Securities Regulation Daily NASAA defends broad interpretation of Howey’s profits prong
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Thursday, August 20, 2020

NASAA defends broad interpretation of Howey’s profits prong

By John M. Jascob, J.D., LL.M.

An amicus brief filed in Colorado by state securities regulators seeks to affirm the prevailing consensus concerning the source of profits expected from an investment contract.

The North American Securities Administrators Association (NASAA) has urged the Colorado Supreme Court to uphold the broad interpretation adopted by state and federal courts concerning the expectation of profits under the Howey test for an investment contract. In an amicus brief, NASAA urged the state high court to reject the petitioner’s narrow suggestion that "solely" in the Howey test means that an investor can have no involvement whatsoever in the enterprise. In NASAA’s view, the transaction at issue was an investment contract, and hence a security, because the victim lacked any real or substantial control of the petitioner’s company and her profits depended on his entrepreneurial and managerial efforts (Lawrence v. People, August 18, 2020).

NASAA argued that the intermediate appellate court correctly stated and applied the prevailing interpretation of the third prong of the Howey test; namely, "whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the success or failure of the enterprise." NASAA noted that this interpretation has found unanimous support among all the federal circuit courts that have addressed the issue and is consistent with both the U.S. Supreme Court's seminal decision in SEC v. W.J. Howey Co. (U.S. 1946) and the purposes of the Colorado Securities Act. Although the language has varied, state and federal courts have generally found an investment contract to exist where the investor lacked real or substantial control over the success or failure of the enterprise, or where the investor’s profits depended upon someone else’s efforts, NASAA observed.

NASAA urged the court to reject the strict, "bright-line" rule advocated by the petitioner, citing language from the Howey court itself that the definition of an investment contract "embodies a flexible rather than a static principle." In defining an investment contract under the federal securities laws, the Howey court looked to interpretations of the term under state securities laws that preexisted the enactment of the Securities Act in 1933. In two cases cited in Howey, state courts found investment contracts where the investors were expected to contribute significant efforts. Contrary to the petitioner' contention, the flexibility necessary to provide investors with a full measure of protection is not a modern trend but has been a part of the definition of an investment contract since the very beginning, NASAA stated.

Turning to the facts of the case, NASAA argued that the victim did not have sufficient control over her investment to exclude her from the anti-fraud protections of the Colorado Securities Act. Given her inexperience and lack of investment sophistication, her expected profit on her investment could only have come from the petitioner's entrepreneurial and managerial efforts, NASAA contended. Although he assigned the victim some ministerial tasks, the petitioner rented office space, registered the company with the Secretary of State, and began creating a website for the business. Moreover, the victim’s 30 percent "equity interest" in the enterprise ensured that she could take no action that the petitioner did not agree with since her vote was guaranteed to be the minority on every decision. Accordingly, NASAA urged the court to affirm the analysis of the Court of Appeals and affirm the petitioner’s convictions for securities fraud.

The case is No. 2019SC556.

Attorneys: Megan Ring, Colorado State Public Defender, for Shaun D. Lawrence. Philip Weiser, Attorney General of Colorado, for The People of the State of Colorado. Theodore Hartl (Ballard Spahr LLP) for North American Securities Administrators Association, Inc.

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