C12 - Business LawCase Analysis 3

1 C12 - Business LawCase Analysis 3 Summarize the facts of the case Charles Edwards ran the company ETS Payphones Inc. in multiple roles such as the Chief Operating Officer, chair of the board and sole shareholder. ETS Payphones Inc. sold payphones to the general public while partially acting through subsidiary, which also happens to be controlled by Edwards. ETS offered customers a package with a total cost of US$7,000 including various agreements such as a site lease, a five-year leaseback and management agreement and a buyback agreement. The company promises that each purchaser will receive 14% of their annual return monthly, which equates to $82 per month with an additional promise of a refund on the full price of the purchase. The return is in accordance with the leaseback and management agreement. The refund would be sent to the purchaser once the lease had ended or could also be returned up to 180 after the initial request of the purchaser. The company made claims in their advertising “[v]ery few business opportunities can offer the potential for ongoing revenue generation that is available in today's pay telephone industry.”(Bagley, C. E. Managers and the Legal Environment: Strategies for Business.) Even with their clever marketing claims and impressive refund offer, ETS were not making the income they anticipated which put them in a difficult position, one that did not allow them to have enough money to pay the refund they promised to the purchasers. In order to meet this claim to purchasers, ETS had to resort to using the money received from new investors to pay its outstanding obligations rather than having it contribute to profit. After facing such financial problems, ETS was forced to file for bankruptcy 2 in the year 2000. Following this, the Securities Exchange Commission alleged that ETS and Edwards were in violation of selling securities among many different provisions regarding the Acts of 1933 &1934. Edwards claims that his fixed rate of return offer should not be considered as an investment contracts as no capital appreciation or revenue of the company is given to purchasers nor is the return conditional upon other purchasers. All purchasers are eligible to a return according to their contract. Identify the parties and explain each party’s position; The defendant, Charles Edwards, ran and operated ETS Payphones, Inc. has charges brought against him from the plaintiff, the Securities and Exchange Commission for violations regarding registration requirements as well as antifraud provisions under both the Securities Act of 1933 and the Securities Exchange Act of 1934. Edwards was also found in violation of Rule 10b-5. Edwards argues that the agreement that ETS provides to its purchasers are not investments due to the fact that no capital appreciation or revenue of the company is given to purchasers nor is the return conditional upon other purchasers. The purchasers are obligated to receive a return according to the terms laid out within the agreement. Outline the case’s procedural history including any appeals The Securities and Exchange Commission sued Edwards, and by extension ETS, and was followed by preliminary injunction during which the Federal District court made the decision to freeze all of Edwards’ assets at the time. Edwards filed for an appeal and the appeal was taken up by the 11th Circuit Court of Appeals where the court established that there was inadequate jurisdictional privilege of the Federal District Court to make this decision. The 11th Circuit Court of Appeals contested that the Securities and Exchange Commission did not provide satisfactory enough proof that the sale of the payphones constituted as an investment contract which lead to 3 the case being presented at the Supreme Court of the United States at which time Edwards was granted a review of his case. What is the legal issue in question in this case? The legal issue in question in this case is the establishment of a revenue generating scheme and its place by definition of an investment contract based on a fixed return rate rather than a return rate which moves with the market such as a variable return rate. How did the court rule on the legal issue of this case? The Eleventh Circuit Court decided that Edwards’ investment scheme operates beyond what was defined due to the fact that the purchasers were eligible for returns under their contract was both inaccurate and did not present as consistent within the court’s precedent. The courts were considering investment contracts and the crucial note that even though investors had the ability to negotiate a decision for a return on their investment, it did not signify that the return was dependent on efforts made by others. The Supreme Court of the United States ruled that Edwards, and by extension ETS, had offered purchasers securities and also sold them securities. What facts did the court find to be most important in making its decision? The court made brought into account the ruling and facts of the SEC v. W.J. Howey Co., 328 U.S 293 case in order to provide a definition for investment contract as a term. The Supreme Court noted that ETS has provided purchasers with a fixed rate of return which did not inhibit the creation of agreement from being deemed as investment contracts. As agreed upon by the court, an investment contract had to provide purchasers with profits that were dependent on others however on the other hand, the court also established the revenue incurred was a result of 4 returns from independent merchants who invested in ETS without the expectation of profits as a result of return but rather as a result of their investments. Why was the Supreme Court unwilling to exclude contracts guaranteeing a fixed rate of return from the definition of security? The Supreme court upheld that if an investment scheme was in place that guaranteed fixed rate of return, then it can be considered an investment contract and can therefore be acknowledged as a security which would be subject to the federal securities laws. A security, as defined in Section 2(a)(1) of the 1933 Act and §3(a)(10) of the 1934 Act, can in fact include an “investment contract,” however there is no definition regarding an “investment contract.” Are mortgage notes securities when they are sold with a package of management services and a promise to repurchase the notes in the event of default? A mortgage note is essentially a contract for a loan which includes various terms such as interest rate, loan term and repayment details. This type of contract ensure that the property being purchased can be used as security for the money being borrowed in the event that payments are delinquent. Mortgage notes can be bought and sold by private or public purchasers. In re Abbett, Sommer & Co., 44 S. E. C. 104 (1969) stated that if a mortgage note were to be considered as investment contracts once the note has been sold with a package of management services and a promise to repurchase the notes in the event of default. Do you agree or disagree with the court’s decision? If you disagree, provide an explanation of your reasoning. I agree with the court’s decision regarding the acknowledgement of Edwards investment scheme as an investment contract on the bases of fixed rate of return promises made to the 5 purchasers, I also agree with their acknowledge of Edwards’ scheme as a security, making his scheme subject to federal securities laws. References Bagley, C. E. Managers and the Legal Environment: Strategies for Business. [VitalSource Bookshelf]. Retrieved from