would first be issued an option, guaranteeing him the right to purchase the contract at a stated price, with the option to remain open for a specified period of time. Continental Commodities neither owned the underlying futures contract nor escrowed any portion of the customer payments for the purpose of acquiring such contracts. In addition, Continental Commodities undertook to advise a customer of the most opportune moment either to sell or to exercise the option. Finally, it also offered investment counseling as to the most propitious time to sell a specific futures contract.

The complaint alleged that several fraudulent acts were committed in connection with the discretionary trading accounts and particular options on futures contracts. Among these were that Continental Commodities misrepresented the lucrativeness of trading in commodities futures and the amount of reserve it had on deposit in a bank to cover for the money invested in such futures, and in specific instances of counseling as to when to exercise options, that it misrepresented the then current market price of the underlying commodity futures contract.6

The second potential base for finding subject matter jurisdiction was that, upon receiving notification that trading on options was suspended, Continental Commodities issued promissory notes to some of its customers as partial reimbursement. Although the record is somewhat obscure as to the precise number of recipients and the maturity date of the notes, it would appear that the notes were ostensibly non-interest bearing, with a maturity date of less than 9 months, and were issued to more than a nominal number of customers.

The complaint, as amplified by verified affidavits before the district court, alleges that the notes represented 40% of the amount of money owed to a customer, and that before issuing them, Continental Commodities exacted a promise of forbearance from legal action if payments were made as promised. Charles Long is alleged to have informed customers that the SEC had frozen his accounts, valued at $3,000,000 and thereby precluded him from paying off the debts owed by Continental Commodities, and to have indicated that the SEC would permit the company to remain in business if it would return 60% of the investors' original investments immediately and give promissory notes for the balance. Moreover, the record contains a letter written by Charles Long to a customer expressing Long's hope that Continental Commodities would square its accounts, register its options, and resume trading again. This letter tends to belie Long's testimony that there was "no way" Continental Commodities could stay in business, and is buttressed by an affidavit submitted by an SEC attorney to the effect that Long had issued the notes in order to leave himself with enough cash to sue the West Coast Commodities Exchange and possibly register options should it become necessary.

Having recounted the facts which spawned this litigation and which were before the district court in its ruling on the SEC's motion for a preliminary injunction, it is critical to take cognizance of the procedural labyrinth traversed by the parties below and on appeal. As we noted earlier, the complaint filed by the SEC posited two theoretical bases for subject matter jurisdiction — that both the scheme for trading on discretionary accounts and the notes issued were securities. The latter argument was somewhat ill-framed, and hence in its April 9, 1973 order denying the motion for a preliminary injunction, the district court merely addressed and rejected the SEC's contention that the scheme of trading on discretionary accounts amounted to an investment contract. Subsequently, the SEC sought a rehearing due to the failure of the court to consider the contention that the notes were securities within the definitions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The district court disposed of this motion on May 3, 1973, ruling that the notes issued by Continental Commodities were not subject to the abuses sought to be curbed by the Acts and hence did not fall within their ambit.

On appeal, the SEC seeks to preserve only its contention that the notes were securities. In its brief, the SEC informs us that assuming a favorable ruling on appeal, it will move for a permanent injunction and may then resurrect the investment contract theory.7 We are, however, reluctant to condone the use of tactical legerdemain when such is designed to bridle an appellate court in its resolution of a case. The issue of whether trading on discretionary accounts amounts to an investment contract was vigorously contested below and was addressed at some length by the district court. Its disposition rested essentially on its perception of the legal contours of the definition of investment contract, and one of the prerequisites subsumed within it — the requirement of a common enterprise. Thus, while not impervious to the hazards of deciding a case on a basis not contested on appeal, we think that this case is particularly appropriate for such an approach.8 Accordingly, we address both the investment contract and note issues.

II

As we noted earlier, the district court rejected the SEC's contention that the trading in discretionary commodities accounts engaged in by Continental Commodities fell within the ambit of the term security,9 as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934. The definitional sections of the two Acts, which are substantially identical, Tcherepnin v. Knight, 389 U.S. 332, 335-336, 88 S.Ct. 548, 552-553, 19 L.Ed.2d 564, 569 (1967), stipulate that the term security includes an investment contract. See 15 U.S.C. § 77b(1) and 15 U.S.C. § 78c(a) (10). The district court correctly concluded that SEC v. W. J. Howey Co., 328 U.S. 293, 298-299, 66 S.Ct. 1100, 1102-1103, 90 L.Ed. 1244, 1249 (1946) expresses the controlling standard for determining whether an investment contract exists. There, the Court stated that:

"An investment contract for purposes of the Securities Act means 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 a third party. . .
...

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