Opinion
No. C-830
Decided November 15, 1976. Rehearing denied December 27, 1976.
The Colorado Securities Commissioner issued a cease and desist order directing New York corporation to refrain from solicitation of certain "investment contracts" determined to be a "security" within the Colorado Securities Act. The district court affirmed on review, the Court of Appeals affirmed in part and reversed in part, 36 Colo. App. 417, 543 P.2d 75 and certiorari was granted.
Reversed
1. SECURITIES REGULATION — "Security" — Definition — Federal and State — Parallel — Federal Cases — Persuasive. In view of fact that the definition of "security" in the federal Securities Act of 1933 ( 15 U.S.C. § 77(b)(1)) is parallel to Colorado's definition, and since "investment contract" is included as a "security" under both statutes, federal cases on the subject can be persuasive to the supreme court.
2. Investment Contract — Definition. An investment contract for the purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.
3. Cease and Desist — Order — Validity — Elements. For the Colorado commissioner's cease and desist order to have validity, the agreements must have the following elements: (1) an investment by an inventor; (2) the investment is in a common enterprise; and (3) the inventor is led to expect profits from the efforts of the company or a third party.
4. Invention and Marketing Agreements — "Common Enterprise" — "Investment Contracts" — Negative. Invention agreements and marketing agreements between New York corporation and Colorado inventors — which required inventor to pay a fee and assign a percentage interest in his invention or a commission in exchange for corporation's efforts to develop and market invention — did not possess the "common enterprise" element of "investment contracts," and were therefore not a "security" within scope of definition of section 11-51-102(12), C.R.S. 1973, of the Colorado Securities Act; Commissioner was therefore without jurisdiction to enter cease and desist order directing corporation to refrain from solicitation of contracts.
Certiorari to the Colorado Court of Appeals
Holme, Roberts Owen, Donald K. Bain, Paul A. Jacobs, Omer Griffin, Eaton, Van Winkle and Greenspoon, for petitioner.
J. D. MacFarlane, Attorney General, Jean E. Dubofsky, Deputy, Edward G. Donovan, Solicitor General, Harry N. MacLean, First Assistant, for respondents.
Norman G. Axe, for amici curiae.
This is on certiorari to the Colorado Court of Appeals to review the decision under the same title to be found in 36 Colo. App. 417, 543 P.2d 75 (1975). The petitioner (The Raymond Lee Organization, Inc.) solicited inventors to enter into contracts, which were of three types. The Colorado Securities Commissioner determined that each type of contract was an "investment contract" and, as such, was a "security," within the scope of the definition of the Colorado Securities Act, section 11-51-102(12), C.R.S. 1973. He issued a cease and desist order directing the petitioner to refrain from the solicitation of the contracts. Upon review under section 11-51-121, C.R.S. 1973, the district court affirmed the decision of the commissioner. On appeal the court of appeals reversed the district court and the commissioner as to one of the contracts and affirmed with respect to the other two. Only the portion affirmed by the court of appeals is here. We reverse.
The three contracts involved are: "Preliminary Product Research Agreement" (Preliminary Agreement), "Development of Invention Agreement" (Invention Agreement) and the "Product and Marketing Development Agreement" (Marketing Agreement). The court of appeals held that the Preliminary Agreement was not an "investment contract," and reversed as to it. Thus we are here concerned only with the Invention Agreement and the Marketing Agreement.
The petitioner solicits ideas and inventions, offering to assist in the development, research, introduction and marketing of the same. It has three departments: engineering, licensing and marketing. We use in substantial part the description of the three contracts given by the court of appeals.
In the Preliminary Agreement, for a fee of $100, the petitioner examines the inventor's proposal, classifies the proposal as to subject matter, researches the record of prior patents relating to the proposal, secures copies from the U.S. Patent Office of patents of related inventions, and presents to the inventor the results of this investigation and proposed procedures for further action.
Under the Invention Agreement, the inventor pays a fee and assigns a percentage interest in the invention to the petitioner. From the briefs filed here, it would seem that the fees range from $675 to $1175, and that the amounts of interest assigned in the invention are from 10% to 20%. Upon entering into the Invention Agreement, the petitioner is to develop and refine the invention for preparation of suitable illustrations, to prepare formal patent drawings and the description to be included in the patent application, to prepare a sales letter and prospectus embracing the general function of the proposal; to contact prospective manufacturers and seek opportunities to negotiate the sale or licensing of the invention; to publicize the invention in consumer and trade publications; and to actively negotiate with those manufacturers expressing an interest in the proposal.
The Marketing Agreement provides for essentially the same services as the Invention Agreement. It requires the inventor to pay a fee plus a commission on any net proceeds received as a result of petitioner's efforts. The particular form of this agreement referred to our attention by the petitioner requires a fee of $375 and a commission of 20%.
In affirming the commissioner's action as to the Invention Agreement and the Marketing Agreement, the court of appeals considered three issues: (1) whether petitioner was denied due process of law; (2) whether the Commissioner's findings of fact were supported by sufficient evidence; and (3) whether either the Invention Agreement or the Marketing Agreement is a "security" as defined in section 11-51-102(12), C.R.S. 1973. We hold that neither of these two agreements is a "security" and, therefore, do not reach the other two issues decided by the court of appeals.
Distilling the issue here considered, the question is whether either of these agreements constitutes an "investment contract" under the statutory definition of "security." The statute cited above reads in part:
"'Security' means 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 of subscription; transferable share; investment contract . . . 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, guarantee of, or warrant or right to subscribe to or purchase any of the foregoing."
[1] As a basis, we follow the path blazed in the opinion announced contemporaneously with this one, written by Mr. Justice Erickson, in Lowery v. Ford Hill Investment Co., 192 Colo. 125, 556 P.2d 1201. There it is stated that the definition of "security" in the federal Securities Act of 1933 ( 15 U.S.C. § 77 b (1) is parallel to Colorado's definition; that "investment contract" is included as a "security" under both statutes; and that, therefore, federal cases on the subject can be persuasive to us. See Sauer v. Hays, 36 Colo. App. 190, 539 P.2d 1343 (1975).
[2] The mother-lode definition, from which emanate the flakes of judicial extension, is found in S.E.C. v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), as follows:
"An investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . . ."
[3] For the commissioner's cease and desist order to have validity, the agreements must have the following elements: (1) an investment by an inventor; (2) the investment is in a common enterprise; and (3) the inventor is led to expect profits from the efforts of petitioner or a third party. See United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975).
It is evident that those contracts possess elements (1) and (3). We differ with the rulings of the other tribunals in this case solely by reason of (2), the "common enterprise" element. The court of appeals found this as its most difficult problem. It concluded not to follow Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.) cert. denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144 (1972). This conclusion was reached because it felt that the Milnarik interpretation of "common enterprise" had been rejected as too stringent by S.E.C. v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974). We think it appropriate to follow Milnarik, and do so.
Koscot dealt with a pyramid promotion plan which involved the sale of cosmetics. As the first phase, the promotor solicited persons to become "beauty advisors". The beauty advisors were in reality retail salesmen who purchased cosmetics from the promotor at a discount. In the second phase, the promoter would make a beauty advisor a "supervisor," if the person made a $1,000 investment with the promotor. In the event that the supervisor persuaded other beauty advisors also to become supervisors and make the investment, the first supervisor received returns on his investment. Under the third phase, upon an investment of $5,000, a supervisor became a "distributor." The distributor would receive returns from his investment upon recruiting supervisors or other distributors. Intermingled in the plan was the purchase and sale of cosmetics from the promoter at different discounts.
We have no trouble regarding the plan in Koscot as common enterprise in which, as there stated, the "fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties." This factor we do not find in the instant case, nor in Milnarik.
In the present matter, no other inventor acquired any interest in, nor received any direct benefit from, a particular inventor's invention. While, as in any business or profession, the petitioner had overhead, the proceeds from sale or license of one invention did not go to the holder of another invention.
In Milnarik, supra, the plaintiffs deposited money with defendant upon the understanding that the defendant would use the funds at defendant's discretion to trade commodity futures for the benefit of the plaintiffs. This investment was made under a written agreement between plaintiffs and defendant. The defendant made various trades on margin, resulting in a greater loss than the amount invested and, under the terms of the agreement, made demand on plaintiffs for additional money. The plaintiffs then sought to rescind the agreement on the ground that it was a "security" under the Securities Act of 1933. In affirming the United States District Court the court stated:
"We find the element of commonality absent here. Although the complaint does allege that [defendant] entered into similar discretionary arrangements with other customers, the success or failure of those other contracts had no direct impact on the profitability of plaintiffs' contract. [Defendant's] various customers were represented by a common agent, but they were not joint participants in the same investment enterprise."
[4] We hold, therefore, that the Invention Agreement and the Marketing Agreement do not possess the element of "common enterprise" and that the Commissioner is without jurisdiction to enter the cease and desist order.
We are not unmindful — and indeed we are quite cognizant — of the possibilities presented to us of deception and other undesirable practices that may be practiced upon inventors. Such possible deception and practices may well be on the subject of statutory prohibitions to be enacted and, conceivably, in some part may now be proscribed by other existing statutes. We simply hold that the Colorado Securities Act (section 11-51-101, et seq., C.R.S. 1973), which is here involved, does not apply in this case.
The matter is returned to the court of appeals for remand to the end that the complaint before the commissioner be dismissed.
MR. CHIEF JUSTICE PRINGLE, MR. JUSTICE ERICKSON and MR. JUSTICE CARRIGAN dissent.