What is a Broker-Dealer? - Davis Polk & Wardwell

What Is a Broker-Dealer? § 1A:4.2
case, SEC v. W.J. Howey Co., the U.S. Supreme Court defined an
“investment contract” as “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.” 246 The
definition establishes a four-part test in determining whether a particular
scheme is an investment contract. Specifically, the test requires
that there is:
(i) an investment of money;
(ii) in a common enterprise;
(iii) with an expectation of profits;
(iv) which are derived solely from the efforts of the promoter.
[B] Investment of Money
The investment does not have to be in the form of “money,” but it
can be any form of consideration in return for a separable financial
interest with the characteristics of a security. 247
[C] Common Enterprise
There is a split in authority among the federal circuit courts
regarding what constitutes a “common enterprise.” A majority of the
circuit courts require or recognize a showing of “horizontal commonality”
which involves the pooling of assets from multiple investors
in such a manner that all share in the profits and risks of the
enterprise. 248 In horizontal commonality, the fortunes of each investor
depend upon the profitability of the enterprise as a whole. 249
246. W.J. Howey Co., 328 U.S. at 298–99.
247. Int’l Bhd. Teamsters v. Daniel, 439 U.S. 551, 559 (1979).
248. The First, Second, Third, Fourth, Sixth, Seventh and D.C. Circuits have
recognized “horizontal commonality” as satisfying the requirement of
“common enterprise.” See, e.g., SEC v. SG Ltd., 265 F.3d 42 (1st Cir.
2001); Revak v. SEC Realty Corp., 18 F.3d 81 (2d Cir. 1994); SEC v. The
Infinity Group Co., 212 F.3d 180, 188 (3rd Cir. 2000), cert. denied, 532
U.S. 905 (2001); Teague v. Bakker, 35 F.3d 978 n.8 (4th Cir. 1994);
Newmyer v. Philatelic Leasing, Ltd., 888 F.2d 385 (6th Cir. 1989); Union
Planters Nat’l Bank of Memphis v. Commercial Credit Bus. Loans, Inc.,
651 F.2d 1174 (6 Cir. 1981), cert. denied, 454 U.S. 1124 (1981); Cooper v.
King, 114 F.3d 1186 (6th Cir. 1997); SEC v. Lauer, 52 F.3d 667, 670 (7th
Cir. 1995); Wals v. Fox Hills Dev. Corp., 24 F.3d 1016 (7th Cir. 1994); SEC
v. Banner Fund Int’l, 211 F.3d 602 (D.C. Cir. 2000); SEC v. Life Partners,
Inc., 87 F.3d 536, 543 (1996), reh’g denied, 102 F.3d 587 (D.C. Cir. 1996).
249. Revak, 18 F.3d 81 (citing Hart v. Pulte Homes of Michigan Corp., 735 F.2d
1001 (6th Cir. 1984) (horizontal commonality ties the fortunes of each
investor in a pool of investors to the success of the overall venture; a
finding of horizontal commonality requires a sharing or pooling of funds)).
(Broker-Dealer Reg., Rel. #9, 9/10)
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