Supreme Court of Canada
Pacific Coast Coin Exchange v. Ontario Securities Commission,
[1978] 2 S.C.R. 112
Date: 1977-11-16
In the Matter of
the Securities Act, R.S.O. 1970, Chapter 426 and Amendments Thereto:
And in the Matter
of Pacific Coast Coin Exchange of Canada Limited (Plaintiff)
Appellant;
And in the Matter
of Monex International Ltd., Carrying on Business Under the Firm Name of Pacific Coast Coin Exchange (Plaintiff) Appellant;
and
Ontario Securities Commission (Defandant) Respondent.
1977: February 15, 16; 1977: November 16.
Present: Laskin C.J. and Martland, Judson,
Ritchie, Spence, Pigeon, Dickson, Beetz and de Grandpré JJ.
ON APPEAL FROM THE COURT OF APPEAL FOR
ONTARIO.
Securities legislation—Scope of
legislation—Offering for sale of silver coins “on margin”—Commodity account
agreement—“Investment agreement”—Tests of commonality of enterprise, dependence
on others for profitability—Risk capital approach—Duty of Courts to give effect
to legislative policy—The Securities Act, R.S.O. 1970, c. 426, ss. 1, 35.
Appellant operated a scheme designed to
enable members of the public to speculate in silver coins. It commenced
business in Ontario in 1973 and
its activities in that province consisted primarily of offering for sale,
selling and delivering bags of silver coins in specie and offering for sale and
selling bags of silver coins on margin. The appeal before the Supreme Court
concerned only the latter activity, margin purchases under appellants’ standard
commodity account agreements. The scheme involved the solicitation of customers
primarily through newspaper advertising inviting the public to request
information by mail. The literature pack which then was sent to potential
customers emphasized silver coins as an “investment” and presented them as “reliable”
and “almost perfect” protection against inflation. The price performance of
silver was compared favourably with other forms of investment such as common
stock. While appellant presented two ways to invest in the coins, cash and
margin purchases, margin purchases were promoted over outright purchases and in
fact over 90 per cent of purchases were on margin. The appellants’ commodity
account agreements were termi-
[Page 113]
nable agreements and under them purchasers on
margin were required to pay by way of deposit 35 per cent of the purchase
price. The result of investment of money under the agreements was to give
appellants a pool of money which became appellants’ money and tied the
customers to the appellants for the consummation of the transactions either by
taking delivery of bags of coins or by closing their accounts and selling at
market price through the appellants. Appellants were not however obliged to
repurchase from such customers, their only obligation was to deliver the number
of bags of silver concerned if and when the customer paid the outstanding
balance and no specific bags of coins were allocated to a customer until then.
The Ontario Securities Commission after a hearing under s. 144(1) of the Act
issued a prohibitory order requiring appellants to cease trading pending the
filing of a prospectus on the basis that appellants’ activities came under s.
1(1) of the Act in that they were investment contracts within s. 1(1)22xiii or
in the alternative constituted “evidence of title to or interest in the
capital, assets, property, profits, earnings or royalties” within s. 1(1)22ii.
The Divisional Court in dismissing appellants’ appeal agree with respondents’ conclusion
on the basis only that the transactions were investment contracts but felt that
the agreements did not constitute evidence of title within the meaning of s.
1(1)22ii. The Court of Appeal affirmed, holding that the transactions did
constitute investment contracts but found it unnecessary to determine whether
they were also securities within the meaning of s. 1(1)22ii. The principal
issue on further appeal was to determine whether the agreement between
appellant and its customers was an investment contract.
Held (Laskin
C.J. dissenting): The appeal should be dismissed.
Per Martland,
Judson, Ritchie, Spence, Pigeon, Dickson, Beetz and de Grandpré JJ.:
Section 35 of the Act prohibits anyone trading in a security in the
absence of a prospectus and section 1(1) (22)xiii defines security as
including “any investment contract, other than an investment contract within
the meaning of The Investment Contracts Act”. [The contract in question
was not one covered by The Investment Contracts Act]. While the
term investment contract is not defined, the policy of the legislation is
clearly the protection of the public through full, true and plain disclosure of
all material facts relating to securities being issued. The fourteen
[Page 114]
subdivisions of the definition encompass
practically all types of transactions and indeed the definition had to be narrowed
down by the long list of exceptions in s. 19. The categories in the definition
are not mutually exclusive and are in the nature of ‘catchalls’. Such remedial
legislation should be construed broadly. Substance, not form, is the governing
factor. The legislation is not aimed solely at schemes that are actually
fraudulent but rather relates to arrangements that do not permit the customers
to know exactly the kind of investment they are making.
The Supreme Court of the United States in SEC
v. W.J. Howey Co., 328 U.S. 293 (1946), with the foregoing in mind
laid down the test “Does the scheme involve ‘an investment of money in a common
enterprise, with profits to come solely from the efforts of others’?” In the
case at bar all aspects of this test can be answered in the affirmative.
Clearly an investment of money was involved; as to the common enterprise aspect
the only commonality necessary for an investment contract is that between the
invester and promoter; and as to the dependence of the customer for the success
of the enterprise the end result of the investment by each customer was
dependent upon the quality of the expertise brought to the administration of
the funds obtained by appellant from its customers. The test to determine the
economic realities of a securities transaction based on “the risk capital
approach” adopted by the Supreme Court of Hawaii in State of Hawaii v. Hawaii
Marker Center, Inc., 485 P. 2d 105, results in the same conclusion that the
agreement in question is an investment contract.
The facts were examined in the sole light of
the Howey and Hawaii tests at the invitation of the parties.
A broader approach could however have been taken. The clear legislative policy
was to replace the harshness of caveat emptor in security related transactions
and the courts should seek to attain that goal even if tests formulated in
prior cases prove ineffective and have to be broadened in scope.
Per Laskin
C.J. dissenting: The term “investment contract” applies to one of
the many kinds of security included within The Securities Act. It was
conceded that the term could not be given a literal meaning as to do so would
bring innumerable transactions which have no public aspect within the scope of
the Act; and it was common ground that commodity futures contracts were not per
se under the Act. It is easy when faced with a widely approved statute for
the protection of the investing public to give broad undefined terms a broad
mean-
[Page 115]
ing so as to bring doubtful schemes under the
authority of the statute. However where the Legislature has deliberately chosen
not to define such a term which embraces various transactions, of which some
are innocent, there is no reason for Courts to be oversolicitous in resolving
doubt in the enlargement of the scope of statutory control.
Only three factors could be said to enter
into the consideration of whether the agreement was an “investment contract” as
included in the definition of “security” under the Act, the fixing of the base
price at which customers made their purchases, the gathering of the pool of
money from the deposits under the agreements and the question of the solvency
of the appellants. These same factors under a similar scheme were present in Jenson
v. Continental Financial Corporation (1975), 404 F. Supp. 792. The
Court in that case like the Courts in this case faced the question of whether a
gamble on the behaviour of the silver market is anything more than a commodity
futures transaction and hence not subject to regulatory securities legislation.
The Court in Jenson laid emphasis on the pooling of investors’ money in
a common enterprise in which the risk depended substantially on the promoters’
ability to gauge the market and assure its own solvency to meet its obligations
to its customers. Such view of the matter involves nothing more than solvency,
because the market would determine whether and when the customer would have a
profit; a customer left free to close out his account or to ask for delivery in
specie at his instance. There was no question of the notion of managerial
effort as arose in Howey as a controlling factor. Neither the test in Howey
nor the broader risk capital approach in Hawaii should be
generalized to decide the present case. Both cases were readily
distinguishable.
[Re Regina Great Way Merchandising Ltd.
(1971), 20 D.L.R. (3d) 67; Re Bestline Products of Canada Ltd. (1972),
29 D.L.R. (3d) 505; Re Ontario Securities Commission and Brigadoon Scotch
Distributors (Canada) Limited, [1970] 3 O.R. 714; Tcherepnin v. Knight,
389 U.S. 332 (1967); SEC v. W.J. Howey Co., 328 U.S. 293 (1946); Koscot
Interplanetary, Inc., 497 F. 2d 473 (1974); SEC v. Glen W. Turner
Enterprises Inc., 474 F. 2d 476 (1973); State of Hawaii v. Hawaii Market
Center, Inc., 485 P. 2d 105 (1971); Jenson v.
[Page 116]
Continental Financial Corporation (1975), 404 F. Supp. 792, referred to.]
APPEAL from a judgment of the Court of Appeal
for Ontario
dismissing an appeal from a judgment of the Divisional Court dismissing an appeal from a “cease trading”
order of the Ontario Securities Commission. Appeal dismissed, Laskin C.J.
dissenting.
Douglas Laidlaw, Q.C., for the
appellants.
B.P. Bellmore and M.W. Bader, for the
respondent.
THE CHIEF JUSTICE (dissenting)—The facts
of this case have been sufficiently highlighted in the reasons proposed by my
brother de Grandpré which I have had the advantage of reading before preparing
my own. We are concerned here with giving meaning and application to the term
“investment contract”, which is one of the many kinds of “security” included
within The Securities Act, R.S.O. 1970, c. 426, as amended and hence
brought within its regulatory authority. The term, it is conceded, cannot be
given a literal meaning because to do so would bring within the scope of The
Securities Act innumerable transactions which have no public aspect. Even
with respect to that, it is common ground that commodity futures contracts are
not per se within the regulatory regime of the Act.
My brother de Grandpré has noted in his reasons
that securities legislation in the United States has similarly left the term
“investment contract” undefined, so that it fell to the Courts in various
proceedings to isolate or extract a meaning consistent with the purpose of
securities legislation, namely, to ensure that investors in public offerings
are supplied with full information to enable them to appreciate (if they are
minded to examine it) the risks involved in making an investment. The more
extensive judicial experience in the United States has been regarded as useful
for Canadian courts called upon to wrestle with similar problems of
interpretation and application, and so it is that in the present case the
so-called Howey test (laid
[Page 117]
down in Securities and Exchange Commission v.
Howey) and
the Hawaii test (laid down in Hawaii Commissioner of Securities v.
Hawaii Market Centre Inc.) were
considered and utilized by the Courts below in determining that the appellants
were dealing in securities through their commodity account agreements with
their customers.
It is easy, in a case like the present one, when
faced with a widely-approved regulatory statute embodying a policy of
protection of the investing public against fraudulent or beguilingly misleading
investment schemes, attractively packaged, to give broad undefined terms a
broad meaning so as to bring doubtful schemes within the regulatory authority.
Yet if the Legislature, in an area as managed and controlled as security
trading has deliberately chosen not to define a term which, admittedly,
embraces different kinds of transactions, of which some are innocent, and
prefers to rest on generality, I see no reason of policy why Courts should be
oversolicitous in resolving doubt in enlargement of the scope of the statutory
control.
Although there was evidence of spot purchases of
silver coins, that is purchases for cash, the issue before this Court concerns
margin purchases under the terms of the appellants’ standard commodity account
agreements. Spot purchases are clearly outside of The Securities Act. The
commodity account agreement is a terminable agreement under which purchasers on
margin contract for some desired number of bags of silver coins and pay by way
of deposit thirty five per cent of the purchase price. Delivery in specie may
be had on 48 hours’ notice after paying up the balance of the purchase
price plus commission, and interest and storage charges as applicable. The
appellants, to honour the contracts, must either have bags of silver coins on
hand or go into the market to buy futures, and they would do so to cover
outstanding obligations to their customers rather than trade in
[Page 118]
silver on their own account.
The result of investment of money under the
commodity account agreements was to give the appellants a pool of money—which
became its money—and tied the customers to the appellants in the consummation
of their purchases, either by taking delivery of bags of coins (which was
rarely done) or by closing out their accounts by selling at the market price
through the appellants, paying a commission on selling as well as on buying.
The commodity account agreements were not assignable by the customers without
the appellants’ consent but, of course, the appellants could use them as bank
collateral.
The appellants controlled the so-called base
price; that is, the price at which investors bought bags of silver coins for
future delivery was fixed by the appellants in relation to the then market
price. The appellants did not, however, control the market price but were
themselves subject to it; nor did they control the cost of money which would
enter into a customer’s calculation, along with the market price, on whether to
close out his account. It was in respect of these features of the transactions
with their customers that counsel for the appellants took objection to the
emphasis placed by the Courts below on hedging, calling it a non-issue.
Counsel contended that it was immaterial to the
customers whether the appellants hedged or not on their future obligations to
them. If they did not hedge, they simply took the risk of a larger loss or a
larger profit when called upon by a customer to deliver the bags of coins which
he purchased or when the customer closed out his account by instructions to
sell. If they did hedge, it was still for the customer to decide, irrespective
of the hedging, whether to call for delivery or whether to sell out if the
market price of silver made it advantageous to do so. Hedging concerned only
the financial position of the appellants and, indeed, it seems to me that it
was only their solvency
[Page 119]
which created any risk to the customer. Yet it
was the view of the Ontario Court of Appeal, speaking through Dubin J.A., that
the solvency issue was not enough to bring the commodity account agreements
within the scope of The Securities Act. I can understand the reluctance
to find that solvency or insolvency is a determining factor in this case. It is
equally a factor in the realization of future benefits under any commercial
contracts providing for them, but there has been no suggestion that, even if
there be a network of such contracts, they should be recognized by the Courts
as investment contracts for security regulation purposes.
I see no more than three factors which can be
said to enter into consideration of the question whether the commodity account
agreement is an “investment contract” as that term is included in the
definition of “security” under the Ontario Securities Act. There is the
fixing of the base price at which customers make their purchases; there is the
consequent gathering up of a pool of money by the appellants representing the
required deposits under the commodity account agreements; and there is the
question of the solvency of the appellants. The same factors under a similar
scheme were present in Jenson v. Continental Financial Corporation, a judgment of the United States
District Court, District of Minnesota, upon which counsel for the respondents
in this case placed heavy reliance. The Court in the Jenson case faced
the same question that the Courts in this case faced, namely, whether a gamble
on the behaviour of the silver market is anything more than a commodity futures
transaction and hence not a security subject to regulatory legislation.
In coming to a conclusion on the Howey test
that the commodity account agreement was within the regulatory statute, the
Court laid emphasis on the pooling of investors’ money in a common enter-
[Page 120]
prise in which the risk of profit or loss
depended solely (or perhaps substantially) on the promoters’ ability to gauge
the market and hence to asure its own solvency to meet its obligations to its
customers. I do not see in this view of the matter anything more than solvency,
because it woud be the market that would determine whether and when the
customer woud have a profit, and he was free to close out his account or to ask
for delivery in specie at his instance and not when the promoter chose to
permit him to do so. Certainly, I do not see any controlling factor in
managerial effort, to which the Court in Jenson alluded, when it is the
market that determines profitability and not the promoter. The notion of
managerial effort obviously came from the Howey case where, on the
facts, the citrus grove enterprise promoted by the respondents there was
managed and serviced by them. Here there is no parallel, any more than there is
a parallel with a manufacturing company whose shares are purchasable in the
open market.
I am not persuaded that a test stemming from a
particular set of facts such as those in Howey, or the broader risk
capital approach based on another set of facts as in Hawaii, can or
should be generalized to fix the conclusion in yet the different set of facts
present here. In Howey and in Hawaii, the Courts were concerned
with schemes relating to land management and to merchandise selling
respectively, under which managerial control rested in the promoters. There was
no such substantial reliance on the market, outside of the promoter’s
control, as existed in the present case. I think it apt to refer to the dissent
of Frankfurter J. in the Howey case, at p. 302, where he objected to
bringing every innocent transaction within the scope of securities legislation
simply because a perversion of them is covered by it.
[Page 121]
I would allow the appeal, set aside the
judgments below and quash the prohibitory order of the Ontario Securities
Commission, with costs to the appellants throughout.
The judgment of Martland, Judson, Ritchie,
Spence, Pigeon, Dickson, Beetz and de Grandpré JJ. was delivered by
DE GRANDPRÉ J.—By notice given pursuant to the
provisions of sub. 1 of s. 144 of The Securities Act, R.S.O. 1970, c.
426, respondent informed appellant that a hearing would be held on the 24th of
July 1974 “to determine whether the Commission should act in the public
interest to order that all trading in the securities of Pacific Coast Coin
Exchange of Canada Limited should cease forthwith pending the filing and
acceptance of a prospectus and compliance with the registration provisions of The
Securities Act”. Appellant was also informed that it would be urged
that such order should issue because the plan or manner of business of
appellant “involves the offer and sale…of securities to the public” in that
1) it constitutes “an investment contract”
within the meaning of s. 1(1)22xiii of the Act;
2) in the alternative, it constitutes “evidence
of title to or interest in the capital, assets, property, profits, earnings or
royalties” of the appellant within the meaning of s. 1(1)22ii of the Act.
On October 11, 1974, following the hearing,
respondent did issue a prohibitory order; its reasons indicate that it relied
principally on s. 1(1)22ii of the Act although it added that s. 1(1)22xiii
is also applicable. The Divisional Court agreed with the conclusion reached by
respondent although it did so only on the basis that the transactions entered
into between appellant and its clients are investment contracts; the Divisional
Court felt that these agreements did not constitute evidence of title within
the meaning of s. 1(1)22ii of the Act. (1975) 7 O.R. (2d) 395; also (1975)
55
[Page 122]
D.L.R. (3d) 331. An appeal to the Court of
Appeal was dismissed, that Court also being of the view that the transactions
constitute investment contracts; it found it unnecessary to determine whether
they are also securities within the meaning of s. 1(1)22ii of the Act. (1975)
8 O.R. (2d) 257; also (1975) 57 D.L.R. (3d) 641.
The principal issue in this appeal is to
determine whether the agreement between appellant and its customers is an
investment contract. Should a negative answer be given to that question, it
will be necessary to examine whether or not the agreement constitutes a
security under s. 1(1)22ii.
THE FACTS
Although the facts have been carefully canvassed
by Houlden J., speaking for the Divisional Court, and although this canvass has
been accepted by the Court of Appeal and by the parties before us, I believe it
important to review once again the most relevant ones.
Appellant Pacific is a Canadian corporation
carrying on business in the Province of Ontario and other Canadian provinces;
its shares are owned by Mr. Louis Carabini and Dr. Neil Chamberlain.
Appellant Monex, a California corporation also controlled by Messrs. Carabini
and Chamberlain, was incorporated in 1971 to replace a previous entity that had
started business in 1967; it is active in several of the United States of
America. Both appellants will be referred to as “Pacific”. It might be noted
that, at the time of the hearing, Pacific had some 12,000 customers in the
United States and 226 in Canada.
Pacific commenced to carry on business in
Ontario in the Spring of 1973. Its activities in that province consist
primarily of offering for sale, selling and delivering bags of silver coins in
specie and offering for sale and selling bags of silver coins on margin. It is
solely this latter activity that is the subject matter of the appeal.
Pacific solicits its customers primarily through
newspaper advertising in which the public is invited to request information by
returning a mail slip to the Company. A “literature pack” is sent to
[Page 123]
potential customers. This pack emphasizes silver
coins as an “investment” and presents them as a “reliable” and “almost perfect”
protection of the customer’s savings and assets against inflation. The price
performance of silver is compared favourably with other forms of investments,
such as common stocks. The literature predicts continued rampant growth of
inflation and suggests a possible return to a depression. Emphasis is placed on
an inevitable increase in the price of silver notwithstanding inflation,
devaluation of money and depressed stock markets.
Appellant presents two ways to invest in silver
coins: the outright purchase of bags of silver coins in specie which are
delivered to the investor and the purchase of bags of silver coins on margin.
Margin purchases are promoted over outright purchases by means of a comparison
which illustrates that a person with $10,000 to invest can purchase seven bags
of silver on margin while he can only purchase two bags in specie.
Over 90 per cent of purchases are by the margin
contract mode. Whichever method is used, Pacific requires the customer to enter
into a “Commodity Account Agreement”. As this is the only document evidencing
the contract between Pacific and its customers, it must now be examined insofar
as it governs the rights and obligations of the margin purchasers:
a) the commodity consists of one or more bags of
silver coins;
b) the customer pays a commission of 2 per cent
on the purchase price and when he sells, he is also asked to pay a second
commission of 2 per cent;
c) the customer puts down a deposit (it was 35
per cent of the purchase price at the time of the hearing) and is required to
maintain adequate margin in his account in such amounts as are from time to
time required by Pacific;
d) Pacific is under no obligation to make
delivery until the customer has paid in full therefor, which means the balance
of the purchase price plus all interest (approximately 12 per cent at
[Page 124]
the time of the hearing), commission and storage
charges; the customer agrees to purchase all the commodities ordered by it and
pay for them in full before delivery;
e) the Agreement is terminable at the will of
either party but in any event will terminate five years from the date of the
last purchase under the Agreement;
f) the price at which Pacific sells to its
customers is fixed by Pacific several times during the day and published by it
and, in total, consists of a base price being the market value quoted by
Pacific plus commissions and other charges;
g) the customer may obtain the release of any or
all of the commodities credited to his account within forty-eight hours after
payment in full for such commodities;
h) Pacific retains no power of attorney nor
authority to direct the customer trading and maintains no control over the
customer’s account subject to certain security provisions to secure outstanding
indebtedness by the customer to Pacific;
i) the customer obtains no specific interest in
any particular bag of silver under the contract until he makes payment in full
therefor and accepts delivery of the bags purchased under the contract;
j) certain events of default are provided for
and remedies retained by Pacific in that event to liquidate the customer’s
account or realize on any commodities purchased by the customer and credited to
his account to off-set any indebtedness in the event of default by the customer
to Pacific;
k) the provisions of the Agreement are
assignable by Pacific but not by the customer without Pacific’s consent.
More than 85 per cent of all margin account
purchasers close-out their account without taking delivery. When a margin
account buyer closes out his account, he receives or pays the difference
between the per unit price at which his position is closed-out and the amount
he owes on margin, plus applicable interest, commissions and storage charges.
[Page 125]
Although the Agreement spells out that Pacific
“may, but need not at all times, make a market in commodities”, Pacific in its
literature points out that it has never failed to make a market for its
customers in the past. Pacific will not repurchase margin contracts acquired
from another coin exchange nor will other coin exchanges repurchase Pacific
margin contracts.
Pacific’s only obligation to margin customers is
to deliver the bags of silver covered by the contract if and when the customer
pays the outstanding balance. In practice, Pacific covers or hedges its
obligation to margin customers:
a) by purchasing futures contracts for silver;
approximately 85 per cent of Pacific’s obligations to margin account customers
is covered by futures contracts;
b) by maintaining a small inventory of silver
coins in specie.
Pacific has a policy of covering not less than
95 per cent of its margin obligations.
Pacific obtains title to the funds paid by the
margin account investors as a deposit. The pooled monies are distributed in
Pacific’s general funds. Some of this money is used to secure its own futures
contracts and some of it is used for its own investment purposes.
In conducting its hedging operations, Pacific
trades for its own account and in its own name; all purchases and sales of
futures contracts are made by Pacific as principal and not as agent for a
customer. As the silver futures contract comes close to delivery date, the
Operations’ Department, some 55 persons strong, must decide whether to pay the
balance owing on the contract and take delivery of the silver, or roll the
contract over by selling it and replacing it with a contract for a more distant
month.
In its literature, Pacific cautions against
individuals speculating in futures contracts. Such investments are not for the
uninitiated or unwary:
They are primarily for speculators who
welcome extremely high-leveraged, short term situations, and for
[Page 126]
hedgers who use futures to balance their
existing long or short commitments with an equal and opposite commitment. If
you plan to buy silver futures, you should be prepared to spend a great deal of
time studying the silver situation, staying on top of it every day.
INVESTMENT CONTRACT
Section 35 of the Act spells out the
prohibition for any one to “trade in a security” in the absence of a
prospectus. “Security” is defined in s. 1 as including fourteen categories, the
thirteenth one being “any investment contract, other than an investment
contract within the meaning of The Investment Contracts Act.” It
is common ground that in the case at bar, the contract is not one covered by
this last mentioned statute.
The expression “investment contract” is not
defined in the Act. In their search for its meaning, the Courts below have been
guided by the leading U.S.
authorities and counsel have invited us to follow the same path. I agree. While
the statute under consideration here does not read word for word like its U.S. counterpart, the expression
“investment contract” is found in both. In addition, the policy behind the
legislation in the two countries is exactly the same, so that considering the
dearth of Canadian authorities, it is a wise course to look at the decisions
reached by the U.S. Courts. This approach has also been adopted by the Court of
Appeal of Alberta in Re Regina Great Way Merchandising Ltd., as well as by Nemetz, J.A., in the
Court of Appeal of British Columbia in Re Bestline Products of Canada Ltd.
I have alluded to the policy of the legislation.
It is clearly the protection of the public as was said by Hartt J. in Re
Ontario Securities Commission and Brigadoon Scotch Distributors (Canada)
Limited, at
p. 717:
…the basic aim or purpose of the Securities
Act, 1966,
…is the protection of the investing
public through full, true and plain disclosure of all material facts relating
to securities being issued.
[Page 127]
If any doubt could be entertained as to the
intention of the Legislature in the present instance, that doubt should be
dispelled by the very wide terms employed in defining the word “security”. The
fourteen subdivisions of the definition encompass practically all types of
transactions to such an extent that this definition had to be narrowed down by
a long list of exceptions to be found in s. 19.
At this point, reference should be made to a
work by Professor Louis Loss who was called by appellant as an expert witness
before the Commission. In the second edition of his Securities Regulation ((1961)
vol. I at pp. 483, 488-489) and in the 1969 supplement thereto (vol. IV at p.
2501), Prof. Loss recognizes that “the various categories in the definition are
not mutually exclusive and are meant to be ‘catchalls’.” This view of the
definition in the United States
statute is valid in our case as well.
Such remedial legislation must be construed
broadly, and it must be read in the context of the economic realities to which
it is addressed. Substance, not form, is the governing factor. As noted in Tcherepnin
v. Knight, at
p. 336:
…in searching for the meaning and scope of
the word ‘security’ in the Act, form should be disregarded for substance and
the emphasis should be on economic reality.
In the search for the true meaning of the
expression “investment contract”, another guideline must also be present in the
forefront of our thinking. In the words of the Supreme Court of the United States in SEC v. W.J.
Howey Co., any
definition must permit (at p. 299):
…the fulfillment of the statutory purpose
of compelling full and fair disclosure relative to the issuance of ‘the many
types of instruments that in our commercial world fall within the ordinary
concept of a security.’…It 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.
[Page 128]
Which does not mean that the legislation is
aimed solely at schemes that are actually fraudulent; rather, it relates to
arrangements that do not permit the customers to know exactly the value of the
investment they are making.
It is with all the foregoing in mind that the
Supreme Court of the United States in Howey (supra, at pp. 298, 299, 301) laid down the
following test:
Does the scheme involve “an investment of
money in a common enterprise, with profits to come solely from the efforts of
others.”?
This test was said by the Court to be just
another expression of a meaning “crystallized” by prior judicial interpretation.
The following passage (at p. 298) is worth quoting:
The term ‘investment contract’ is undefined
by the Securities Act or by relevant legislative reports. But the term was
common in many state ‘blue sky’ laws in existence prior to the adoption of the
federal statute and, although the term was also undefined by the state laws, it
had been broadly construed by state courts so as to afford the investing public
a full measure of protection. Form was disregarded for substance and emphasis
was placed upon economic reality. An investment contract thus came to mean a
contract or scheme for ‘the placing of capital or laying out of money in a way
intended to secure income or profit from its employment.’ State v. Gopher
Tire & Rubber Co., 146 Minn. 52, 56, 177 N.W. 937, 938. This definition was uniformly applied by
state courts to a variety of situations where individuals were led to invest
money in a common enterprise with the expectation that they would earn a profit
solely through the efforts of the promoter or of some one other than
themselves.
By including an investment contract within
the scope of s. 2(1) of the Securities Act, Congress was using a term the
meaning of which had been crystallized by this prior judicial interpretation.
It is therefore reasonable to attach that meaning to the term as used by
Congress, especially since such a definition is consistent with the statutory
aims.
In the case at bar, it is obvious that an
investment of money has been made with an intention of profit. The questions
before us are the following: Is there a common enterprise? Are the profits to
come solely from the efforts of others? These two
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questions are so interwoven that I will be
endeavouring to answer them together.
The word ‘solely’ in that test has been criticized
and toned down by many jurisdictions in the United
States. It is sufficient to refer to SEC v. Koscot
Interplanetary, Inc. and
to SEC v. Glen W. Turner Enterprises, Inc. As mentioned in the Turner case, to
give a strict interpretation to the word “solely” (at p. 482) “would not serve
the purpose of the legislation. Rather we adopt a more realistic test, whether
the efforts made by those other than the investor are the undeniably
significant ones, those essential managerial efforts which affect the failure
or success of the enterprise”. In the same case of Turner, the
expression “common enterprise” has been defined to mean (p. 482) “one in which
the fortunes of the investor are interwoven with and dependent upon the efforts
and success of those seeking the investment or of third parties”. These
refinements of the test, I accept.
Like the Courts below, I hold the view that both
these questions must be answered in the affirmative. Their analysis of the
situation being exhaustive, it would serve no useful purpose to restate it in
my own words and to repeat the facts summarized earlier in these reasons. I
will simply underline the common enterprise aspect and attempt to highlight two
facets of the dependence of the customer upon Pacific, namely for the success
of the venture and for the existence of a true market.
In my view, the test of common enterprise is met
in the case at bar. I accept respondent’s submission that such an enterprise
exists when it is undertaken for the benefit of the supplier of capital (the
investor) and of those who solicit the capital (the promoter). In this
relationship, the investor’s role is limited to the advancement of money, the
managerial control over the success of the enterprise being that of the
promoter; therein lies the community. In other words the “commonality”
necessary for an investment contract is that between the investor and the
promoter. There is no
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need for the enterprise to be common to the
investors between themselves.
As to the dependence of the customer for the
success of the enterprise, it should be recalled that appellant in its
literature underlines the danger for the ordinary investor to deal in futures;
the text of the warning has been quoted earlier in these reasons. This is
echoed by Professor Loss in his testimony: “The ordinary fellow isn’t equipped
to trade in commodity futures”. Appellant now attempts to recant from that
position and submits that there is nothing mysterious about dealing in
commodity futures contracts. The Courts below have refused to accept that
submission and have held quite rightly that the end result of the investment
made by each customer is dependent upon the quality of the expertise brought to
the administration of the funds obtained by appellant from its customers. If
Pacific does not properly invest the pooled deposit, the purchaser will obtain
no return on his investment regardless of the prevailing value of silver; there
is nothing that the customer can do to avoid that result.
This dependence of the investors upon the
appellant is also apparent when it is noted that the margin purchaser may only
look to Pacific for the performance of his contract. Until the investor has
paid the full purchase price, he has no title to any physical property but only
a claim against Pacific. Should the price of silver go down, there is no
possibility for the investor to finance his balance (except through his own
resources) and from that moment, he is at the mercy of Pacific. This is not to
say that we are looking at a pure question of solvency. As pointed out by the
Court of Appeal (p. 259), the conclusion of the Divisional
Court does not rest “on such a narrow basis”.
The key to the success of the venture is the
efforts of the promoter alone, for a benefit that will accrue to both the
investor and the promoter. Thus, the nature of the relationship between Pacific
and its margin customers establishes that it satisfies the Howey test.
It matters not that the relationship was built around an object that is a
commodity and which in another context could be
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the subject matter of transactions in the
futures market that would not attract the restrictions of The Securities
Act.
Another test to determine the economic realities
of a security transaction is to be found in the decision of the Supreme Court
of Hawaii in State of Hawaii v. Hawaii Market Center, Inc., a decision of 1971. This test is
possibly still more favourable to respondent in the present instance and the Divisional Court has examined the facts in
that light also and has concluded that the risk capital approach would bring
about the same conclusion. I agree.
At the risk of repetition, I will underscore
that the question raised by this appeal is not whether or not commodity futures
contracts are investment contracts. The parties agree that they are not. What
is at issue is the relationship between Pacific and its margin customers
examined particularly in the light of the Howey and the Hawaii tests.
Such a relationship was studied recently in Jenson v. Continental
Financial Corporation, a
decision of the U.S. District Court of Minnesota rendered on November 19, 1975, and to be found in CCH
Federal Securities Law Reporters, para. 95-436, where the facts were nearly
identical to our own. There, the question was expressed in these words (at pp.
99, 202):
…the plaintiffs do not argue that the sale
of the coins standing alone constitutes an investment contract. It is their
position that the defendants method of operation transforms what is made to
appear as the sale of a commodities futures contract into an investment
contract.
And the Court answered (at pp. 99, 205):
It is thus clear that the defendants
operation entailed more than just the sale of a standard commodity futures
contract. By virtue of their pooling of investor payments and then investing
such funds in their own name, the defendants transferred the risk of their
operation to the plaintiff investors who thereby became partners in a common
enterprise with the defendants.
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Substantially to the same effect is State of Idaho ex rel. Park v. International Silver
(Silver) Mint Corporation, a decision of July 20, 1972, by the District Court of the
Fourth Judicial District of the State of Idaho.
A last word. At the invitation of the parties, I
have examined the facts in the sole light of the Howey and Hawaii tests.
Like the Divisional Court,
however, I would be inclined to take a broader approach. It is clearly
legislative policy to replace the harshness of caveat emptor in security
related transactions and courts should seek to attain that goal even if tests
carefully formulated in prior cases prove ineffective and must continually be
broadened in scope. It is the policy and not the subsequently formulated
judicial test that is decisive.
* * *
Having reached the conclusion that the commodity
account agreement entered into between appellant and its margin customers is an
investment contract, there is no need for me to determine whether that
agreement also falls within the definition of security under s. 1(1)22ii of the
Act.
I would dismiss the appeal with costs.
Appeal dismissed with costs, LASKIN
C.J. dissenting.
Solicitors for the appellants: McCarthy
& McCarthy, Toronto.
Solicitor for the respondent: M.W. Bader,
Toronto.
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