King Commodity Co. of Texas, Inc. v. State

• Court: Texas Civil Court of Appeals
• Writing for the Court: GUITTARD
• Citation: King Commodity Co. of Texas, Inc. v. State, 508 S.W.2d 439 (Tex. Ct. App. 1974)
• Decision Date: 07 March 1974
• Docket Number: No. 18291,18291
• Parties: Blue Sky L. Rep. P 71,121 KING COMMODITY COMPANY OF TEXAS, INC., Appellant, v. The STATE of Texas, Appellee.

Page 439

508 S.W.2d 439

Blue Sky L. Rep. P 71,121

KING COMMODITY COMPANY OF TEXAS, INC., Appellant, v. The STATE of Texas, Appellee.

No. 18291.

Court of Civil Appeals of Texas Dallas.

March 7, 1974.

Rehearing Denied April 4, 1974.

Mark W. Perrin, Houston, for appellant.

John L. Hill, Atty. Gen. for the State of Texas, Bill Flanary, Asst. Atty. Gen., Austin, for appellee.

GUITTARD, Justice.

On this interlocutory appeal our questions are whether 'commodity options' are 'securities' subject to registration under the Texas Securities Act and whether a district court of a county other than that in which a corporation subject to the Texas Business Corporations Act has its registered office may appoint a receiver for the assets and business of the corporation.

The appeal comes from one of the district courts of Dallas County, which granted a temporary injunction restraining King Commodity Company of Texas, Inc., and its officers and employees from selling 'commodity options' without first obtaining the registration and licenses required by the Texas Securities Act, Tex.Rev.Civ.Stat.Ann. arts, 581--7 and 581--12 (Vernon 1964). The court also found that defendant corporation, which had its registered office in Harris County, was in imminent danger of insolvency and appointed a temporary receiver to take over all its records and assets. We agree with the trial court that the options were 'securities' subject to registration, but we hold that the district court of Dallas County had no authority to appoint a receiver for the corporation.

I. SECURITIES SUBJECT TO REGISTRATION

'Securities' are defined in the Texas Securities Act, Tex.Rev.Civ.Stat.Ann. art. 581--4(A), as follows:

The term 'security' or 'securities' shall include any share, stock . . . note, bond, debenture, mortgage certificate or other Evidence of indebtedness . . . or any certificate or instrument representing or secured by an interest in any or all of the capital, property, assets, profits or earnings of any company, Investment contract, or any other instrument commonly known as a security, whether similar to those herein referred to or not. (Emphasis added.)

The State contends that the 'commodity options' sold by defendants are both 'evidence(s) of indebtedness' and 'investment contract(s)' within this definition. We agree.

(1) 'Investment contract'

The term 'investment contract' appears to have been taken from § 2(1) of the Federal Securities Act of 1933, 15 U.S.C. § 77b(1) (1971). This term was construed by the Supreme Court of the United States in Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244, 163 A.L.R. 1043 (1946) as follows:

The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

This test was accepted for the same term in the Texas Securities Act in Koscot Interplanetary, Inc. v. King, 452 S.W.2d 531 (Tex.Civ.App.--Austin 1970, writ ref'd n.r.e.).

Defendants concede that the options in question involved investment of money with an expectation of profit, but deny that they involved a 'common enterprise' or that the profits would result 'solely from the efforts of others.' They rely on authorities holding that commodities futures contracts are not 'investment contracts,' ¹ and argue that if commodity futures contracts are not 'securities,' then options to purchase them cannot be 'securities.' This argument ignores an important distinction. A speculator in commodity futures risks his own money, and his only source of profit is the commodity market itself. The evidence here shows that on purchase of a 'commodity option,' the customer's money is not placed at risk beyond a relatively small 'premium' of between two and one-half and eight percent of the value of the commodity. The source of profit is not solely the commodity market, but also the trading operations of the option dealer, who must use funds other than those of the individual customer.

This conclusion is supported by the advertising literature which King distributed to its customers. We take this literature as defining the nature of the transaction because the alleged 'securities' offered may be judged as being what they were represented to be. Securities and Exchange Commission v. C. M. Joiner Leasing Corp., 320 U.S. 344, 353, 64 S.Ct. 120, 88 L.Ed. 88 (1943). Among this literature is a brochure characterizing 'commodity options' as 'an investment technique that combines aspects of conservatism, speculation and leverage,' and explaining:

The amount of capital at risk in purchasing an option is limited to the cost of premium paid for the option. The investor can never lose more than the amount of his premium. . . . The potential profit on a commodity option is unlimited--a return of several 100% In as short a period as 30 days is not impossible. . . . By purchasing an option, a given position can be retained in any market without margin calls of any kind, even if the price of the commodity should fluctuate widely.

The brochure goes on to describe a 'double option program' as 'an investment program designed to make use of the tremendous leverage and volatility of the Commodity Futures Market, while limiting the risk and with no margin calls or forced liquidation.' A 'call option' is defined in the brochure as 'the right to buy a future contract at a guaranteed price on or before a specified date.' A 'put option' is defined as 'the right to sell a future contract at a guaranteed price on or before a specified date.'

The brochure further explains:

A DOUBLE OPTION is a PUT and CALL purchased back to back for the same contract, or in other words a straddle. Because you will have both a PUT and CALL it does not matter whether the market moves up or down, just so it moves away from the striking price. (The price at which you buy in.) To avoid a loss, the market must move up or down enough to cover the cost of the premium. Further movement in the same direction produces a profit.

When the price of the world commodity has moved enough to return a PREDETERMINED NET PROFIT, you exercise the DOUBLE OPTION (selling both the PUT and the CALL back to King Commodity Company) take your profit and reinvest in a New DOUBLE OPTION with a new striking price.

Also in evidence is a printed document entitled 'Investor's Guaranty Corporation Commodity Option Operating Rules and Procedures.' Defendants admit that 'Investor's Guaranty Corporation' was only an assumed name for King Commodity Company of Texas, Inc. This document describes the market operations as follows:

Investors Guaranty Corporation, through its membership with the West Coast Commodity Exchange and other affiliated exchanges, takes a position on the open futures market for all options sold; by they puts, calls, or double options. These options are thus hedged with the movement of the futures market.

For example, if the market is on the downtrend, a short position is established; if the market is in an uptrend, a long position is established. This position may be changed from time to time as the movement of the market dictates, but all options remain fully hedged.

In the advertising material King is represented to be a 'member West Coast Commodity Exchange' and 'world commodity specialists.' Its president, C. Lee Harshfield, who is one of the defendants here, is designated 'chief administrator,' and is represented to have 'over 20 years experience in all phases of administration and management.'

The conclusion that King used other money in its trading operations is supported also by testimony at the hearing. Don Thompson, who was formerly employed by King as a salesman, testified that he told his clients that their positions were being protected on the futures market by hedging on the West Coast Commodity Exchange. In other words, he said, if a person bought a 'call option,' the company would take a long position in the futures market and would hold that position until the option was exercised. Thompson further explained that in the case of a 'call option,' the hedger would buy a contract on the futures market and in the case of a 'put' he would sell the contract. In case of a 'double option,' the hedger would wait until the market 'penetrated' one way or the other and then would take a position. If the market continued to go up, the option dealer would be able to take enough money out of the futures market plus a portion of the premium to pay off the customer. If the market reversed the 'striking price' several times, the dealer would have to lift the hedge several times, and eventually the option money would be eaten up, so that the dealer would be predicating his profit on the fact that the market would not move through the 'striking price' more than a few times.

It is a reasonable inference from this evidence that the money necessary to hedge each option could only come from pooling of the premiums paid by other customers and that if King's use of this money in its trading operations was not profitable, no funds would be available to pay the customers their profits. Thus the trial court would have been justified in finding, and we presume that it did find, that the evidence establishes a 'common enterprise' within the Howey test.

Defendants also deny that the profits would come 'solely from the efforts of others' within the Howey test. As we have already explained, the profits were apparently generated by King's management of funds other than the premium advanced by the individual customer. Whether absolute nonparticipation of the investor is an essential element of an 'investment contract' is doubtful in light of such decisions as Securities and Exchange Commission v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir. 1973) and State Commissioner of Securities v. Hawaii Market Center, Inc., 52 Haw. 642, 485 P.2d 105, 108 (1971). In the present case the...