bankruptcy

Charles Edward founded a company that sold pay telephones and he was leasing them back from
the purchasers at a monthly fee. Edwards later on filled for bankruptcy, and Securities and
Exchange Commission sued him for selling his securities and this amounted to a violation of the
registration and anti-fraud provisions of the federal securities.
A federal district court froze the assets of Edward through a preliminary injunction. In issuing its
judgment the District Court concluded that the payphone sale and leaseback arrangement was an
investment contract as defined under Act, thereby it was to be subjected under the federal
securities laws. Being dissatisfied with the judgment of the district court Edward appealed.
The legal issue, in this case, was whether selling pay telephone by Edward amounted to an
investment contract.
In rendering its judgment, the 11 th Circuit Court of Appeal held that the district court lacked
jurisdiction to issue the preliminary injunction. The court reasoning was that the district court
had failed to show that the act of Edward selling pay telephones amounted to an “investment
contract” within the meaning of the federal security laws. The court relied on the case of SEC v.
W. L Howey Co. (1946) to define the meaning of “investment contract.” In this case, it was
defined that a financial interest amounted to an investment contract if it fulfilled the following
tests:
1. An investment of money;
2. In a common enterprise; and
3. With the expectation of profits to be derived solely from the efforts of others.

In rendering its decision, the 11 th Circuit court found out that the district court in its judgment had
failed to fulfill the third test. Thereby the acts of Edward did not amount to “investment
contract.”
The court was not unwilling but rather it subjected the contracts guaranteeing a fixed rate of
return to a test. The test was to see if there was the expectation of profits to be derived solely
from the efforts of others. The contracts failed this test as it did not depend on the efforts of
others to generate profits. As a result of failing this test then it was no fit to be declared as an
“investment contract”
Mortgages notes are securities when they are sold with a package of management service and a
promise to repurchase the notes in the event of default. The court in the same case gave a
unanimous opinion, where it held that an investment scheme promising a fixed rate of return can
be an “investment contract” and thus a “security” subjected to the federal securities law. The
court highlighted that the test used to determine 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.
I agree with the decision of the court; this is because there needs to be a standard approach taken
or used by the court. For consistency, the court had applied three tests to find if the judgment by
the district court fulfilled all the tests. The failure of the district court not to satisfy those tests
means that the courts will have challenges in interpreting such cases in the future.