St. Mary's Law Journal


St. Mary's University School of Law


Franchises, founder-member contracts, and referral-sales agreements are marketing practices used to expand retail businesses and typically categorized as investment contracts. These marketing schemes continue to leave investors susceptible to fraud and misrepresentation because security regulations may fail to adapt to continuously varying methods in which promoters acquire capital. The Securities Act of 1933, the Securities Exchange Commission of 1934, and the Blue Sky Laws were attempts to regulate marketing schemes by establishing purposefully broad definitions of investment contracts. Securities laws were meant to have a liberal application for the purpose of being flexible and adaptive. In 1946, the landmark case SEC v. W.J. Howey Co. constructed a test to determine which marketing schemes would be regulated under the securities acts. Its immediate progeny applied a strict reading of the test which failed to account for the continuous variety of promotional practices. A strict application of Howey led to a rigid and inflexible reading that said profits must come “solely through the efforts of others” and disqualified many investment contracts from protection against fraud and misrepresentation. The critics of a strict application have rejected the Howey test entirely or have applied the test more liberally regarding the expectation of profits. The rejection of Howey established the “risk-capital concept,” which identified any form of capital an investor risked, in a transaction of which they had no managerial control, to determine if a security contract existed. The liberal approach to Howey avoided the efforts in creating a new framework, and it focused on the principle rather than the plain meaning of the test to determine that “solely through the efforts of others” referred to managerial efforts. The risk-capital concept and the liberal application of Howey have both refocused on the nature of the transaction and provide the securities acts with adaptable regulatory schemes.