State v. Philips, s. 53210-9

CourtUnited States State Supreme Court of Washington
Citation108 Wn.2d 627,741 P.2d 24
Decision Date06 August 1987
Docket NumberNos. 53210-9,53333-4 and 53336-9,s. 53210-9
Parties, Blue Sky L. Rep. P 72,639 STATE of Washington, Respondent, v. Roberta PHILIPS, et al., Petitioners. STATE of Washington, Respondent, v. Eugene R. MONTGOMERY, Petitioner. In the Matter of the Personal Restraint of Eugene MONTGOMERY, Petitioner.

Page 627

108 Wn.2d 627
741 P.2d 24, Blue Sky L. Rep. P 72,639
STATE of Washington, Respondent,
Roberta PHILIPS, et al., Petitioners.
STATE of Washington, Respondent,
Eugene R. MONTGOMERY, Petitioner.
In the Matter of the Personal Restraint of Eugene
MONTGOMERY, Petitioner.
Nos. 53210-9, 53333-4 and 53336-9.
Supreme Court of Washington,
En Banc.
Aug. 6, 1987.

Page 628

[741 P.2d 27] Elizabeth K. Selleck, Seattle, for petitioner Philips.

E. Gary Donion, Seattle, for petitioner Smith.

William H. Fligeltaub, Seattle, for petitioner Thompson.

Paul J. Bernstein, Seattle, for petitioner Montgomery.

Norm Maleng, King County Pros., Greg Montgomery, Deputy Pros., Seattle, for respondent.

Kenneth Eikenberry, Atty. Gen., Jeffrey Lane, Asst. Atty. Gen., Olympia, amici curiae for respondent.

Page 629

DORE, Justice.

Petitioners were convicted of several counts of securities fraud--RCW 21.20.010. They argue that the promissory notes that they marketed to investors were not securities; that their cases should have been severed; and that their individual convictions were not supported by substantial evidence. We affirm.


Sea-Tac Mortgage, Inc. was founded in August 1981, with a principal business of brokering institutional and private loans. The brokerage of private loans involved matching borrowers who applied for loans with investors who funded those loans. The loans were typically high risks and the borrowers were typically unable to obtain loans elsewhere because of lack of steady employment or a strong credit history. The borrowers signed documents provided by Sea-Tac stating that the loans were for business purposes; however, all the loans at issue in this case were for nonbusiness purposes, such as making mortgage payments, or paying overdue personal bills. The borrowers apparently were unaware that a 30 percent interest rate for a nonbusiness loan is usurious in this state.

Sea-Tac advertised in newspapers and on television offering investments with a 30 percent rate of return. The potential investors were told that all the private loans brokered by Sea-Tac were for business purposes. Sea-Tac allowed investors to choose loans to fund after showing them credit documents and appraisals of the borrowers' property. In all the transactions leading to convictions, Sea-Tac failed to inform investors of the risky nature of the loans or that they were not in fact for business purposes, making the 30 percent interest rate illegal.

Sea-Tac performed various services for investors: it screened borrowers; prepared the paper work; had credit checks and property appraisals done on borrowers; obtained borrowers' signatures on documents stating the loans were for business purposes; often guaranteed investments or had investments refinanced; and offered to collect

Page 630

bad loans for investors for an extra fee. Investors made their checks payable to Sea-Tac, and Sea-Tac retained fees of up to 50 percent of the loan amount before issuing checks to the borrowers. The borrowers signed promissory notes secured by deeds of trust on their property payable to the individual investors that financed their loans.

The Washington State Securities Division ordered Sea-Tac to cease operations in February 1982. By that time the loans had started to go bad, and Sea-Tac was unable to cover them.

Defendants Gordon Thompson and Eugene Montgomery, principals and officers of Sea-Tac, and defendants William Smith and Roberta Philips, employees of Sea-Tac, were charged with securities fraud and theft in a 16-count information. After a 3-week trial, a jury found the defendants guilty of various counts of securities fraud under RCW 21.20.010. The Court of Appeals affirmed the convictions. State v. Philips, 45 Wash.App. 321, 725 P.2d 627 (1986). We granted the petitions for discretionary review and consolidated them with petitioner Montgomery's personal restraint petition.


The threshold issue is whether the promissory notes that Sea-Tac marketed to investors were "securities" under RCW 21.20.010. The term "security" is defined in [741 P.2d 28] RCW 21.20.005, which states in pertinent part:

The definitions set forth in this section shall apply throughout this chapter, unless the context otherwise requires:

* * *

(12) "Security" means any note; ... evidence of indebtedness; ... investment contract ...

That definition mirrors the definitions of the federal Securities Act of 1933, 15 U.S.C. §§ 77a, 77b et seq. and the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. Sauve v. K.C., Inc., 91 Wash.2d 698, 700, 591 P.2d 1207 (1979). We therefore look to federal law to determine the meaning of the term "security". McClellan v. Sundholm, 89

Page 631

Wash.2d 527, 531, 574 P.2d 371 (1978); see also RCW 21.20.900 (policy of the Securities Act of Washington is to make uniform the law and to coordinate its interpretation and administration with related federal regulation).

Petitioners first allege that the court erroneously submitted to the jury the issue of whether the notes marketed by Sea-Tac were securities. Federal criminal securities fraud cases in which there are disputed facts have held that it is proper to submit the issue of whether an instrument is a security to the jury. United States v. Carman, 577 F.2d 556, 562-63 (9th Cir.1978); United States v. Austin, 462 F.2d 724, 736-37 (10th Cir.), cert. denied, 409 U.S. 1048, 93 S.Ct. 518, 34 L.Ed.2d 501 (1972). Here, the underlying facts that determined whether the notes were securities were disputed. Under those circumstances, the trial court was correct in instructing the jury to determine if the notes marketed by petitioners were securities.

Petitioners next allege that the evidence does not support a finding that the notes they marketed were securities. In determining whether an instrument is a security, substance and economic realities are more important than form. E.g., SEC v. W.J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 1102, 163 A.L.R. 1043 (1946). Therefore, neither the fact that the instruments marketed by Sea-Tac were notes, which are within the definition of security in RCW 21.20.005(12), nor the fact that Sea-Tac referred to the purchasers of those notes as "investors" is determinative of whether Sea-Tac marketed securities. "What distinguishes a security transaction ... is an investment where one parts with his money in the hope of receiving profits from the efforts of others ..." United Housing Found., Inc. v. Forman, 421 U.S. 837, 858, 95 S.Ct. 2051, 2063, 44 L.Ed.2d 621 (1975). Because the securities fraud acts are remedial and designed to protect the public from speculative or fraudulent schemes of promoters, we apply a broad definition to the term "security", as do the federal courts. SEC v. Glenn W. Turner Enters., Inc., 474 F.2d 476, 480-81 (9th Cir.1973).

Page 632

The definition of security in RCW 21.20.005(12) includes any "investment contract". An investment contract for the purpose of this definition is 1) an investment of money, 2) in a common enterprise, 3) where the investor expects to reap profits from the efforts of the promoter or a third party. McClellan, at 531, 574 P.2d 371; W.J. Howey Co., at 298, 66 S.Ct. at 1102. The "Howey test" "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." W.J. Howey Co., 328 U.S. at 299, 66 S.Ct. at 1103.

Here, the investments marketed by Sea-Tac clearly meet the first prong of the Howey test. The promissory notes secured by deeds of trust were sold to members of the public as high interest investments. Sea-Tac's literature distributed to potential purchasers of the notes was addressed "To: Potential Investor," and after giving an example of the return on a note, urged them to "[c]ompare these figures with any other sound investment available." Exhibit 69. None of the investors testifying in this case was in the business of purchasing or selling notes secured by deeds of trust, and they each apparently viewed the transaction as an investment.

[741 P.2d 29] The second prong of the Howey test is the existence of a common enterprise. "[A] common enterprise need not be a common fund. The term denotes rather an interdependence of fortunes, a dependence by one party for his profit on the success of some other party in performing his part of the venture." McClellan, at 532, 574 P.2d 371. Petitioners argue that the investors were simply purchasers through Sea-Tac of promissory notes and were depending on the value of the notes themselves, and not on Sea-Tac for their profits. The State argues that the many services Sea-Tac offered its investors made them depend on the common enterprise of Sea-Tac, rather than merely on the value of the notes for their profits.

The sale of a distinct item, such as a secured promissory note or even a piece of real property, can under some circumstances

Page 633

be the sale of a security, even where the item sold appears to have extrinsic independent value. The crucial question is whether extra services are offered to purchasers that would tend to make them dependent on the seller or another for their profits, rather than the value of the item purchased. Thus, in United States v. Farris, 614 F.2d 634 (9th Cir.1979) the court found that a scheme involving the marketing of notes secured by deeds of trust to constitute the offer and sale of securities. In Farris an investment company acquired either actual or paper interests in Arizona land, divided the land into lots, marketed these lots taking notes and deeds of trust from the purchasers, and then, in turn, sold those notes and deeds of trust to investors. If a lot purchaser defaulted the investor would have the option of foreclosure, a substitute note, or refund of the unpaid principal. The investment company agreed to make all...

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