1. ETS argued that the arrangement involved commercial equipment leases, not securities. Did Congress intend to cover the leases under the securities laws?

2. Is it fair to say that investments promising a fixed return are attractive to individuals more vulnerable to investment fraud?

3. State the Hovey test for determining whether a particular scheme is an investment contract.

“Opportunity doesn’t always knock … sometimes it rings” (ETS Payphones promotional brochure). And sometimes it hangs up. So it did for the 10,000 people who invested a total of $300 million in the payphone sale-and-leaseback arrangements touted by ETS under that slogan. Charles Edwards was the chairman, chief executive officer, and sole shareholder of ETS Payphones, Inc. ETS, acting partly through a subsidiary sold payphones to the public via independent distributors. The payphones were offered packaged with a site lease, a five-year leaseback and management agreement, and a buyback agreement. The purchase price for the payphone packages was approximately $7,000.

Under the leaseback and management agreement, purchasers received $82 per month, a 14 percent annual return. Purchasers were not involved in the day-to-day operation of the payphones they owned. ETS selected the site for the phones, installed the equipment, arranged for connection and long distance service, collected coin revenues, and maintained and repaired the phones. Under the buyback agreement, ETS promised to refund the full purchase price of the package at the end of the lease or within 180 days of the purchaser’s request. The payphones did not generate enough revenue for ETS to make the payments required by the leaseback agreements, so the company depended on funds from new investors to meet its obligations. In September 2000, ETS filed for bankruptcy protection. The SEC brought this civil enforcement action alleging that Edwards and ETS had violated the registration requirements and antifraud provisions of the 1933 act. The district court concluded the arrangement was an “investment contract” subject to the securities laws. The Eleventh Circuit Court of Appeals reversed the lower court because the scheme offered a contractual entitlement to a fixed rather than a variable return.

JUDICIAL OPINION

O’CONNOR, J.… “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” Reves v. Ernst & Young, 494 U.S. 56, 61, 110 S. Ct. 945, 108 L.Ed.2d 47 (1990). To that end, it enacted a broad definition of “security,” sufficient “to encompass virtually any instrument that might be sold as an investment.” Ibid…. The test for whether a particular scheme is an investment contract was established in our decision in SEC v. W.J. Howey Co., 328 U.S. 293, (1946). We look to “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” Id., at 301. This definition “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.” Id., at 299.…

… [W]hen we held that “profits” must “come solely from the efforts of others,” we were speaking of the profits that investors seek on their investment, not the profits of the scheme in which they invest. We used “profits” in the sense of income or return, to include, for example, dividends, …………………