Securities and Exchange Commission v. Edwards

PETITIONER: Securities and Exchange Commission
RESPONDENT: Charles E. Edwards
LOCATION: Guantanamo Bay, Cuba

DOCKET NO.: 02-1196
DECIDED BY: Rehnquist Court (1986-2005)
LOWER COURT: United States Court of Appeals for the Eleventh Circuit

CITATION: 540 US 389 (2004)
GRANTED: Apr 21, 2003
ARGUED: Nov 04, 2003
DECIDED: Jan 13, 2004

ADVOCATES:
Michael K. Wolensky - argued the cause for Respondent
Theodore B. Olson - argued the cause for Petitioner

Facts of the case

Charles Edwards founded a company that sold pay telephones and then leased them back from the purchasers for a fixed monthly fee. After Edwards filed for bankruptcy, the Securities and Exchange Commission (SEC) sued him for selling securities (considering the telephones to be investments on the part of the purchasers and therefore securities) in violation of the registration and anti-fraud provisions of the federal securities laws.

A federal district court froze Edwards' assets in a preliminary injunction. The 11th Circuit Court of Appeals overruled the district court's injunction for lack of jurisdiction. The SEC, the court reasoned, failed to show that Edwards' selling pay telephones was an "investment contract" under federal securities laws. In defining "investment contract," the court used the Supreme Court's ruling in SEC v. W.J. Howey Co. (1946), that a financial interest is an "investment contract" if it involves (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profits to be derived solely from the efforts of others. The 11th Circuit ruled that the SEC could not meet the test's third part because the purchasers received a fixed fee that was guaranteed by contract and therefore not dependant on Edwards' success.

Question

Does the Securities Exchange Act's (1934) term "investment contract" include an investment scheme in which the promoter promises a fixed return or the investor is entitled to a particular rate of return?

Media for Securities and Exchange Commission v. Edwards

Audio Transcription for Oral Argument - November 04, 2003 in Securities and Exchange Commission v. Edwards

Audio Transcription for Opinion Announcement - January 13, 2004 in Securities and Exchange Commission v. Edwards

William H. Rehnquist:

The opinion of the Court in No. 02-1196 Securities and Exchange Commission versus Edwards will be announced by Justice O’Connor.

Sandra Day O'Connor:

This case is here on writ of certiorari to the Eleventh Circuit.

The respondent, Charles Edwards, was the chief executive officer and sole shareholder of a company called ETS Payphones.

ETS sold payphones to the public packaged with an agreement under which the purchaser would lease the payphone back to the ETS for a fixed monthly payment.

These payments amounted to approximately a 14% annual return on the purchaser’s investment.

ETS was unable to meet its obligations under the leaseback agreements and filed for bankruptcy.

The Securities and Exchange Commission then initiated this civil enforcement action claiming that the sale and leaseback arrangements were subject to the registration requirements and anti-fraud provisions of the federal securities law.

The District Court concluded that the arrangements were investment contracts, one of the investment instruments included in the definition of security in the Securities Act in 1933 and the Securities Exchange Act of 1934.

The Eleventh Circuit disagreed.

It read our prior cases to require that an investment contract offer either capital appreciation or participation in earnings and thus, to exclude schemes such as this one that offered a fixed rate of return.

In our opinion filed today, we conclude that an investment scheme promising a fixed rate of return can be an investment contract and thus a security subject to the federal securities law.

In our 1946 decision in SEC versus Howey, we established that the test for determining whether a scheme is an investment contract is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

When we spoke of profits, we were referring simply to the income or return that investors seek on their investment.

Thus, there is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of this test.

Moreover, excluding fix return schemes from the securities laws would open up and easily exploit a loophole and would leave unregulated a set of schemes particularly attractive to those most vulnerable to investment fraud.

In light of these factors, it is not surprising that the SEC has consistently rejected the limited reading of investment contract that respondent advances, and we do the same.

The decision of the Court is unanimous.