Securities Administrator v. COLLEGE ASSIST. PLAN

• Decision Date: 22 December 1981
• Docket Number: Civ. No. 80-0222A.
• Citation: 533 F. Supp. 118
• Parties: SECURITIES ADMINISTRATOR, Plaintiff-Appellant, v. The COLLEGE ASSISTANCE PLAN (GUAM) INCORPORATED, Enrique A. Sobrepena, Jr., Rose Sobrepena, and Alexander Bernales, Defendants-Appellees.
• Court: U.S. District Court — District of Guam

533 F. Supp. 118

SECURITIES ADMINISTRATOR, Plaintiff-Appellant, v. The COLLEGE ASSISTANCE PLAN (GUAM) INCORPORATED, Enrique A. Sobrepena, Jr., Rose Sobrepena, and Alexander Bernales, Defendants-Appellees.

Civ. No. 80-0222A.

District Court of Guam, Appellate Division.

December 22, 1981.

Russell Wong, Asst. Atty. Gen., Government of Guam, Agana, Guam, for plaintiff-appellant.

Paul J. Rodgers, Ferenz, Williams, Gruskin & Ashton, Agana, Guam, for defendants-appellees.

Before DUENAS, LAURETA and CONTI, District Judges.

OPINION

LAURETA, District Judge:

Plaintiff-Appellant Securities Administrator appeals the dismissal of its complaint to enjoin defendants' sale of educational funding plans. The issue is whether the plans are investment contracts subject to registration as securities under the Guam Uniform Securities Act. We conclude that they are. We reverse.

In so deciding we hold that under the Guam Uniform Securities Act an investment contract is created whenever:

1. An offeree furnishes value to an offeror; and

2. a portion of the value is subjected to the risks of the enterprise; and

3. the furnishing of the value is induced by the offeror's promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the value, will accrue to the offeree as a result of the operation of the enterprise; and

4. the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise.

I. FACTS

The College Assistance Plan of Guam (CAP) incorporated in May 1979. The individual appellees are its directors. Pursuant to purposes identified in its corporate articles, CAP offers for public sale prepaid college tuition assistance plans. It did not register the plans as securities prior to selling them.

CAP's contract scholarship plans operate as follows. After remitting a lump sum or arranging for installment payments, the purchaser designates a beneficiary under eleven years of age. Once the beneficiary begins college, the plan pays for first semester tuition and subsequent standard college fees and services. The purchaser may transfer benefits from one beneficiary to another, but may not redeem payments or resell the right to future benefits.

Under a standard CAP agreement, CAP receives the first 40% of the purchaser's payments for administrative costs. The remaining 60% becomes a "scholarship reserve" to be placed in a trust account managed solely by CAP. CAP pools all purchaser contributions into a single fund. Although CAP apparently drafted a trust agreement, it never established a trust account. Instead it opened checking and savings accounts to which only it had access.

Although only 40% of the scholarship reserve's income actually accrues to the reserve, the CAP "trustee" possesses unlimited investment power. The purchaser may not participate in investment decisions. Any income realized by the reserve results solely from CAP's investment judgment and abilities.

On February 12, 1980, appellant Securities Administrator sued to enjoin further CAP activities and to place CAP in receivership. The court below granted a temporary restraining order against CAP on the same day. On August 12, 1980, the court dismissed for failure to state a claim. It held that CAP's educational funding plans are not investment contracts. On September 2, 1980, it entered judgment on its dismissal order.

II. INVESTMENT CONTRACT TEST

The issue is whether CAP's plans are investment contracts subject to registration as securities under the Guam Uniform Securities Act.¹ The Act does not specifically define what an investment contract is.

Early securities acts included the general definitional term "investment contract" to ensure that regulatory coverage would reach unusual forms of investment. See L. Loss, Commentary on the Uniform Securities Act 106 (1976); Long, Partnership, Limited Partnership, and Joint Venture Interests as Securities 37 Mo.L.Rev. 581, 584 n.15 (1972). Courts have accordingly construed this elastic phrase broadly to effectuate the remedial purposes of securities legislation. Sales of cable television partnerships,² whiskey casks³ and warehouse receipts,⁴ rare coins,⁵ animals,⁶ and other items⁷ have been found to be investment contracts.

Three judicially developed tests articulate standards for identifying investment contracts where, as here, the applicable legislation provides no guidance. The adoption of an investment contracts test is a matter of first impression which the Court must address in order to adjudicate this appeal. The tests which the Court now reviews are the federal, risk capital, and Hawaii tests.

a. The Federal Test

Under federal securities law, an investment contract is an investment (1) in a common venture premised on (2) a reasonable expectation of profits to be (3) derived solely from the entrepreneurial or managerial efforts of others. International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 558, 99 S.Ct. 790, 796, 58 L.Ed.2d 808 (1979); United Housing Foundation Inc. v. Forman, 421 U.S. 837, 852, 95 S.Ct. 2051, 2060, 44 L.Ed.2d 621, reh. denied 423 U.S. 884, 96 S.Ct. 157, 46 L.Ed.2d 115 (1975); SEC v. W. J. Howey Co., 328 U.S. 293, 298-299, 301, 66 S.Ct. 1100, 1102-1104, 90 L.Ed. 1244, reh. denied 329 U.S. 819, 67 S.Ct. 27, 91 L.Ed. 697 (1946).

In theory the federal test focuses upon economic realities by examining the substance rather than the form of a transaction. 439 U.S. at 558, 99 S.Ct. at 796; 421 U.S. at 851-852, 95 S.Ct. at 2060. In application the test has generated confusion and criticism for its failure to do so. We reject it for three reasons.

First, it is unclear under what circumstances this test recognizes non-cash value, such as services or goods, as consideration for a security. International Brotherhood of Teamsters v. Daniel illustrates this uncertainty. In Daniel the Supreme Court ruled that a compulsory, non-contributory employee pension plan was not an investment contract. 439 U.S. at 559, 99 S.Ct. at 796. The employer rather than the plaintiff employee made direct payments into the plan. The employee contended that he had invested in the plan by permitting part of his compensation to be diverted into the pension fund in exchange for his labor. Rejecting this argument, the Daniel court stated that "(o)nly in the most abstract sense may it be said that an employee `exchanges' some portion of his labor in return for these possible benefits." Id. at 560, 99 S.Ct. at 797. Yet, the court hedged that "this is not to say that a person's `investment,' in order to meet the definition of an investment contract, must take the form of cash only, rather than of goods and services." Id. at 560 n.12, 99 S.Ct. at 797 n.12.

One may arguably reconcile these pronouncements.⁸ Nonetheless, commentary has questioned whether Daniel's analysis of the consideration issue recognizes economic reality. See FitzGibbon, What Is a Security? A Redefinition Based on Eligibility to Participate in the Financial Markets, 64 Minn.L.Rev. 893, 905 (1980).

Second, the federal test does not clarify whether an investment contract exists when profits result substantially, but not solely, from the efforts of someone other than the investor. Howey originally framed the test to require that the efforts be solely those of others. 328 U.S. at 299, 301, 66 S.Ct. at 1103-1104. Forman⁹ and Daniel¹⁰ reiterated Howey's formulation, yet also discussed the "efforts" prong of the test while omitting the qualifying word "solely."

Forman created further doubt about the "solely" component of the test in its treatment of SEC v. Glenn Turner Enterprises, 474 F.2d 476 (9th Cir. 1973), cert. denied 414 U.S. 821, 94 S.Ct. 117, 38 L.Ed.2d 53 (1973). Turner held that "the word `solely' should not be read as a strict or literal limitation on the definition of an investment contract, but rather must be construed realistically, so as to include within the definition those schemes which involve in substance, if not in form, securities." Id. at 482. Forman acknowledged this holding yet expressly refused to state whether it was correct. 421 U.S. at 852 n.16, 95 S.Ct. at 2060 n.16.

Since Forman, courts and commentators have debated whether the federal test has effectively if not explicitly adopted the Turner rationale.¹¹ Forman's non-committal avoidance of Turner counsels against prematurely so concluding. Daniel's retention of the word "solely" in its post-Forman statement of the test likewise underscores the lingering ambiguity.¹²

Third, the federal test reflects an unduly restrictive view of what constitutes "profits." Profits consist either of the increased value of invested capital or of money received for invested capital. 421 U.S. at 852, 95 S.Ct. at 2060. Cost savings are benefits which do not qualify as profits. Id. at 851, 855-857, 95 S.Ct. at 2060, 2062-2063.

This narrow definition has been criticized as economically unrealistic:

(T)he Court must surprise knowledgeable economists with its proposition ... that profits cannot assume forms other than appreciation of capital or participation in earnings. All of the varieties of profit involved here accrue ... in the form of money saved rather than money earned. Not only would common sense teach that the two are the same, but a more sophisticated economic analysis also compels the conclusion that in a practical world there is no difference between the two forms of income ... Under a statute having as one of its "central purposes" to protect investors ... The Court errs in distinguishing among types of economic inducements which have no bearing on the motives of investors. Construction of the statute in terms of economic reality is more faithful to its "central" purpose to protect investors. (citation and footnotes omitted)

421 U.S. at 863-864, 95 S.Ct. at 2066 (Brennan, Douglas, and White, dissenting).

Accord, 64 Minn.L.Rev. at 905-906; Note, Is a...