Shaw v. Hiawatha, Inc., 88-6001

Decision Date25 August 1989
Docket NumberNo. 88-6001,88-6001
Citation884 F.2d 582
PartiesUnpublished Disposition NOTICE: Ninth Circuit Rule 36-3 provides that dispositions other than opinions or orders designated for publication are not precedential and should not be cited except when relevant under the doctrines of law of the case, res judicata, or collateral estoppel. Robert SHAW and Velda Shaw, Plaintiffs-Appellants, v. HIAWATHA, INC., Patrick J. Hall, Douglas Jones, Gene Hill, Dennis Roberts A.K.A. Douglas Campbell A.K.A. Dennis Murphy, Michael Ellis, N & N Locators, and Thomas J. Kuebler, Defendants-Appellees.
CourtU.S. Court of Appeals — Ninth Circuit

Before FLETCHER, PREGERSON and LEAVY, Circuit Judges.

MEMORANDUM *

Plaintiffs Robert and Velda Shaw appeal the district court's order dismissing for lack of subject matter jurisdiction their complaint for securities fraud and related state law claims. The district court concluded that the agreement between the Shaws and the defendant, Hiawatha, is not a "security" as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934. We reverse and remand.

I. FACTS

Robert and Velda Shaw responded to a Nov. 1, 1986 advertisement in the San Diego Union newspaper, inviting them to "SHARE THE WEALTH OF THE LOTTERY CRAZE...." Calling the number listed in the advertisement, the Shaws arranged a meeting with Patrick J. Hall, Executive Vice President of Hiawatha, Inc. Hall informed the Shaws that Hiawatha manufactured and sold the "Odds Maker," a machine designed to provide lottery ticket purchasers with a series of numbers to use on California State Lottery tickets. Hall stated that operators of the machines faced no meaningful competition, and that if the Shaws purchased the machines, they could recover their initial investment within one year.

Hall also said that Hiawatha makes money from ongoing ticket sales, and that it and the Shaws "would be in business together." Hall represented that Hiawatha would obtain the right to locate in all "7-11" convenience stores where lottery tickets are sold, and that Hiawatha would provide a "locator" who would find suitable locations for the Shaws' "Odds Maker" machines.

The next day, the Shaws met with Douglas Jones, another representative of Hiawatha, who reaffirmed many of the points made by Hall. Jones, who stated that he was in charge of Hiawatha's California operations, also represented that Hiawatha would have the Shaws in business within three weeks of full payment on the machines. On that date, the Shaws signed an "Intent and Commitment Agreement," and paid $5,000 to Hiawatha.

On Nov. 11, while visiting Hall at Hiawatha's Indiana offices, the Shaws expressed concern that parts of their prospective territory had high crime rates. Because of these fears, they demanded a right to approve expressly the locations selected for each machine. This discussion led to an "Addendum" to the contract providing in relevant part:

Hiawatha guarantees to Shaw [that] approved locations will be provided for each and every dispensing machine purchased by Shaw. In the event such location cannot be furnished, Hiawatha shall repurchase the machine and related equipment.

On Nov. 12, the Shaws paid an additional $27,250, and were again assured that Hiawatha would provide a "locator" to secure acceptable locations and install the machines. The locator's cost would be $50.00 per machine, or $5,000. On Nov. 24, the Shaws paid another $32,250 to Hiawatha.

Thomas J. Kuebler telephoned the Shaws on Dec. 1, 1986, and informed them that he was their assigned locator. After some negotiations, the Shaws advanced Kuebler $2,500 of the locator's fee. By March 16, 1987, Kuebler had secured locations for only 48 of the 100 machines, and had installed only 25, many in locations which had not been approved by the Shaws. On June 1, 1987, the Shaws filed this action, seeking a return of their $67,000 investment.

The Shaws' complaint contained four causes of action for alleged violations of federal securities laws, as well as several pendent state law claims. They alleged that Hiawatha made a number of material misrepresentations, including: (1) there was no competition to the machines, (2) the Shaws could recover their investment within one year; (3) Hiawatha had the right to locate in all "7-11" stores; (4) the Shaws would be in business within three weeks of purchase; (5) a locator would find suitable locations for all the machines; and (6) Hiawatha would refund the purchase price of the machines if suitable locations were not provided.

Defendants filed a motion to dismiss for lack of subject matter jurisdiction and improper venue. On March 22, 1988, the district court granted defendants' motion for lack of subject matter jurisdiction, finding that the contract was not an "investment contract," and therefore not a security, within the meaning of the federal securities laws. Because no other basis for federal jurisdiction was alleged, the entire complaint was dismissed. Because the district court implicitly found that no possible amendment would cure the perceived deficiency in the complaint, its order is final and appealable for purposes of 28 U.S.C. Sec. 1291. See Ginter v. State Bar of Nevada, 625 F.2d 829, 830 (9th Cir.1980); Smith v. Gross, 604 F.2d 639, 641 (9th Cir.1979).

II. STANDARD OF REVIEW

The district court treated defendants' motion as one for dismissal for lack of subject matter jurisdiction under Fed.R.Civ.P. 12(b)(1). We have held, however, that dismissal of similar actions on the basis that the transaction at issue is not a "security" under the federal securities laws relates to the merits of the claim, and is therefore a judgment based on failure to state a claim rather than on lack of subject matter jurisdiction. Mason v. Unkeless, 618 F.2d 597, 598-99 (9th Cir.1980); Smith v. Gross, 604 F.2d at 641; Black v. Payne, 591 F.2d 83, 86 n. 1 (9th Cir.), cert. denied, 444 U.S. 867 (1979).

                See also Jackson Transit Authority v. Local Div. 1285, Amalgamated Transit Union, 457 U.S. 15, 21 n. 6 (1982);  Bell v. Hood, 327 U.S. 678 (1946). 1   This distinction is one of some significance.  Unlike 12(b)(6) motions, 12(b)(1) motions need not be afforded summary judgment treatment even though the court goes beyond the pleadings.  Under 12(b)(1), a court has wide discretion to allow affidavits, documents, and even a limited evidentiary hearing to resolve disputed jurisdictional facts.  We have held, however, that such jurisdictional fact finding is inappropriate where, as here, jurisdiction and merits issues are intertwined.    Sun Valley Gasoline, Inc. v. Ernst Enterprises, Inc., 711 F.2d 138, 139 (9th Cir.1983).
                

Because the district court appears to have considered matters beyond the pleadings, its order must be construed as a grant of summary judgment in favor of the defendants. Mason, 618 F.2d at 598. We review the grant of summary judgment de novo. Darring v. Kincheloe, 783 F.2d 874, 876 (9th Cir.1986). 2 To affirm, we must determine, viewing the evidence in the light most favorable to the Shaws, that the defendants have established that there are no genuine issues of material fact, and that defendants are entitled to judgment as a matter of law.

III. DISCUSSION

The Shaws may recover under the federal securities laws only if Hiawatha offered the Shaws a "security" within the meaning of section 2(1) of the Securities Act of 1933, 15 U.S.C. Sec. 77(b)(1), and section 3(a)(10) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78(c)(a)(10). These provisions, which are considered identical, Tcherepnin v. Knight, 389 U.S. 332, 335-36 (1967), define a security to include any "investment contract." In Securities & Exchange Comm'n v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946), the Supreme Court held that an investment contract consists of (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit produced solely by the efforts of others.

That the first element of the test has been met in this case is undisputed. However, the parties disagree about whether the second and third elements of the Howey test have been met.

A. Common Enterprise

The circuit courts are split over what satisfies the requirement of a common enterprise. Some require "horizontal commonality," or the pooling of assets among investors, in order to establish a common enterprise. See e.g., Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 100-101 (7th Cir.1977). The Ninth Circuit has rejected the more restrictive horizontal commonality rule in favor of a vertical commonality requirement. Vertical commonality dispenses with the pooling requirement. The vertical commonality requirement is met where the "fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment, or of third parties." Securities & Exchange Comm'n v. Glenn W. Turner Enter. Inc., 474 F.2d 476, 482 n. 7 (9th Cir.), cert. denied, 414 U.S. 821 (1973).

Viewing the evidence in the light most favorable to the Shaws, it appears that the Shaws' fortunes are dependent upon the efforts of Hiawatha in placing the machines. Unless the machines are successfully placed, the Shaws can make no money. Moreover, the Shaws maintain that the location of the machines is the principal factor affecting profitability. 3 Thus, the Shaws' financial success depends, at least in some degree, on the work and expertise of Hiawatha.

Hiawatha argues that the investors' reliance on the efforts of the promoter is insufficient to establish vertical commonality. It argues that Brodt v. Bache & Co., 595 F.2d 459 (9th Cir.1978), and similar cases establish that there must be a direct and mutual relationship between the success of the investor and success of the promoter. In other words, Hiawatha argues that the Shaws must show that Hiawatha's success depends upon the Shaws' success, a condition which it contends does not...

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