Cohen v. William Goldberg & Co., Inc.

• Decision Date: 01 December 1992
• Docket Number: No. S92G0381,S92G0381
• Citation: 262 Ga. 606,423 S.E.2d 231
• Parties: , Blue Sky L. Rep. P 73,681, 61 USLW 2436, Fed. Sec. L. Rep. P 97,446 COHEN v. WILLIAM GOLDBERG & COMPANY, INC. et al.
• Court: Georgia Supreme Court

Page 231

423 S.E.2d 231

262 Ga. 606, Blue Sky L. Rep. P 73,681,

61 USLW 2436,

Fed. Sec. L. Rep. P 97,446

COHEN v. WILLIAM GOLDBERG & COMPANY, INC. et al.

No. S92G0381.

Supreme Court of Georgia.

Dec. 1, 1992.

Reconsideration Denied Dec. 17, 1992.

Frank Love, Jr., William G. Leonard, James D. Meadows, Powell, Goldstein, Frazier & Murphy, Atlanta, for Cohen.

Irwin W. Stolz, Jr., Gambrell, Clarke, Anderson & Stolz, Andrew R. Kirschner, Bedford, Kirschner & Venker, P.C., Atlanta, for William Goldberg & Co., Inc. et al.

Michael J. Bowers, Atty. Gen., Beverly B. Martin, David I. Adelman, Asst. Attys. Gen., Dept. of Law, Atlanta, for amicus appellant.

BELL, Presiding Justice.

This case involves the determination whether certain stock of a closely-held corporation qualifies as a "security" for purposes of the Georgia Securities Act of 1973, OCGA Title 10, Ch. 5, and the federal securities acts. The trial court granted cross-motions for partial summary judgment against all claims stemming from alleged violations of the state and federal securities laws. The Court of Appeals affirmed, holding that the stock neither met the state or federal statutory definition of a security, Cohen v. William Goldberg & Company, Inc., 202 Ga.App. 172, 179(5), 413 S.E.2d 759 (1991), nor qualified as a security under the "economic reality" test, id. at 179-80, 413 S.E.2d 759. We granted certiorari, and for the following reasons we hold that the stock meets the statutory definitions of a security.

1. The initial question for our consideration is the appropriate test for determining whether the stock is a security. In Tech Resources v. Estate of Hubbard, 246 Ga. 583, 272 S.E.2d 314 (1980), this Court applied the federal "economic reality" test that had been outlined in SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). The economic reality test is that "[i]n order for a transaction to constitute a securities transaction under the law, there must be an investment, a reasonable expectation of profits, and a reliance on the management of another party to bring about the profits." Tech Resources, supra, 246 Ga. at 585, 272 S.E.2d 314. The United States Supreme Court, however, subsequently explained that the economic reality test was not the threshold test for deciding whether stock is a security. Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985). In Landreth Timber the Supreme Court applied a "stock characterization" test as the initial inquiry to determine whether the stock in question there should be treated as "securities":

It is axiomatic that "[t]he starting point in every case involving construction of a statute is the language itself." [Cits.] ... The face of the [federal statutory] definition shows that "stock" is considered to be a "security" within the meaning of the [federal securities] Acts.... [M]ost instruments bearing such a traditional title are likely to be covered by the definition. [Cit.]

[But] the fact that instruments bear the label "stock" is not of itself sufficient to invoke the coverage of the Acts. Rather, ... we must also determine whether those instruments possess "some of the significant characteristics typically associated with" stock, [cit.], recognizing that when an instrument is both called "stock" and bears stock's usual characteristics, "a purchaser justifiably [may] assume that the federal securities laws apply," [cit.]. [Those] characteristics usually associated with common stock [are] (i) the right to receive dividends contingent upon an apportionment of profits; (ii) negotiability; (iii) the ability to be pledged or hypothecated; (iv) the conferring of voting rights in proportion to the number of shares owned; and (v) the capacity to appreciate in value. [Cit.] [Landreth Timber, supra, 471 U.S. at 685-86, 105 S.Ct. at 2301-02.]

Having set forth the stock characterization test, the Supreme Court then addressed the argument that it was necessary in every instance to "look beyond the label 'stock' and the characteristics of the instruments involved to determine whether application of the [federal] Acts is mandated by the economic substance of the transaction." Id. at 688, 105 S.Ct. at 2303. The Court rejected that argument, distinguishing prior cases such as Howey supra, 328 U.S. 293, 66 S.Ct. 1100, and United Housing Foundation v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975), as having

involved unusual instruments not easily characterized as "securities." [Cit.] Thus, if the [federal] Acts were to apply in those cases at all, it would have to have been because the economic reality underlying the transactions indicated that the instruments were actually of a type that falls within the usual concept of a security. In the case at bar, in contrast, the instrument involved is traditional stock, plainly within the statutory definition. There is no need here, as there was in the prior cases, to look beyond the characteristics of the instrument to determine whether the Acts apply, [Landreth Timber, 471 U.S. at 690, 105 S.Ct. at 2304 (emphasis supplied) ].

The application of Landreth Timber to Georgia law was first considered by the Court of Appeals in Henderson v. KMSystems, Inc., 188 Ga.App. 893, 896-97(2), 374 S.E.2d 550 (1988). We now adopt the Court of Appeals' two findings therein concerning the appropriate integration of Landreth Timber with Tech Resources, supra, 246 Ga., 272 S.E.2d 314. The first of those findings was that

Landreth Timber provides appropriate guidance in resolving issues of whether particular "stock" is a "security" under the amended Georgia Securities Act of 1973. In applying the Landreth stock-characterization test to ... transaction[s] ..., we will use a balancing test. The appropriate test to be employed is whether the ... stock bears such characteristics usually associated with common stock that a purchaser justifiably may assume that appropriate security laws apply. [Henderson at 897, 374 S.E.2d 550.]

The second finding by the Court of Appeals which we adopt is that if (and, we emphasize, only if, ) the stock does "not meet the statutory definition of 'stock' under either the Georgia or federal securities act," id., the next inquiry should be

whether [the] stock otherwise qualifies as a security within the meaning of OCGA § 10-5-2(16). The test appropriate for this determination is the Howey economic reality test, as that test has been tailored by Tech Resources [, supra, 246 Ga. 583, 272 S.E.2d 314,] for application under the Georgia Securities Act, to resolve issues concerning "investment contracts" and any "instrument commonly known as a 'security.' " [Henderson, supra, 188 Ga.App. at 897-98, 374 S.E.2d 550.]

2. We begin our analysis of the present case by applying the stock characterization test to the facts in order to determine whether the stock is a "security." In Henderson itself, the Court of Appeals found that the stock at issue (referred to as "the KMS stock") was not classifiable as "stock" for purposes of the state and federal securities laws because it did not have the characteristics of "negotiability" and "the ability to be pledged or hypothecated" which were specified in Landreth Timber, and also because the stock was unregistered:

We find that the characteristics of the KMS stock do not justifiably give rise to [the] assumption [that the appropriate security laws apply.] Particularly, the KMS stock contained a conspicuous notice that substantially impaired both the negotiability of the stock and its ability in the real world of business to be pledged or hypothecated effectively, and also expressly negated any assumption that the securities had been registered under either the Georgia or federal securities act. Accordingly, we find that the KMS stock does not meet the statutory definition of "stock" under either the Georgia or federal securities act. [Henderson, supra, 188 Ga.App. at 897, 374 S.E.2d 550.]

In this case the Court of Appeals again applied the stock characterization test, and reached the conclusion that the stock in question does not meet the statutory definition of "security." And, as in Henderson, the Court of Appeals reached that conclusion because of restrictions on negotiability and lack of registration:

Substantially similar to the situation in Henderson, the parties sub judice signed a shareholders' agreement which provided in pertinent part that each certificate would contain a notice stating (1) that the stock was subject to the conditions in the shareholders' agreement (such as restrictions on transfer without WGC's [the corporation issuing the stock] prior written...