Thursday, January 14, 2016

Securities and Exchange Commission vs., Inc. [GR 164197, January 25, 2012]

FACTS: Prosperity.Com, Inc. (PCI) sold computer software and hosted websites. To make a profit, PCI devised a scheme in which for the price of US$234.00, a buyer would acquire from it an internet website of a 15-mega byte (MB) capacity. At the same time, by referring to PCI his own down-line buyers, a first-time buyer could earn commission, interest in real estate, and insurance coverage. To benefit from this scheme, a PCI buyer must enlist and sponsor at least two other buyers as his own downlines. These second tier of buyers could in turn build up their own downlines. For each pair of downlines, the buyer-sponsor receives at US$92.00 commission. But referrals in a day by the buyer-sponsor should not exceed 16 since the commissions due from excess referrals inure to PCI, not to the buyer-sponsor. SEC ruled that PCI's scheme constitutes an investment contract and, following the Securities Regulation Code, it should have first registered such contract or securities with the SEC.

ISSUE: Whether or not PCI's scheme constitutes an investment contract

RULING: No. An investment contract is a 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 United States Supreme Court held in Securities and Exchange Commission v. W.J. Howey Co. that, for an investment contract to exist, the following elements, referred to as the Howey test must concur: (a) a contract, transaction, or scheme; (b) an investment of money; (c) investment is made in a common enterprise;  (d) expectation of profits; and (e) profits arising primarily from the efforts of others.

In this case, PCI's clients do not make such investments. They buy a product of some value to them: an internet website of a 15-MB capacity. The client can use this website to enable people to have internet access to what he has to offer to them. The buyers of the website do not invest money in PCI that it could use for running some business that would generate profits for the investors. The price of US$234 is what the buyer pays for the use of the website, a tangible asset that PCI creates, using the computer facilities and technical skills.

The commission, interest in real estate, and insurance coverage are incentives to downline sellers to bring in other customers. These can hardly be regarded as profits from investment of money under the Howey test. The CA is right in ruling that the last requisite in the Howey test is lacking in the marketing scheme that PCI has adopted. Evidently, it is PCI that expects profit from the network marketing of its products. PCI is correct in saying that the US$234 it gets from its clients is merely a consideration for the sale of the websites that it provides.

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