Securities and Exchange Commission

 

It may seem odd, but MLM distributorships can be considered “securities” under the federal and state securities laws.  This is because the federal securities laws are not limited to publicly traded securities, but also cover “investment contracts.”   The statutes do not define “investment contracts”, so it has been up to the federal courts to determine what sorts of relationships or entities constitute investment contracts.  The Supreme Court has held that “[t]he test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”  Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed 1244 (1945).  In a case involving the infamous Glenn Turner, founder of the Koscot Interplanetary MLM, the Ninth Circuit rejected a strict interpretation of the “solely from the efforts of others” requirement, adopting of a flexible approach that focuses on “whether the efforts made by those other than the investor are the undeniably significant ones.” Securities and Exchange Commission v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 480-83 (9th Cir.), cert. den., 414 U.S. 821 (1973).   Many other courts, including state courts applying state securities laws, have followed suit and held that MLM offerings can constitute securities.  See, e.g. Webster v. Omnitrition International, Inc., 79 F.3d 776 (9th Cir. 1996); Securities and Exchange Commission v. Koscot Interplanetary, Inc., 497 F.2d 473, 478-485 (5th Cir. 1974); Piambino v. Bailey, 610 F.2d 1306 (5th Cir), cert. den., 449 U.S. 1011 (1980), appeal after remand, 757 F.2d 1112 (11th Cir. 1985); Securities and Exchange Commission v. International Loan Network, Inc., 770 F.Supp. 678 (D.D.C. 1991), aff’d, 968 F.2d 1304 (D.C.Cir. 1992); Davis v. Avco Corp., 371 F.Supp. 782 (N.D.Ohio 1974), aff’d sub nom Davis v. Avco Financial Services, Inc., 739 F.2d 1057 (6th Cir. 1984), cert. den., 470 U.S. 1005, 472 U.S. 1012, 105 S.Ct. 1359, 105 S.Ct. 2713; Mitzner v. Cardet International, Inc., 358 F.Supp. 1262 (N.D.Ill. 1973); Frye v. Taylor, 263 So.2d 835, 840-41 (Fla.App. 1972); Bond v. Koscot Interplanetary, Inc., 246 So.2d 631 (Fla. App. 1971), appeal after remand, 276 So.2d 198 (Fla.App. 1973); Florida Discount Centers, Inc. v. Antinori, 226 So.2d 693 (Fla.App. 1969); Frye v. Taylor, 263 So.2d 835 (Fla.App. 1972).  But see U.S. v. Holtzclaw, Fed.Sec.L.Rep. [CCH] &99,423 (S.D.W.Va. 1997) (holding multi-level marketing plan involving sale of gold coins was not security due to lack of horizontal commonality).

In Webster v. Omnitrition International, Inc., supra, the Ninth Circuit held that the FTC’s definition of “pyramid scheme” in the Koscot case was also applicable to cases under the federal securities laws, as well as the federal Racketeer Influenced and Corrupt Organizations (RICO) statute.

The federal securities laws require registration of offerings and prohibit fraudulent statements and omissions.  Failure to register is essentially a strict liability offense, entitling the purchaser to rescission without proof of fraud.   Webster v. Omnitrition, supra.   In addition, Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful “[t]o use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.” 15 U.S.C. 78j(b).  Securities and Exchange Commission Rule 10b-5 prohibits engaging “in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”  17 C.F.R. § 240.10b-5(c).