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We agree with the district court that viatical That is not how LPI does business, however. LPI
settlements are not exempt from the securities sells fractional interests in insurance policies to
laws as insurance contracts. Contrary to the retail investors, who may pay as little as $650 and
district court, however, we conclude that LPI's buy as little as 3% of the benefits of a policy. In
contracts are not securities subject to the federal order to reach its customers, LPI uses some 500
securities laws because the profits from their commissioned "licensees," mostly independent
purchase do not derive predominantly from the financial planners. For its efforts, LPI's net
compensation is roughly 10% of the purchase
price after payment of referral and other fees. look to the efforts of others for their profits
Pardo claims that LPI is by far the largest of about because the only variable affecting profits is the
60 firms serving the rapidly growing market for timing of the insured's death, which is outside of
viatical settlements; in 1994 the company LPI's and Sterling's control.
accounted for more than half of the industry's
estimated annual revenues of $300 million. The
company is 95% beneficially owned by Pardo Summary and Conclusion
through a trust, and 5% owned by Dr. Jack Kelly,
who performs medical evaluations of LPI advances two arguments in support of the
policyholders on LPI's behalf. proposition that its viatical settlements are not
subject to the federal securities laws. First, the
LPI was also the first company to develop a plan company contends that its contracts are exempt
by which an investor could participate in a viatical as insurance contracts under the Securities Act of
settlement through an Individual Retirement 1933 and the McCarran-Ferguson Act. For the
Account. In order to circumvent the Internal reasons set forth in Part II.A, however, we
Revenue Code prohibition upon IRAs investing in conclude that a viatical settlement is not an
life insurance contracts, LPI structures the insurance policy, and that the business of selling
purchase through a separate trust established for fractional interests in insurance policies is not part
that purpose. The IRA lends money to the trust, of "the business of insurance." We therefore
for which it receives a non-recourse note; the trust reject LPI's exemption argument.
then uses the loan proceeds to purchase an
interest in a life insurance policy, the death Second, LPI maintains that the fractional interests
benefits of which collateralize the note. When the which it sells to investors are not securities within
insured dies and the benefits are paid, the the meaning of the 1933 Act, as controlled by the
proceeds go to pay off the note held by the IRA. Supreme Court's decision in Howey. In Parts
II.B(1) and II.B(2), respectively, we conclude that
Both LPI's program for individual investors and its LPI's contracts meet two parts of the Howey test:
IRA program have gone through three iterations investors purchase the contracts with an
during the course of this litigation. In each, LPI expectation of profits; and they pool their funds,
performed or performs a number of pre-purchase then share any profits or losses that arise. In Part
functions: Specifically, even before assembling II.B(3), however, we hold that fractional interests
the investors, LPI evaluates the insured's medical in viatical settlements, in any of the three versions
condition, reviews his insurance policy, marketed or proposed by LPI, are not securities.
negotiates the purchase price, and prepares the The combination of LPI's pre-purchase services
legal documents. The difference among the three as a finder-promoter and its largely ministerial
versions is that LPI performs ever fewer (and post-purchase services is not enough to satisfy
ultimately no) post-purchase functions. the third requirement in Howey: the investors'
profits do not flow predominantly from the efforts
If viatical settlements are insurance contracts, of others. Finally, we hold that the notes issued to
then they are altogether exempt from coverage IRAs by LPI-sponsored trusts are not securities
under the federal securities laws. either. Looking to the substance of such
transactions, we see that the notes are used
n this connection, the SEC suggests that solely for tax purposes, not as a means of raising
investors in LPI's viatical settlements are capital.
essentially passive; their profits, the Commission
argues, depend predominantly upon the efforts of Accordingly, this case is remanded to the district
LPI, which provides pre-purchase expertise in court with instructions to vacate the three
identifying existing policyholders and, together injunctions entered against LPI in August 1995,
with Sterling, provides post-purchase January 1996, and March 1996.
management of the investment. Meanwhile, LPI
argues that its pre-purchase functions are wholly
irrelevant and that the post-purchase functions,
by whomever performed, should not count
because they are only ministerial. On this view,
once the transaction closes, the investors do not
POWER HOMES UNLIMITED CORP VS SEC & On the first issue, Sec. 64 of R.A. No. 8799
NOEL MANERO provides: Sec. 64. Cease and Desist Order. —
64.1. The Commission, after proper investigation
Power Homes is a domestic corporation or verification, motu proprio or upon verified
registered with SEC on Oct 2000. complaint by any aggrieved party, may issue a
cease and desist order without the necessity of a
prior hearing if in its judgment the act or practice,
Primary purpose: To engage in the transaction of
promoting, acquiring, managing, leasing, unless restrained, will operate as a fraud on
obtaining options on, development, and investors or is otherwise likely to cause grave or
irreparable injury or prejudice to the investing
improvement of real estate properties for
public.
subdivision and allied purposes, and in the
purchase, sale and/or exchange of said
subdivision and properties through network Power Homes was not denied due process. SEC
marketing. properly examined Power Homes’ business
operations when it (1) called into conference
three of petitioner's incorporators, (2) requested
N. Manero requested SEC to investigate Power
information from the incorporators regarding the
Homes claiming that he attended a seminar
nature of petitioner's business operations, (3)
conducted by the latter claiming to sell properties
that were inexistent and had no broker’s license. asked them to submit documents pertinent
thereto, and (4) visited petitioner's business
premises and gathered information thereat. All
R. Munsayac inquired from SEC whether Power these were done before the CDO was issued by
Homes business involves LEGITIMATE the public respondent SEC. Trite to state, a formal
NETWORK MARKETING. trial or hearing is not necessary to comply with the
requirements of due process. Its essence is
On this basis, SEC held a conference on Dec simply the opportunity to explain one's position.
2000 that was attended by Power Homes Public respondent SEC abundantly allowed
incorporators – John Lim, Paul and Leonito petitioner to prove its side.
Nicolas.
The second issue is whether the business of
Power Homes submitted to SEC copies of its petitioner involves an investment contract that is
marketing course module and letter of considered security and thus, must be registered
confirmation from Fil Estate, Crown Asia and prior to sale or offer for sale or distribution to the
Pioneer. SEC visited the premises to gather public pursuant to Section 8.1 of R.A. No. 8799,
pertinent information. viz: Section 8. Requirement of Registration of
Securities. — 8.1. Securities shall not be sold or
Power Homes is engaged in the sale or offer for offered for sale or distribution within the
sale or distribution of investment contracts, which Philippines, without a registration statement duly
are considered securities under Sec. 3.1 (b) of filed with and approved by the Commission. Prior
(R.A.) No. 8799 (The Securities Regulation to such sale, information on the securities, in such
Code), but failed to register them in violation of form and with such substance as the Commission
Sec. 8.1 of the same Act, SEC issued CDO. may prescribe, shall be made available to each
prospective purchaser.
Power Homes moved for the lifting of CDO but
SEC denied for lack of merit. SEC found the petitioner "as a marketing
company that promotes and facilitates sales of
CA: imputing GADALEJ by SEC – favored SEC. real properties and other related products of real
estate developers through effective leverage
marketing."
The issues for determination are: (1) whether
public respondent SEC followed due process in
the issuance of the assailed CDO; and (2) It also described the conduct of petitioner's
whether petitioner's business constitutes an business as follows: The scheme of the
investment contract which should be registered [petitioner] corporation requires an investor to
with public respondent SEC before its sale or become a Business Center Owner (BCO) who
offer for sale or distribution to the public. must fill-up and sign its application form. The
Terms and Conditions printed at the back of the the Howey Test "embodies a flexible rather than
application form indicate that the BCO shall mean a static principle, one that is capable of adaptation
an independent representative of Power Homes, to meet the countless and variable schemes
who is enrolled in the company's referral program devised by those who seek the use of the money
and who will ultimately purchase real property of others on the promise of profits." Needless to
from any accredited real estate developers and state, any investment contract covered by the
as such he is entitled to a referral Howey Test must be registered under the
bonus/commission. Paragraph 5 of the same Securities Act, regardless of whether its issuer
indicates that there exists no employer/employee was engaged in fraudulent practices.
relationship between the BCO and the Power
Homes Unlimited, Corp. The business scheme of petitioner in the case at
bar is essentially similar. An investor enrolls in
The BCO is required to pay US$234 as his petitioner's program by paying US$234. This
enrollment fee. His enrollment entitles him to entitles him to recruit two (2) investors who pay
recruit two investors who should pay US$234 US$234 each and out of which amount he
each and out of which amount he shall receive receives US$92. A minimum recruitment of four
US$92. In case the two referrals/enrollees would (4) investors by these two (2) recruits, who then
recruit a minimum of four (4) persons each recruit at least two (2) each, entitles the principal
recruiting two (2) persons who become his/her investor to US$184 and the pyramid goes on.
own down lines, the BCO will receive a total
amount of US$147.20 after deducting the amount We reject petitioner's claim that the payment of
of US$36.80 as property fund from the gross US$234 is for the seminars on leverage
amount of US$184. After recruiting 128 persons marketing and not for any product. Clearly, the
in a period of eight (8) months for each Left and trainings or seminars are merely designed to
Right business groups or a total of 256 enrollees enhance petitioner's business of teaching its
whether directly referred by the BCO or through investors the knowhow of its multi-level marketing
his down lines, the BCO who receives a total business. An investor enrolls under the scheme
amount of US$11,412.80 after deducting the of petitioner to be entitled to recruit other
amount of US$363.20 as property fund from the investors and to receive commissions from the
gross amount of US$11,776, has now an investments of those directly recruited by him.
accumulated amount of US$2,700 constituting as Under the scheme, the accumulated amount
his Property Fund placed in a Property Fund received by the investor comes primarily from the
account with the Chinabank. This accumulated efforts of his recruits.
amount of US$2,700 is used as partial/full down
payment for the real property chosen by the BCO
We therefore rule that the business operation or
from any of [petitioner's] accredited real estate the scheme of petitioner constitutes an
developers. investment contract that is a security under R.A.
No. 8799. Thus, it must be registered with public
An investment contract is deDned in the respondent SEC before its sale or offer for sale or
Amended Implementing Rules and Regulations distribution to the public. As petitioner failed to
of R.A. No. 8799 as a "contract, transaction or register the same, its offering to the public was
scheme (collectively 'contract') whereby a person rightfully enjoined by public respondent SEC. The
invests his money in a common enterprise and is CDO was proper even without a finding of fraud.
led to expect profits primarily from the efforts of As an investment contract that is security under
others." R.A. No. 8799, it must be registered with public
respondent SEC, otherwise the SEC cannot
Known as the Howey Test, it requires a protect the investing public from fraudulent
transaction, contract, or scheme whereby a securities. The strict regulation of securities is
person (1) makes an investment of money, (2) in founded on the premise that the capital markets
a common enterprise, (3) with the expectation of depend on the investing public's level of
profits, (4) to be derived solely from the efforts of confidence in the system.
others.
IN VIEW WHEREOF, the petition is DENIED. The
Although the proponents must establish all four July 31, 2003 Decision of the Court of Appeals,
elements, the US Supreme Court stressed that a8rming the January 26, 2001 Cease and Desist
Order issued by public respondent Securities and SEC VS PROSPERITY.COM INC
Exchange Commission against petitioner Power
Homes Unlimited Corporation, and its June 18, This case involves the application of the Howey
2004 Resolution denying petitioner's Motion for test in order to determine if a particular
Reconsideration are AFFIRMED. No costs. transaction is an investment contract.
he Securities Regulation Code treats investment WHEREFORE, the Court DENIES the petition
contracts as "securities" that have to be and AFFIRMS the decision dated July 31, 2003
registered with the SEC before they can be and the resolution dated June 18, 2004 of the
distributed and sold. An investment contract is a Court of Appeals in CA-G.R. SP 62890.
contract, transaction, or scheme where a person
invests his money in a common enterprise and is
led to expect profits primarily from the efforts of
others.
The issue in these cases is whether shares of "[I]n searching for the meaning and scope of the
stock entitling a purchaser to lease an apartment word 'security' in the Act[s], form should be
in Co-op City, a state subsidized and supervised disregarded for substance and the emphasis
nonprofit housing cooperative, are "securities" should be on economic reality."
within the purview of the Securities Act of 1933
and the Securities Exchange Act of 1934. The primary purpose of the Acts of 1933 and
1934 was to eliminate serious abuses in a
Co-op City is a massive housing cooperative in largely unregulated securities market. The focus
New York City. Built between 1965 and 1971, it of the Acts is on the capital market of the
presently houses approximately 50,000 people enterprise system: the sale of securities to raise
on a 200-acre site containing 35 high-rise capital for profit-making purposes, the
buildings and 236 town houses. The project was exchanges on which securities are traded, and
organized, financed, and constructed under the the need for regulation to prevent fraud and to
New York State Private Housing Finance Law, protect the interest of investors. Because
commonly known as the Mitchell-Lama Act, securities transactions are economic in
enacted to ameliorate a perceived crisis in the character, Congress intended the application of
availability of decent low income urban housing. these statutes to turn on the economic realities
In order to encourage private developers to build underlying a transaction, and not on the name
low-cost cooperative housing, New York provides appended thereto. Thus, in construing these
them with large long-term, low interest mortgage Acts against the background of their purpose,
loans and substantial tax exemptions. Receipt of we are guided by a traditional canon of statutory
such benefits is conditioned on a willingness to construction:
have the State review virtually every step in the
development of the cooperative. "[A] thing may be within the letter of the statute
and yet not within the statute, because not within
its spirit, nor within the intention of its makers."
In the present case, respondents do not contend, LANDRETH TIMBER CO VS LANDRETH
nor could they, that they were misled by use of
the word "stock" into believing that the federal Respondents father and sons, who owned all of
securities laws governed their purchase. the common stock of a lumber business that they
Common sense suggests that people who intend operated, offered their stock for sale through
to acquire only a residential apartment in a state- brokers. The company's sawmill was
subsidized cooperative, for their personal use, subsequently damaged by fire, but potential
are not likely to believe that, in reality they are purchasers were told that the mill would be rebuilt
purchasing investment securities simply because and modernized. Thereafter, a stock purchase
the transaction is evidenced by something called agreement for all of the stock was executed, and
a share of stock. These shares have none of the ultimately petitioner company was formed by the
characteristics "that, in our commercial world fall purchasers. Respondent father agreed to stay on
within the ordinary concept of a security." as a consultant for some time to help with the
H.R.Rep. No. 85, supra, at 11. Despite their daily operations of the mill. After the acquisition
name, they lack what the Court was completed, the mill did not live up to the
in Tcherepnin deemed the most common feature purchasers' expectations. Eventually, petitioner
of stock: the right to receive "dividends contingent sold the mill at a loss and went into receivership.
upon an apportionment of profits." 389 U.S. Petitioner then filed suit in Federal District Court
at 389 U. S. 339. Nor do they possess the other for rescission of the sale of stock and damages,
characteristics traditionally associated with stock: alleging that respondents had violated the
they are not negotiable; they cannot be pledged registration provisions of the Securities Act of
or hypothecated; they confer no voting rights in 1933 (1933 Act) and the antifraud provisions of
proportion to the number of shares owned; and the Securities Exchange Act of 1934 (1934 Act).
they cannot appreciate in value. In short, the The court granted summary judgment for
inducement to purchase was solely to acquire respondents, holding that, under the "sale of
subsidized low-cost living space; it was not to business" doctrine, the stock could not be
invest for profit. considered a "security" for purposes of the Acts
because managerial control of the business had
passed into the hands of the purchasers, who
bought 100% of the stock. The court concluded
that the transaction thus was a commercial
venture, rather than a typical investment. The
Court of Appeals affirmed.