The opinion of the court was delivered by: DALZELL
Dalzell, J. February 5, 1998
Now before us is an action the Securities and Exchange Commission (hereinafter "SEC" or "Commission") filed on August 27, 1997, alleging that defendants Geoffrey P. Benson, Geoffrey J. O'Connor, and The Infinity Group Company (hereinafter "TIGC") engaged in an ongoing scheme to defraud public investors of their money through the offer and sale of TIGC securities. The complaint further charged that the defendants' actions violated Section 20(b) of the Securities Act of 1933, 15 U.S.C. § 77t(b) (hereinafter "1933 Act"), and Section 21(d) of the Securities Exchange Act of 1934, 15 U.S.C. 78u(d) (hereinafter "1934 Act"). The Commission sought an injunction barring defendants from violating the two Acts, and disgorgement of ill-gotten gains. In addition, the SEC also sought disgorgement from relief defendants Susan L. Benson, JGS Trust, SLB Charitable Trust, Futures Holding Company, and Lindsey K. Springer d/b/a Bondage Breaker Ministries.
On the same day the SEC filed the complaint, Judge Brody, as Emergency Judge, granted the Commission's motion for a temporary restraining order, temporarily enjoining defendants from future violations of the federal securities laws and freezing defendants' and relief defendants' assets.
After hearings on September 3 and 4, 1997, on September 5, 1997, we granted the Commission's motion for a preliminary injunction in the matter. In addition to continuing the injunction and asset-freeze granted in the TRO we also, inter alia, appointed Robert F. Sanville, C.P.A., as trustee of the TIGC Trust. We empowered Mr. Sanville to take control and possession of all of TIGC's funds, assets, and other property of TIGC, and directed him to provide an accounting of the Trust. On January 16, 1998, the Trustee submitted that account.
We held a final injunction hearing on February 2 through 4, 1997, at the close of which defendants filed what they styled as a "motion" to dismiss under Fed. R. Civ. P. 12(b)(1), but which in reality is a suggestion of lack of subject matter jurisdiction under Fed. R. Civ. P. 12(h)(3). See Berkshire Fashions, Inc. v. M.V. Hakusan II, 954 F.2d 874, 880 n.3 (3d Cir. 1992)(noting that the distinction between the two "is simply that [a 12(h)(3) suggestion] may be asserted at any time and need not be responsive to any pleading of the other party"). Defendants' "motion" is without merit.
In order to invoke the protections of the securities laws, the Commission must, as a threshold matter, show that TIGC's "property transfer agreement" was a security. Among other categories of instruments included within the definition of a "security" under § 2(1) of the 1933 Act and § 3(a)(10) of the 1934 Act is the category of "investment contracts." In SEC v. W.J. Howey, 328 U.S. 293, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946), the 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." Id. at 66 S. Ct. at 1103. It is the representations made by the promoters, not their actual conduct, that determine whether an interest is an investment contract or other security. SEC v. United Benefit Life Ins. Co., 387 U.S. 202, 211, 87 S. Ct. 1557, 1562, 18 L. Ed. 2d 673 (1967); SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S. Ct. 120, 123-24, 88 L. Ed. 88 (1943).
There is ample documentary and testimonial evidence that many people invested money with TIGC. Indeed, the Trustee has produced a list of over 10,000 people, based on TIGC's own records, who invested in excess of $ 26.6 million in the TIGC Trust. Thus, element one of Howey is satisfied.
The Commission has also satisfied its burden of proof as to element two of Howey, which requires showing that, by mailing checks to TIGC, TIGC's members were investing in a "common enterprise." There are two definitions of a "common enterprise," one based on "horizontal commonality" and the other based on "vertical commonality." Horizontal commonality has been explicitly adopted by the our Court of Appeals, but that Court has not yet decided whether to adopt vertical commonality. See Steinhardt Group, Inc. v. Citicorp, 126 F.3d 144, 152 (3d Cir. 1997). We find that the record amply supports finding "horizontal commonality" in TIGC's operations, and therefore -- although we think that vertical commonality also exists on these facts, and we note that the Fourth, Eighth, Ninth, and Tenth Circuits have all adopted vertical as well as horizontal commonality
-- we find it unnecessary to determine whether to adopt that definition as well.
According to our Court of Appeals, horizontal commonality "requires a pooling of investors' contributions and distribution of profits and losses on a pro-rata basis among investors." Steinhardt, 126 F.3d 144, 151 (3d Cir. 1997). Salcer v. Merrill Lynch, Pierce, Fenner and Smith, 682 F.2d 459, 460 (3d Cir. 1982), the only other Third Circuit case to address horizontal commonality, focused on pooling of investor funds. Our review of cases in other Circuits that apply the definition of horizontal commonality suggests that pooling of investor funds is most often the determinative factor. It does not appear that the defendants object to the evidence of pooling, nor could they. TIGC's literature is rife with references to pooling, such as the following from a widely-distributed TIGC offering document:
The Infinity Group Company invests for profit by accepting amounts as low as $ 1,200 from thousands of people like you, and creating large blocks of funds that are in the millions of dollars. This gives the Trust a leverage position whereby we can command large profits, and have the security of never putting the principal at risk. This is very sophisticated investing that cannot be accomplished unless you have millions of dollars to deposit in a top world US bank.
Ex. 499 at "Private Member Material and Manual" at unnumbered p. 5 (emphasis in original). In addition, TIGC's description of the "trading programs" to which they had access also confirms the existence of investor pooling: "These 'trading' programs are run by a very tight knit inner circle that requires an invitation by the right person and a large amount of cash, for you to get even a hint of what is transpiring." Ex. 499 at "TIGC Private Member Manual" at 1.
Defendants only object to the second aspect of horizontal commonality, i.e., that profits and losses are shared on a pro rata basis among investors. They argue that because the investment contracts were fixed at either 138% or 181%, investors did not share pro rata in profits and losses.
Defendants' argument fails in three respects. First, the Supreme Court stated in Howey that "the definition of a security 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." Howey, 66 S. Ct. at 1103; see also Tcherepnin v. Knight, 389 U.S. 332, 338 88 S. Ct. 548, 554, 19 L. Ed. 2d 564 (1967). In other words, the duck theory applies: if it looks, reads, ...