"Opportunity doesn't always knock… sometimes it rings. And sometimes it hangs up." This is how Justice O'Conner began the unanimous Supreme Court decision of Sec. & Exch. Comm'n v. Edwards. A well suited beginning to an opinion that closed the door, or in this case, hung up the phone, on a purchase, leaseback, and management agreement scheme. The transactions were deemed to be securities and the investors were granted fraud protections under the Securities Acts of 1933 and 1934.
While securities laws have been a part of the United States Code and federal jurisprudence for many years, ambiguity still exists with regard to one of the basic tests created by the Supreme Court to determine if an economic transaction is a security. The Supreme Court had the opportunity in Edwards to resolve a three-way circuit split, but chose not to do so.
A security, for purposes of federal law, is regulated by two United States statutes. The Securities Act of 1933 regulates initial offerings of securities while the Securities Exchange Act of 1934 governs the subsequent exchange of those securities and established the Securities and Exchange Commission (SEC). Together, these two Acts were promulgated to protect potential investors from fraud, principally by requiring full disclosure.
A security is defined in both the 1933 and 1934 Acts. Each definition uses both specific terms and vague phrases to define what constitutes a security, thus ensuring a broad and flexible definition. Each Act contains the vague term "investment contract" within its definition of security. No matter what act the term falls under, the courts apply the same test to determine if an agreement is a security by its classification as an investment contract. The test for an investment contract was first established in Sec. & Exch. Comm'n v. W.J. Howey Co.. "The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Since Congress took the term "investment contract" from state "blue sky" laws, the Supreme Court adopted the investment contract test from state courts. When the Supreme Court established the test for an investment contract, it declared that the test "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." The Supreme Court was establishing a test sufficiently broad to cover many different arrangements in an effort to effectuate Congress' intent to provide a broad definition of a security.
However, since the four-part Howey test was first articulated in 1946, the definition of common enterprise, the second prong in the four-part test, has been defined by the circuit courts in three different ways. This note will briefly describe in Part II the three-way circuit split on the definition of common enterprise. In Part III, this note will discuss the unanimous decision in Sec. & Exch. Comm'n v. Edwards. Part IV will explore some of the possible reasons why the Supreme Court did not address the circuit court split over the common enterprise definition in the Edwards decision. Part V will argue that only one of the three currently articulated definitions of a common enterprise is a viable option and will recommend that the Supreme Court adopt this definition in its next investment contract decision. Part VI will provide a conclusion.
II. The Three Different Interpretations of "Common Enterprise"
The Supreme Court, in its Howey opinion, relied on prior state court decisions to create a four-part test to determine when an investment contract is a security. The second prong of the Howey test requires that the investment of money be "in a common enterprise." However, the Supreme Court did not define what constitutes a common enterprise. Thus, "[t]he circuit courts have developed three distinct methods for defining the Howey test's common enterprise element." While the Supreme Court did not expressly mention what constitutes a common enterprise, the Court did mention in their Howey opinion that a common enterprise was an important part of the test. "A common enterprise managed by respondents or third parties with adequate personnel and equipment is therefore essential if the investors are to achieve their paramount aim of a return on their investments."
Because the Supreme Court has not yet chosen to resolve the investment contract issue, it is important to appreciate the differences among the approaches currently employed in the circuit courts. Three different methods are employed to determine whether or not a scheme satisfies the common enterprise requirement of the Howey test: (1) the horizontal approach, (2) the narrow vertical approach, and (3) the broad vertical approach. While the Sec. & Exch. Comm'n v. Edwards opinion does not address the differences among the three approaches, the Eleventh Circuit did so in its earlier opinion on the same facts.
A. The Horizontal Approach
"The horizontal approach to common enterprise focuses on the relationship among investors in an economic venture." Integral to this approach is the pooling of investors' money in a common venture. The Eleventh Circuit correctly noted that "[m]ost circuits that have considered the issue [of what is a common enterprise] find it satisfied where a movant shows 'horizontal commonality,' that is the 'pooling' of investors' funds as a result of which the individual investors share all the risks and benefits of the business enterprise."
The D.C., First, Second, Third, Fourth, Sixth, and Seventh Circuits all apply the horizontal approach. These circuits place great weight on whether the scheme involves a "pooling" of assets. For the common enterprise prong to be satisfied, horizontal commonality requires that an investor's assets be joined with another investor's assets into a joint venture where each investor shares the risk of profit and loss according to their individual investment.
B. The Narrow Vertical Approach
"The narrow vertical approach finds a common enterprise if there is a correlation between the fortunes of an investor and a promoter." Under narrow vertical commonality
[a] common enterprise is a venture "in which the 'fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment....'" It is not necessary that the funds of investors are pooled; what must be shown is that the fortunes of the investors are linked with those of the promoters, thereby establishing the requisite element of vertical commonality. Thus, a common enterprise exists if a direct correlation has been established between success or failure of [the promoter's] efforts and success or failure of the investment.
Only the Ninth Circuit follows this approach after earlier accepting both narrow vertical commonality and horizontal commonality. Under this view, the test is satisfied if the promoter and the investor are both exposed to risk and the profits and losses of investor and promoter are correlated.
C. The Broad Vertical Approach
"[T]he broad vertical approach finds a common enterprise if the success of an investor depends on a promoter's expertise." "Broad vertical commonality … only requires a movant to show that the investors are dependent upon the expertise or efforts of the investment promoter for their returns."
The Fifth Circuit and the Eleventh Circuit (because of the Eleventh Circuit's acceptance of pre-split Fifth Circuit opinions) both follow this view. These courts focus on the expertise of the promoter in the industry of the alleged security. If the investor relies on the promoter's expertise, then the transaction or scheme represents a common enterprise and satisfies the second prong of the Howey test.
D. Comparison of the Three Approaches
The broad vertical commonality approach is the easiest to satisfy. The broad vertical approach looks only at the relationship between the investor and promoter, specifically whether expertise was required or not. By looking at this relationship only, the test is easily satisfied since the promoter frequently has more knowledge than the investor. Similarly, if the promoter stands to benefit in the same manner as the investor, irrespective of the promoter's expertise, the narrow vertical commonality test is satisfied.
While the vertical commonality test is the easiest to satisfy, the horizontal commonality approach is the most difficult. Unlike the vertical commonality tests, horizontal commonality requires multiple investors in the common venture. Because it focuses on the relationship between investors, irrespective of the promoter, it is a more difficult standard to meet. Thus, the horizontal commonality test frequently fails whereas the vertical commonality test rarely does.
III. Sec. & Exch. Comm'n v. Edwards
The common enterprise circuit split was mentioned in both the district court and Eleventh Circuit opinions. However, the Supreme Court did not address the disagreement. But since the Supreme Court is not frequently able to look into the investment contract definition and, more specifically, the common enterprise prong of that definition, it is important to determine what value the Sec. & Exch. Comm'n v. Edwards opinion adds to the investment contract debate. This part will evaluate all three opinions by first presenting the facts of the case. Part IV will then evaluate why the Supreme Court did not address the three-way circuit split.
A. The Facts
The original suit, decided in November 2000, was brought by the Security and Exchange Commission (SEC) against ETS Payphones, Inc. and Charles E. Edwards. The SEC sought injunctive relief as well as the freezing of both business and personal assets. The SEC alleged that the ETS sale/leaseback agreements of pay telephones were securities and that the defendants violated the anti-fraud provisions of the federal securities laws.
Charles E. Edwards founded ETS Payphones, Inc., a Georgia corporation, in October 1994. ETS wholly owned a subsidiary, Payphone Systems Acquisitions, Inc. (PSA), which was also founded by Edwards. "Edwards was the chairman, chief executive officer, and sole shareholder of ETS payphones, Inc." and thus, the complete owner of PSA. A third company, Twinleaf, Inc., a consulting company providing support to ETS, was also principally owned by Edwards. "PSA purchased telephone equipment and locations, which it sold at wholesale to distributors." "ETS was incorporated to provide management services, i.e. placement, advertising, maintenance, coin collecting, and accounting, for owners of pay telephones."
These three companies worked closely together. An investor would purchase a pay telephone from PSA and then lease the telephone "back" to ETS to provide its management services. In return for its $6,750 pay telephone purchase, the investor would receive a monthly fixed fee of 14.1% on investment, or $82 a month, during the 5-year leaseback and management agreement. "Under the lease agreement, investors retain[ed] little, if any, control."
ETS offered these purchase and lease agreements to the general public through a sales force and distributors, who solicited by mail and on the internet. ETS portrayed the company in its sales literature as experienced and successful in the telephone industry and invited investors to "watch the profits add up." "Unfortunately for investors, these brochures, advertisements and websites failed to disclose the company's true financial condition. In reality, ETS always lost money on its payphone operations." The company lost more than $30 million a year. "Because revenue from payphone operations never covered operating expenses, ETS had to attract an ever expanding number of investors to meet its obligations to existing investors;" an estimated $300 million was invested by some 10,000 investors. Ultimately, ETS Payphones, Inc. filed for bankruptcy on September 11, 2000.
"Despite these losses, Edwards continued to personally profit from the operation, receiving $2.24 million in compensation from ETS and Twinleaf, Inc. between 1998 and 2000." During this time, ETS also made interest-free loans to other entities owned by Edwards.
B. The District Court
The district court opinion focused on whether injunctive relief should be granted. In its successful claim for injunctive relief, the SEC proved both "(1) a prima facie case of previous violations of federal securities laws, and (2) a reasonable likelihood that the wrong will be repeated." The district court correctly applied the Howey test to determine if the aggregate of the purchase agreements and lease agreements were securities under the definition of an investment contract. The court focused on the common enterprise prong and the expectation of profits prong.
Under the common enterprise prong analysis, the district court noted that many circuits use the "horizontal commonality" test for common enterprise "which requires investors to share or pool funds in order to succeed in a venture." However, the court noted that it was bound by Eleventh Circuit precedent to apply "vertical commonality." Under the Eleventh Circuit's vertical commonality test, "the requisite commonality is evidenced by the fact that the fortunes of all investors are tied to the efficacy of the promoter." Because the court concluded that the investors' fortunes were tied to the promoter, Edwards and ETS, this element was satisfied.
Under the expectation of profits analysis, the court focused on who had control to secure profits. By so doing, the district court combined the "expectation of profits" and the "to be derived solely from the efforts of others" into one prong. "Investors never saw the telephones, never used the telephones, and often did not know where they were located." Thus, the investors' control was only "illusory."
After establishing that the agreements constituted a security by means of an investment contract, the SEC successfully showed that ETS violated both registration and anti-fraud security laws. The district court found that ETS's failure to adequately inform investors that the company had never posted a profit, was losing money, and needed investors for operational purposes constituted material misrepresentations and omissions "because [this information goes] to the essence of the investment decisions made by individual investors." In addition, all of the other elements of securities fraud were met.
The SEC was further successful in showing that future violations were reasonably likely to continue. The court outlined many factors leading to the conclusion that ETS and Edwards would continue to violate federal securities laws by placing special emphasis on past substantive violations. By showing past violations and the likelihood of future violations, the SEC successfully established a basis for injunctive relief.
Finally, the SEC was successful in showing that the asset freeze was appropriate since the SEC was likely to ultimately succeed on the merits of its claims. "The purpose of an asset freeze is to insure that any funds which may become due can be collected." Edwards had many assets derived from the company prior to bankruptcy, including $15 million in interest-free loans and $2.24 million in compensation which was used to purchase real estate valued at $7 million.
C. The Eleventh Circuit
Upon appeal to the Eleventh Circuit, a narrower set of issues was discussed. The court examined whether the transactions constituted a security under the definition of an investment contract. Ultimately, the Eleventh Circuit reversed the district court's holding that the agreements constituted a security. The court cited a lack of "profits" derived from the efforts of others.
The Eleventh Circuit first examined the meaning of common enterprise, not because of the SEC's desire for clarity among the circuits, but because of defendant/appellant's request that the circuit adopt the horizontal commonality test. Edwards argued for this standard because "[b]road vertical commonality, the easiest to satisfy of the alternative tests, only requires a movant to show that the investors are dependent upon the expertise or efforts of the investment promoter for their returns." By arguing for a more difficult standard, he was hoping that this transaction, by not satisfying the common enterprise prong, would not be deemed a security.
However, the court felt bound by precedent to apply the broad vertical commonality test. After establishing the law, the court did not apply the facts to the law since it found that "the last prong, 'expectations of profits,' clearly [was] unsatisfied."  This proved sufficient for the panel to reverse the district court's opinion.
In the Eleventh Circuit's analysis of whether these transactions met the "expectation of profits to be derived solely from the efforts of others" prong, the court focused on the meaning of "profits." According to its reading of Forman, profits "require either a participation in earnings by the investor or capital appreciation." While no one disagrees that these transactions were not going to result in capital appreciation, the court also said that participation in earnings was not satisfied since "the investors received a fixed monthly sum, the actual earnings of their telephone, or ETS, were irrelevant." With no capital appreciation or participation in earnings, there were no "profits," and thus, the agreements were not securities under the investment contract definition.
In addition, the court found that the earnings were not derived solely from the efforts of others. "Because their returns were contractually guaranteed, those returns were not derived from the efforts of Edwards or anyone else at ETS; rather, they were derived as a benefit of the investors' bargain under the contract." In essence, the court turned to the fixed-rate return element of the contract to hold that there were no profits and that the efforts of others were irrelevant.
While the main opinion did not provide a holding on commonality, the Eleventh Circuit's opinion contains a concurring opinion by U.S. Circuit Judge, Donald P. Lay, a visiting judge from the Eighth Circuit, which states that horizontal commonality should apply in the Eleventh Circuit. In his opinion, "horizontal commonality is the only valid test for a common enterprise." "Proof of horizontal commonality is required because requiring only proof of broad vertical commonality makes Howey's third prong - expectation of profits to be derived from the efforts of others - superfluous." His arguments will be outlined in more detail in Part V.B of this note.
However, Judge Lay concluded that even if the horizontal commonality test were applied, the SEC would still have failed to satisfy the common enterprise prong. He came to this conclusion by adopting the holding of the main opinion, which focused on the contractual nature of the returns and noted that investors did not pool their funds together but instead received profits on a fixed-rate return.
D. The Supreme Court
When the Supreme Court addressed the Eleventh Circuit's opinion, Justice O'Conner's unanimously adopted opinion focused on the policy reasons behind the Howey test. "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.'" By so doing, it rejected the claim that profits were limited by the Forman opinion.
Thus, when 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, other periodic payments, or the increased value of the investment.
With that framework in mind, the court held that "[t]here is no reason to distinguish between promises of fixed returns and promises of variable returns." The Justices argued that the Howey test was intended to be broad enough to include fixed-rate returns, similar to how state blue sky laws, the precursors to the Howey test, included fixed-rate returns in the definition of securities. Besides, "investments pitched as low-risk (such as those offering a 'guaranteed' fixed return) are particularly attractive to individuals more vulnerable to investment fraud." For this reason, the securities laws should protect investors by classifying some fixed-rate return agreements as securities. "The fact that investors have bargained for a return on their investment does not mean that the return is not also expected to come solely from the efforts of others." The opinion makes absolutely clear "that an investment scheme promising a fixed rate of return can be an 'investment contract' and thus a 'security' subject to the federal securities laws." Nevertheless, the court did not address the commonality question of what test to apply under the common enterprise prong of the Howey test. The Court gave no opinion regarding the three-way circuit split previously discussed in this note.
IV. The Supreme Court's Avoidance of the Circuit Split
There are several reasonable explanations for the Supreme Court's avoidance of the subject. For example, the Supreme Court may have realized that, at best, it could only reach a plurality opinion if it were to address the issue. Another possible explanation is that this case arises under the procedural posture of injunctive relief without a full recitation of the facts. However, this reason is implausible because questions of law can be settled upon appellate review of injunctive orders. This note instead takes the position that the Supreme Court, while interested in resolving the circuit split, was not able to address the commonality question given the specific facts and circumstances of this case.
This view is based on the oral arguments at the Supreme Court on Tuesday, November 4, 2003. The Court was fully aware of the three-way circuit split and even asked Solicitor General Theodore B. Olsen for his opinion. However, in the end, the court wrote an opinion on fixed-rate returns only.
A. Supreme Court's Desire to Address the Issue
During the oral arguments for Sec. & Exch. Comm'n v. Edwards, a number of Supreme Court justices indicated their desire to address the three-way circuit court split. One justice remarked early on that "we could just talk about these facts and it'd be a case good for this ride only, but we're wondering about whether or not these facts yield certain insights as to what might be definitional principles for an investment contract." To this observation Solicitor General Olsen stated that "the question presented here is considerably more narrow, the question presented here is, is it disqualified as an investment contract simply because the return is fixed or specified?" He continued to say that if the Supreme Court were to provide an opinion on this narrow topic, the Court's holding would be enough to prevent a "super highway loophole … in the Securities Act." If investment contracts were only to apply to variable-rate returns, companies would simply restructure their transactions to fixed-rate returns to avoid the securities laws.
But the Supreme Court Justices still wanted to address the three-way circuit split. While they agreed that they could "remand it to the Eleventh Circuit for it to figure out the puzzle," one Justice was not satisfied and crystallized the issue by asking: "So isn't the question about the individual transaction really related to the conflict of this horizontal and vertical distinction that Judge Lay relied on in his concurring opinion?" Again, Solicitor General Olsen avoided the subject of commonality by stating: "Judge Lay discussed that in his concurring opinion, but the court did not rely upon that, the parties have not briefed that, and that question is not before the Court."
As Solicitor General Olsen pointed out, one of the main reasons the parties did not address the commonality circuit court split stems from the fact that the question was not in front of the court. When petitioning for Writ of Certiorari, the question presented by the SEC dealt with the rate of return question only. Since the SEC was the petitioner, it did not seek a review of the circuit split because Eleventh Circuit's application of the broad vertical approach is the easiest for the SEC to satisfy.
A request to review the commonality split would have given the Supreme Court the opportunity to apply a more difficult standard in establishing whether a certain transaction or scheme was a security through the investment contract clause. The Supreme Court did not hear oral arguments on the subject and did not receive briefs from the parties regarding which test to apply since commonality was not the reason the Eleventh Circuit overturned the district court. Instead, the Court chose to render a unanimous opinion stating that fixed-rate returns could be considered an investment contract and hence a security.
B. When the Three-Way Circuit Split Will be Resolved
Since the SEC faces the most difficult commonality standard (horizontal) in the majority of circuits, it is not going to argue against those circuits applying easier commonality standards. Also, in those circuits adopting the horizontal commonality requirement, the SEC has conceded in briefs that the horizontal commonality test is the only practical interpretation of the Supreme Court's common enterprise test in Howey. Thus, for the Supreme Court to hear the three-way circuit split question, the petition will need to come from a business owner accused of alleged securities violations in a vertical commonality circuit.
Under this type of factual scenario, a business owner would seek to reverse an adverse circuit court decision imposed under the vertical commonality approach by arguing that the horizontal commonality approach is a more equitable national standard. This individual would petition the Supreme Court to clarify which commonality test should be applied in defining an investment contract. The petitioner would argue for horizontal commonality since it is the most difficult standard for the SEC to prove. In this scenario, the commonality test chosen would determine whether the scheme was an investment contract and, thus, a security subject to federal anti-fraud laws.
Edwards was not this petitioner. While he did argue in front of the Eleventh Circuit that the horizontal commonality test should be applied to the common enterprise prong of the Howey test, the court did not reverse the district court on this theory. In fact, the Eleventh Circuit did not even enter a judgment on the common enterprise prong. The court reversed the district court on the "profits to come solely from the efforts of others" prong.
On remand, Edwards could become the petitioner needed to address the three-way circuit split. The Eleventh Circuit will need to change its opinion of the "profits to come solely from the efforts of others" prong to be consistent with the Supreme Court's holding, thus forcing the court to address whether Edwards' payphone business is a common enterprise. If the Eleventh Circuit were to rule that Edwards' company qualifies as a common enterprise under the broad vertical commonality test, the easiest standard to satisfy, then Edwards could petition the Supreme Court to determine whether the Eleventh Circuit applied the correct test or whether the horizontal commonality test should have been applied. The differences in the tests would change the determination of whether the aggregate contracts constituted an investment contract and, thus, a security.
V. The Horizontal Approach Should be Adopted
This now leaves one final question: What will the Supreme Court do once they receive a case questioning which common enterprise prong test is appropriate? A look into the facts of Howey will provide insight into why the horizontal approach should be adopted as this Supreme Court opinion was the origin of the investment contract test, including its vague term of common enterprise. Additionally, the defects associated with the other commonality tests make clear that the horizontal commonality approach should be adopted.
A. Facts of the Howey Decision Led to the Horizontal Commonality Approach
In the Howey opinion, W. J. Howey Company, a Florida corporation, owned large quantities of citrus land. Its sister company, Howey-in-the-Hills Service Inc., another Florida company, serviced the land by harvesting and marketing the crops. "Each prospective customer [was] offered both a land sales contract and a service contract."
In its analysis, the Supreme Court examined individual investor input and return on investment. Each investor was subject to a "uniform purchase price per acre" which was simply "a convenient method of determining the investors' allocable shares of the profits." The average tract of land a customer bought was 1.33 acres, too small to perform individual citrus operation. The "tracts [were] not separately fenced and the sole indication of several ownership [was] found in small landmarks intelligible only through a plat book record."
The Supreme Court also looked at investor output or return on investment. Each investor had "no right to specific fruit" at the time of the fruit harvest. "All the produce [was] pooled by the respondent companies." Thus, the proceeds were combined in one venture prior to their distribution to individual investors.
The Supreme Court further considered the investors' relationship with each other. Each investor owned a piece of land on which it "would seldom be economically feasible due to [its] small size" to support its own citrus operation. "Such tracts gain utility as citrus groves only when cultivated and developed as component parts of a larger area." It was thus by "pooling" many investors' assets or resources together, such as land, that a "utility" was gained, since the "component parts" were part of a "larger" whole.
These sentences were directly applicable to the common enterprise prong since the court's next sentence spoke of the importance of the common enterprise. The Supreme Court stated, "[a] common enterprise managed by respondents or third parties with adequate personnel and equipment is therefore essential if the investors are to achieve their paramount aim of a return on their investments." In Howey, the common enterprise prong was satisfied using horizontal commonality. The investments of land were "component parts" and the proceeds or returns on investment were "pooled" by the common "larger area" citrus operation.  The Supreme Court focused on the relationship among investors, the same relationship that horizontal commonality scrutinizes.
B. Defects in the Vertical Commonality Common Enterprise Approaches
Each of the three common enterprise approaches comes with certain defects and critiques. Both of the vertical commonality approaches are justly criticized by author Marc G. Alcser. However, Alcser unjustly criticizes the horizontal commonality test for requiring multiple investors and, thus, not providing adequate protection to the individual investor.
The narrow vertical approach "does not comport with the purposes of the Securities Acts because it emphasizes form over substance." "The narrow vertical approach focuses on the terms of the agreement rather than the undisclosed risks that an investor faces." This violates Howey's express policy of flexible interpretation and application. Consequently, "promoters could avoid regulation simply by choosing a flat-rate commission rather than a share of the profits." To avoid the securities regulations, a promoter can contractually break the link between the risk of investor return and the risk of promoter return.
The broad vertical approach "may discriminate against investors that possess expertise in a scheme" because reliance on the expertise of another is required. If an investor possesses the same expertise as the promoter, the investor's investment might not be considered a common enterprise. Also, as stated earlier, "the broad vertical approach essentially duplicates the fourth element of the Howey test." The promoter's expertise is already an element of the Howey test by reference to the "profits to come from the efforts of others" language. Therefore, the broad vertical approach voids any possibility that the term "common enterprise" has its own meaning.
C. No Defect to Horizontal Approach
Alcser's critique of the horizontal approach is nonetheless defective because he confuses the relationship among multiple investments a single investor holds with the relationship among multiple investors in a single enterprise. Financial planners agree that having a diverse investment portfolio "lowers the risk [of loss] because … a decrease in the value of one asset [can be] offset by a corresponding increase in the value of another asset." However, to determine whether an investment contract is a security, the question is not how many assets a single investor possesses, but how many investors are in a common enterprise. The question goes to the diversity of the common enterprise, not to the diversity of an individual investor's investment portfolio. To find differently would mean that an investment for one investor could be a security, while the same investment to another investor would not be a security simply because of the difference in their investment portfolios. The court looks to the group of investors rather than to the group of investments a single investor may hold.
Moreover, since a horizontal approach requires multiple investors, Alcser criticizes the horizontal approach for not adequately protecting a single investor. This criticism is unwarranted. Securities laws expressly provide for a private exception to small companies seeking capital from a small group of investors. While it may seem there is an "arbitrary lack of protection for single investors," the United States Congress has created this distinction through the creation of the private offering exemptions.
Single investors possess other sources of protection, such as state contract, anti-fraud, and securities laws. They can also choose to do business with large public enterprises that are subject to the securities laws. A single investor should be extremely wary of any investment in which he is the sole investor. That investor will need to use his own due diligence in a private transaction and should not rely on the federal securities laws to protect him. The government cannot protect every individual from a bad business investment through the securities laws. The federal securities system is not intended to protect a single investor in a private transaction but to protect multiple investors in a common enterprise.
D. Judge Lay's Concurring Opinion in Sec. & Exch. Comm'n v. ETS Payphones, Inc.
Adoption of the horizontal approach is warranted by the fact that the Howey facts led the Supreme Court to conclude a common enterprise was satisfied by an analysis akin to the horizontal commonality analysis and by the fact that there is no compelling criticism of the horizontal approach. Further, U.S. Circuit Judge, Donald P. Lay, a visiting judge from the Eighth Circuit, articulated other reasons why the horizontal approach should be adopted in his concurring Eleventh Circuit opinion of Sec. & Exch. Comm'n v. ETS Payphones, Inc.
Judge Lay correctly argues that horizontal commonality should apply because "horizontal commonality is the only valid test for a common enterprise." "Proof of horizontal commonality is required because requiring only proof of broad vertical commonality makes Howey's third prong - expectation of profits to be derived from the efforts of others - superfluous." If the common enterprise test looks to "the expertise or efforts of the investment promoter" then the phrase "common enterprise" has no unique meaning. If the Supreme Court intended the "common enterprise" to have any meaning separate from the other elements of the Howey test, "requiring proof of horizontal commonality is the only logical approach to understanding the concept of a common enterprise."
The SEC has conceded this point in one of its briefs. In its brief to the First Circuit, the SEC wrote that "[t]he commission has also long taken the position that broad vertical commonality is not an appropriate test because it collapses the second prong of the Howey test into the third prong." The First Circuit went on to rule that the horizontal commonality test applies to the common enterprise prong of the Howey test.
In summary, the Supreme Court in Sec. & Exch. Comm'n v. Edwards clearly states that fixed-rate returns can be classified as securities under the definition of an investment contract. The fixed-rate return satisfies "the profits derived solely from the efforts of others" prong of the Howey test. However, the same opinion did not address the "common enterprise" prong of the investment contract test. The Supreme Court left a three-way circuit split unresolved.
A common enterprise has been defined by horizontal commonality, narrow vertical commonality, or broad vertical commonality. Despite the Supreme Court's desire to resolve the split and the Eleventh Circuit's discussion of the differences among the approaches, the Eleventh Circuit's opinion did not hinge on the commonality definition and hence did not give the Supreme Court the opportunity to resolve the circuit split. Only the horizontal commonality test can be supported by history and practice. The facts of the Howey opinion show that the Supreme Court relied on horizontal commonality analysis in that case. Furthermore, the vertical commonality tests have practical defects inconsistent with the Howey opinion. Therefore, when the proper set of facts comes before the Supreme Court, the Court should adopt the horizontal commonality approach.
 "Congress' intent [was] to regulate all of the 'countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.'" Sec. & Exch. Comm'n v. Edwards, 540 U.S. 389, 396 (2004) (quoting Sec. & Exch. Comm'n v. W.J. Howey Co., 328 U.S. 293, 299 (1946)). See also United Hous. Found. v. Forman, 421 U.S. 837, 849 (1975) ("The primary purpose of the Acts of 1933 and 1934 was to eliminate serious abuses in a largely unregulated securities market.").
 Section 2(1) of the Securities Act of 1933 defines a security as "any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, or, in general, any interest or instrument commonly known as a 'security,' or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing." 15 U.S.C. § 77b(a)(1).
 Section 3(a)(10) of the Securities and Exchange Act of 1934 defines a security as "any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a 'security;' or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or bankers acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." 15 U.S.C. § 78c(a)(10).
 Reves v. Ernst & Young, 494 U.S. 56, 60-61 (1990) ("Congress painted with a broad brush. It recognized the virtually limitless scope of human ingenuity, especially in the creation of 'countless and variable schemes devised by those who seek the use of the money of others on the promise of profits,' and determined that the best way to achieve its goal of protecting investors was to define the term 'security' in sufficiently broad and general terms so as to include within that definition the many types of instruments that in our commercial world fall within the ordinary concept of a security.'").
 Id. at 298 ("[T]he term was common in many state 'blue sky' laws in existence prior to the adoption of the federal statute.") Blue sky laws were state laws that are the precursors to the federal securities regulations.
 "The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Sec. & Exch. Comm'n v. W.J. Howey Co., 328 U.S. 293, 301 (1946). Some courts define it as a three-part test by combining the "common enterprise" and "profits to come solely from the efforts of others" as one prong. See Sec. & Exch. Comm'n v. ETS Payphones, Inc., 300 F.3d 1281 (11th Cir., 2002).
 See generally, Sec. & Exch. Comm'n v. ETS Payphones, Inc., 300 F.3d 1281, (11th Cir., 2002). Note that the ETS Payphones, Inc. was the defendant in the district court and Eleventh Circuit decision but that Edwards, a co-defendant in the two lower court decisions and sole owner of ETS and other subsidiaries in question, is the sole defendant in front of the Supreme Court, hence, the name change. The facts in question are the same for all three cases. The Eleventh Circuit's decision is outlined in Part III.
 "Pool" is defined as "[a]n association of individuals or entities who share resources and funds to promote their joint undertaking; esp., an association of persons engaged in buying or selling commodities." Black's Law Dictionary, 7th ed., 1180.
 Sec. & Exch. Comm'n v. SG Ltd., 265 F.3d 42 (1st Cir., 2001) ("Courts are in some disarray as to the legal rules associated with the ascertainment of a common enterprise. See generally II Louis Loss & Joel Seligman, Securities Regulation 989-97 (3d ed. rev.1999). Many courts require a showing of horizontal commonality--a type of commonality that involves the pooling of assets from multiple investors so that all share in the profits and risks of the enterprise. Other courts have modeled the concept of common enterprise around fact patterns in which an investor's fortunes are tied to the promoter's success rather than to the fortunes of his or her fellow investors. This doctrine, known as vertical commonality, has two variants. Broad vertical commonality requires that the well-being of all investors be dependent upon the promoter's expertise. In contrast, narrow vertical commonality requires that the investors' fortunes be 'interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties.'")
 Wasnowic v. Chicago Board of Trade, 352 F.Supp. 1066 (D. Pa., 1972), aff'd without opinion, 491 F.2d 752 (3d Cir., 1973), cert. denied, 94 S.Ct. 2405 (1974). See also Salcer v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 682 F.2d 459, 460 (3d Cir.,1982).
 Id. ("Courts must consider 'the egregiousness of the defendant's actions, the isolated or recurrent nature of the infractions, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupations will present opportunities for future violations.'") (Quoting SEC v. Int'l Heritage, Inc., 4 F.Supp.2d 1368, 1372 (D. Ga., 1998))
 Id. at 1283-84. (As Edwards points out, there is disagreement among the circuits as to the requirements of the second prong of the Howey test. "Most circuits that have considered the issue find it satisfied where a movant shows 'horizontal commonality,' that is the 'pooling' of investors' funds as a result of which the individual investors share all the risks and benefits of the business enterprise.")
 Judge Lay wrote, "With all due respect to the law of this circuit, which I am bound to follow as a visiting judge, I must respectfully disagree that this panel is bound by precedent to require only proof of broad vertical commonality." Id. at 1286 (Lay, J., Concurring).
 Judge Lay also rejects the Eleventh Circuit's reliance on the Fifth Circuit's opinion that requires vertical commonality prior to the creation of the Eleventh Circuit. Id. at 1286 The Eleventh Circuit "adopted as binding precedent all decisions of the former Fifth Circuit handed down prior to the October 1, 1981." Id. at 1287 n. 4. While the Fifth Circuit's Villeneuve panel created the broad vertical commonality test, that decision was later vacated in an en banc decision that did not address the commonality part of the panel's decision. "When the full circuit court vacates a panel decision and hears a case en banc, the panel opinion and judgment are totally vacated and, thus, have no precedential value in whole or in part." Id.; See also 11th Cir., R. 26(k). Subsequent cases in the Fifth Circuit also incorrectly rely on this vacated panel decision. Id at 1287.
 Id. at 395.; In oral arguments, Solicitor General Olsen focused on why fixed-rate returns could be an investment contract by specifically citing state securities cases that dealt with fixed-rate return investments that were used in creating the Howey test. Transcript of Oral Argument at 14, Sec. & Exch. Comm'n v. Edwards, 124 S.Ct. 892 (2004) (No. 02-1196); see People v. White, 124 Cal.App. 548 (1938); Stevens v. Liberty Packing Corp., 111 N.J.Eq. 61 (1932). He also showed that within the definition of security, some of the expressly listed items that were included as securities were fixed-rate return investment products. Transcript of Oral Argument at 5, 15, Sec. & Exch. Comm'n v. Edwards, 124 S.Ct. 892 (2004) (No. 02-1196).
 FPP § 3921.1 ("Appellate consideration of interlocutory injunction appeals … ordinarily focuses on the injunction decision itself, but the scope of appeal is not rigidly limited. Even with respect to preliminary injunction decisions, other matters may be inextricably bound up with the decision or may be considered in the wise administration of appellate resources. Interlocutory appeals with respect to permanent injunctions frequently require decision of the merits. As flexible as the scope of the appeal can be, however, the opportunity to seek review of matters beyond the injunction determination usually should not become a command that forces forfeiture of matters that might have been urged but were not. These propositions are explored in turn in the following pages.").
 Id.; This is also reiterated in a separate question by one of the justices. "So your point is that's all we have to decide, whether the fact that it's a fixed return excludes it from the definition of a security?" Id.
 Whether the court of appeals erred in dismissing the complaint on the ground that an investment scheme is excluded from the term "investment contract" in the definitions of "security" in Section 2(a)(1) of the Securities Act of 1933, 15 U.S.C. 77b(a)(1), and Section 3(a)(10) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(10), if the promoter promises a fixed rather than variable return or if the investor is contractually entitled to a particular amount or rate of return. Petition for a Writ of Certiorari, Sec. & Exch. Comm'n v. Edwards, 540 U.S. 389 (2004) (No. 02-1196).
 Sec. & Exch. Comm'n v. ETS Payphones, Inc., 300 F.3d 1281, 1286 (11th Cir., 2002) (Lay, J., Concurring) ("Indeed, in its arguments in a case out of the First Circuit, the SEC concedes that this reason is correct and broad vertical commonality is an inappropriate test for Howey's common enterprise requirement.").
 Id.; It should be noted that the facts parallel the Edwards case in that the service contracts were controlled by a separate corporation. Both cases dealt with a purchase and lease-back agreement. See generally, the facts of Sec. & Exch. Comm'n v. ETS Payphones, Inc., 123 F. Supp. 2d 1349 (D. Ga., 2000). The Howey case is an important decision in the investment contract analysis. Edwards adds significantly to that analysis.
 Id.; While the court quickly mentioned that the investors lacked "the knowledge, skill and equipment necessary for the care and cultivation of citrus trees," the court focused on the pooling of the assets of these investors. The court made the expertise analysis only after first showing all the reasons why the pooling of funds constituted a common enterprise. It most likely looked to the promoter's expertise at this time only to show that the next element of "profits to come solely from the efforts of others" was satisfied. Sec. & Exch. Comm'n v. W.J. Howey Co., 328 U.S. 293, 296 (1946),
 The confusion is evident from the argument that "a single investor may face an even greater risk of loss if her sole asset performs badly than if she pools the failing asset with others that succeed." Alcser, Supra note 11, at 1233.
 Limited Offering Exemptions: Regulation D; In fact, the ETS Payphones decision of the district court addressed the private exemption (without saying it) in its recitation of the facts. The facts show that ETS did not qualify for the private exemption. Sec. & Exch. Comm'n v. ETS Payphones, Inc., 123 F.Supp.2d 1349, 1351-52 (D. Ga., 2000).