Securities Law and MLM - What's the Deal?
By Spencer M. Reese (1)
No one will claim that the application of securities law in the multilevel marketing field is
anything new. Securities laws have been regularly applied to the MLM industry at both the state and
federal levels since the early 1970s, and many MLM programs have been found to cross the line into
the realm of unregistered securities since that time. In recent years there have been several high
profile securities actions brought against MLMs. Most recently, the Securities and Exchange
Commission (S.E.C.) brought an action against International Heritage, Inc. (IHI) in the United States
District Court for the Northern District of Georgia (Case No. 1-98-CV-0803). Interestingly, IHI had
been operating for several years, and was quite visible. Although the company had some difficulties
with several state attorneys general, it had not had problems with the S.E.C. However, on March
6, 1998, IHI went public by entering into a reverse merger with Kara International, Inc. In March
1998, the S.E.C. filed for and received a temporary restraining order, an order freezing the company's
assets, and an accounting, including lists of expenditures and payments to distributors. The following
April the court entered a preliminary injunction that prohibited IHI from conducting business under
its then-current marketing plan, and further ordered IHI to adopt a new compensation plan.
The company prepared a new plan and submitted it to the court. Although the court removed
the injunction, it nevertheless expressed grave reservations about the new plan. However, the court
stated that the implementation of the plan was critical to the determination whether it constituted a
security, and since no evidence existed regarding how the plan was actually promoted in the field, the
plan could not be deemed a security on its face. The S.E.C. claimed the new plan also constitutes a
security, so they remained locked in battle with IHI until the burdens of the litigation ultimately forced
the company out of business.
In a class action lawsuit brought by Nu Skin's Canadian distributors, the plaintiffs alleged that
the Nu Skin program constituted the sale of a security. Capone v. Nu Skin (Case No. 93-C-0285-S,
United States District Court for the District Of Utah). Nu Skin made a motion for summary
judgment requesting that the court rule in its favor as a matter of law. The court denied the motion,
finding that there was a basis upon which a jury could find that the Nu Skin program was a security.
In March 1997 the court issued an order that contained language that is nothing short of frightening
for those familiar with the MLM industry:
The court is of the view that a reasonable jury could conclude from the relevant
evidence that plaintiff reasonably expected to receive significant profits from the
efforts of others... . Indeed, it appears to the court that, in marketing this program,
defendants place great emphasis on distributors duplicating themselves, receiving
commissions from the sales of others, making big money from building a sales force,
becoming financially independent and the like.
This language is frightening since the approach taken by Nu Skin, that distributors should
duplicate themselves and hope to earn commissions on this duplication process, goes to the very
foundation of every MLM compensation plan. If duplication of one's efforts were to be generally
recognized as a basis for finding that a program constituted a security, as the above quote and
language suggests, every MLM might as well only enroll registered securities brokers as distributors,
because no one else would be able to participate in the compensation plans.
On March 26, 1998 the United States District Court for the Central District of Utah entered
a final judgment of permanent injunction against Investors Dynamics Corporation (S.E.C. v. Investors
Dynamics Corp., Case No. 2:96CV 0220 S). In arguing that the company's program was a pyramid,
and thus also a security, the S.E.C. focused on the fact that 99% of the company's sales were made
to its own distributors, and of the sales to those distributors, there were very few sales to retail
With these recent decision one might think that there is a resurgence of regulatory and class
action activity based on new developments in securities law. That, however, is not the situation. The
rules of securities law that are applied to MLMs today have not gone through dramatic evolutionary
changes. In fact, the same rules that were applied 25 years ago remain intact today.
Rather, there are several forces at work that result in the problem. First, the provisions of the
securities laws that apply to MLMs are very complex and have been applied inconsistently by the
courts. This has left MLMs in various states, ranging from confusion to absolute bewilderment, as
far as the legality of their marketing plans are concerned. But the blame for securities actions against
MLMs cannot rest entirely upon judicial contradiction and confusion over the correct application of
the law. Numerous members of the MLM industry must shoulder a portion of the blame. The
methods by which many companies have operated and promoted themselves have called for the
application of the securities laws. Indeed, there is not a day that goes by that I do not receive an
unsolicited fax from some fly-by-night operation that guarantees an income of $1,000.00 or more per
week, with no selling required, no recruiting, no meetings, no inventory, no cold calling and no
telephoning. Such operations are promoting nothing more than a passive investment (or more
accurately, a "passive divestment," since any participant will soon lose all money invested). While
there is no question that such programs violate the securities laws, legitimate companies are also
pushing the envelope in an effort to make their programs "turn key" businesses that bring in profits
but require as little effort as possible.
As a result of the efforts of many companies to offer "turn key" opportunities to their
distributors, combined with the inconsistent application of the securities laws by the courts and
regulators, it becomes apparent why, despite the long standing foundational principals of securities
law, MLMs continue to be attacked as securities. It is therefore appropriate to explore the securities
laws and examine how they are applied to MLMs, and to discuss ways that companies can operate
their programs to avoid the pitfalls presented by the securities laws. We will therefore take a trip
through "S.E.C.dom," starting with the ramifications of being classified as a security, identification
of persons who can be held liable for violating the securities laws (this may surprise you), and a
discussion of the various elements necessary to establish a violation of the securities laws. However,
the most extensive discussion shall explore the issue of how an MLM can be classified as a security
in the first place, since this is the proverbial $64.00 question.
II. RAMIFICATIONS OF BEING CLASSIFIED AS A SECURITY
Classification as a security is a death sentence for any MLM program. Securities are regulated
at both the federal and state levels. At the federal level, they are regulated by the Securities Act of
1933 (the "Securities Act" 15 U.S. C. §77a et.seq.) and the Securities and Exchange Act of 1934 (the
"Exchange Act" 15 U.S.C. §78a et seq.). At the state level they are regulated by state securities acts,
which are known as "blue sky" laws. One of the key requirements common to all regulatory schemes
is that securities must be registered with the S.E.C. at the federal level, (2) and with the various state
securities departments at the state level.
Failure to Register Securities - Criminal and Civil Penalties
A federal conviction for failure to register securities is a fairly simple matter to establish since
there are only three elements to prove: 1) no registration statement was in effect for the securities;
2) the defendant sold or offered to sell the securities; and 3) interstate transportation or
communication or the mails were used in connection with the sale or offer of sale. (3) If an MLM
program is classified as a security, there is little question that all three of these elements will be
established since 1) no MLM would ever file a registration statement because, by conceding it was
offering a security, only licensed securities brokers could enroll people into the program; (4) 2) every
enrollment or attempted enrollment would constitute the sale or offer to sell a security; and 3) it is
impossible to run an MLM without using some medium of interstate commerce, whether it be the mail
or the telephone.
If convicted, the defendant can face serious penalties. Under the Securities Act, for example,
a single violation carries up to a $10,000 fine and up to a five year prison sentence. (5) Criminal
penalties can be equally onerous at the state level. In State of Nebraska v. Irons, (6) the defendant was
convicted of operating a pyramid scheme called the "Friends Network." He was prosecuted and
convicted of selling an unregistered security under the state's blue sky statute, and sentenced to one
to three years in prison. On appeal his conviction and sentence were affirmed by the Nebraska
Moreover, the S.E.C. or a state securities department can literally shut down a company. It
is not uncommon to see court orders enjoining the defendant company from conducting business
under its compensation plan, freezing the company's assets, placing the company into a receivership,
suspending the trading of the company's stock (if it is publicly traded), and ordering that the company
disgorge itself of all ill-gotten profits.
Persons Who May Be Prosecuted Under the Securities Laws
Any MLM company that violates the securities laws may unquestionably be prosecuted. This
comes as no surprise to anyone. However, few independent MLM distributors have stopped to
consider whether they can be held personally liable, either in a civil or criminal action, for violation
of the securities laws. The Irons case illustrates the criminal penalties that can befall a distributor at
the state level. But independent distributors must also recognize that they can be held personally
liable for monetary damages in a civil action as well.
Under section 12(2) of the Securities Act of 1933 [15 U.S.C. §77I(2)], secondary liability
can be imposed on distributors. Davis v. Avco Financial Services, Inc. (7) provides an excellent case
study of a situation in which an independent distributor was held personally liable under the Securities
Act. In Davis, the defendant Avco was a commercial lender. One of the defendant's managers was
involved in the infamous Dare to be Great pyramid scheme. He made loans to customers to finance
their participation in Dare to be Great, and also promoted the Dare program to others. The plaintiffs
brought an action against Avco and the individual manager. In the claims pursued against the
manager, the plaintiffs alleged that he violated section 12(2), which provides:
Civil liabilities arising in connection with prospectuses and communications. Any
person who - (2) offers or sells a security, ..., by the use of any means or instruments
of transportation or communication, ... , by means of a prospectus or oral
communication, which includes an untrue statement of a material fact or omits to state
a material fact necessary in order to make the statements, ..., not misleading, ... , and
who shall not sustain the burden of proof that he did not know, and in the exercise of
reasonable care could not have known, of such untruth or omission, shall be liable to
the person purchasing such security from him, who may sue either at law or in equity,
..., to recover the consideration paid for such security with interest thereon, less the
amount of any income received thereon, upon the tender of such security, or for
damages if he no longer owns the security.
In deciding the circumstances under which this statute is properly applied to individuals who
were secondary sellers of the security, the court adopted the "proximate cause" theory of liability.
Pursuant to this approach, the court inquires whether the defendant's acts were both necessary to and
a substantial factor in bringing about the sales transaction. (8) In applying this analysis, the court found
that with regard to some of the witnesses, the activities of Avco's manager's "presence at meetings,
his making speeches, his furnishing forms, and in general his contribution to the selling momentum"
created a sufficient intrusion into the sales process that his activities could satisfy the proximate cause
The court did, however, note that an individual could present a defense to §12(2) liability if
they exercised "ordinary care" in their conduct. Considerations to establish the "ordinary care"
defense are: "(1) the quantum of decisional (planning) and facilitative (promotional) participation,
such as designing the deal and contacting and attempting to persuade potential purchasers, (2) access
to source data against which the truth or falsity of representations can be tested, (3) relative skill in
ferreting out the truth, ... (4) pecuniary interest in the completion of the transaction, and (5) the
existence of a relationship of trust and confidence between the plaintiff and the alleged "seller." (10)
What is disturbing about the Avco and the Irons cases from a distributor's perspective is that
both courts found scienter (the intent to violate the law) was not a necessary element for prosecution
or liability. In each case the defendant claimed that he did not know that the program he was selling
was a security. The courts nevertheless found that the absence of intent to violate the law was not
a defense. On this point, the Irons decision highlights the harshness with which the law can be
In this case, it is apparent that Irons was aware that he was offering or selling the right
to participate in a multilevel chain distribution gifting program. The fact that he did
not know that this participation was legally classified as a "security" indicates only
that Irons did not act with specific intent or knowledge that he was violating the law.
Knowledge by a defendant that the item sold is a security is not required in order to
convict under the registration provisions of the Uniform Securities Act. There is no
requirement that the defendant purposely intended to violate the law in order to be
This is a stark reminder that ignorance is not bliss, and what a distributor does not know
about his or her company can be dangerous to their livelihood.
Fraud in the Sale of Securities
Rarely will regulators attack a program based solely on the failure of the promoters to register
the securities. Rather, it is common practice to raise fraud claims against the program promoters in
conjunction with the registration claims. Regulators are well-armed when pursuing fraud claims
because the anti-fraud provisions of the Securities Act and the Exchange Act, and of course, the
infamous Rule 10b-5, are worded in extremely broad fashion. (12) The conduct most frequently cited
as fraudulent in actions against MLMs in connection with the sale of a security is that the MLM is
operating an illegal pyramid. The argument is that since a pyramid is destined to collapse, it is a
material omission not to disclose to the participants that they will lose their investment when the
pyramid fails. (13) Another common approach is to attack the income projections that are frequently
extolled by MLMs. Under this scenario, the S.E.C. will claim that it is a deceptive practice to lead
investors to believe that they can earn the represented income when in fact few, if any, ever actually
achieve the stated income.
The application of the anti-fraud provisions of the securities laws to an MLM program is well
illustrated in S.E.C. v. Galaxy Foods, Inc. (14) In that case, the court found that the defendant's
marketing plan was a security (Galaxy was selling grocery store items). In applying the fraud
provisions of the Securities Act, the Exchange Act, and Rule 10b-5, the court found a number of
fraudulent acts and omissions that were attributable to Galaxy. Included among the list of fraudulent
acts were: 1) the "fake it 'til you make it" approach (borrowing money to acquire expensive cars,
clothes, etc., to lead prospects to believe the wealth was derived from the program); 2) the pervasive
high pressure 'carnival-like atmosphere" at the company's sales meetings; 3) guaranteeing the
prospect's investment; and 4) representing that the company would accumulate and distribute retail
customers to distributors.
Significant omissions included the failure of Galaxy to disclose: 1) that Galaxy's management
was receiving overrides totaling 18% of gross franchise sales; 2) some Galaxy executives had received
franchises for "services;" 3) none of Galaxy's incorporators or key executives had any managerial
experience in the retail food industry; and 4) no retail commissions were to be paid during the
company's pilot program. (15)
The court further held that one of the company's principal distributors was individually liable
for violation of the anti-fraud provisions. The distributor's sponsoring activities (which the court
noted were particularly unscrupulous), were sufficient to render the distributor an aidor and abettor
to the fraudulent conduct of Galaxy's operation. Moreover, the distributor was found to be
individually liable because he had knowingly made false representations in the course of his recruiting
activities. The court was careful to point out, however, that the distributor need not knowingly make
misrepresentations. Rather, in an enforcement action, negligent misrepresentations are also
sufficient. (16) As a result of the finding that the distributor had violated the anti-fraud provisions, the
court ordered the distributor to disgorge himself of the profits he had made through participating in
Scienter as an Element of a Fraud Action
While the Irons decision makes it abundantly clear that one can be held liable for failure to
register securities even if the element of scienter is missing, this is not the case with all of the anti-fraud provisions of the law. With the exception of §§ 17(a)(2) and (a)(3) of the Securities Act, (17) in
order for regulators or a private plaintiff to prove the violation of the fraud provisions of the law, they
must first establish that the defendant intended to violate the act and that the misrepresentation was
material. The Supreme Court has defined "scientier" under the securities laws as: "a mental state
embracing intent to deceive, manipulate, or defraud." (18) Some Circuits have also adopted a "knowing
misconduct or severe recklessness" standard. (19)
Although it is necessary to prove scienter, this is not an overwhelmingly difficult task. In IHI,
the court found scienter proven because the program was similar to the Omnitrition program, which
was the subject of scrutiny by the Ninth Circuit Court of Appeals in Webster v. Omnitrition
International, Inc. (20) In the Omnitrition decision, the defendant company was sued by its distributors
in a class action case. The plaintiffs pursued theories of securities and pyramid law violations. The
district court (the trial court) had awarded summary judgment to Omnitrition on the securities and
pyramid claims, but the Ninth Circuit reversed the district court on the grounds that facts existed from
which a jury could find that Omnitrition had violated the securities and pyramid laws.
It is extremely troublesome that a court could find that a company acted recklessly because
its program was similar to the Omnitrition program. This is troubling because the Ninth Circuit did
not find that Omnitrition was a security or a pyramid. Rather, it simply said that facts existed from
which a jury could potentially find that the program was a pyramid and a security. The Ninth Circuit
remanded the case back to the district court to make the appropriate factual determinations.
Amazingly, the IHI court found that the defendant had acted recklessly because its program was
similar to another program that might be a pyramid. While the IHI court's analysis was flawed, it
nevertheless represents an example of just how easily a court can find the existence of scienter.
When determining whether scienter exists, a company's actual business practices will be
analyzed even if the company's written materials display an intent not to violate the law. In S.E.C.
v. International Loan Network, Inc., (21) the defendant presented its written promotional materials that
emphasized its penchant for fair dealing and conscientious business practices as evidence that it did
not act with scienter. The court, however, rejected this evidence in favor of evidence of what the
distributor force was actually presenting in the field:
Although defendants have not addressed materiality in either their brief or their oral
argument, they have argued vigorously that there is no evidence of scienter. As the
Court has already noted, ILN's Independent Representatives and Marketing
Representatives have been repeatedly instructed not to make false statements or veer
from the official written descriptions of ILN's programs. ILN has frequently sent
memos to its marketing employees instructing them not to use unauthorized materials
to try to promote ILN. This seems to the Court to almost prove too much. It is a
valiant effort to create a paper trail showing defendants' efforts to comply with the
law. The problem is that the paper trail is contradicted by oral statements of Ford and
others and by ILN's history and stated goals. (22)
Finally, the misrepresentations or omissions made by a company must be "material"
misrepresentations before they are actionable under the anti-fraud provisions of the securities laws.
The test to determine if a misrepresentation or omission are "material" is whether a reasonable
investor would consider the representation important in their decision to invest. (23) The easiest way
for regulators to prove a material misrepresentation is again to argue that the MLM program is really
a pyramid scheme. Since pyramids are destined to fail, it is certainly a "material" omission to fail to
disclose that the program will collapse.
While the preceding analysis identifies the securities pitfalls that face MLMs and their
participants, it does not address the critical questions of how does a program become classified as a
security, and what can be done to avoid such classification. These questions present perplexing legal
issues that the courts and attorneys for MLMs have wrestled with for years.
III. LEGAL FRAMEWORK FOR SECURITIES REGULATIONS FOR MLMs
There are three regulatory securities schemes that multilevel marketers must be aware of. At
the federal level, the Securities Act of 1933 and the Securities Exchange Act of 1934 both supply a
definition of the term "security" that the courts have interpreted to be sufficiently broad to include
pyramid operations. At the state level, blue sky laws are similar to the federal acts. In addition, a
limited number of state statutes and the Omnitrition decision specify that a pyramid or chain
distribution scheme constitutes a security.
A. The Securities Act of 1933 and the Securities and Exchange Act of 1934
The starting point to determine if a program constitutes a security is, of course, the statutory
definition of a security:
The term "security" means any note, stock, treasury stock, bond, debenture,
evidence of indebtedness, certificate of interest or participation in any
profit-sharing agreement, collateral-trust certificate, preorganization
certificate or subscription, transferable share, investment contract, voting-trust
certificate, certificate of deposit for a security, fractional undivided interest in
oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on
any security, certificate of deposit, or group or index of securities (including
any interest therein or based on the value thereof), or any put, call, straddle,
option, or privilege entered into on a national securities exchange relating to
foreign currency, or, in general, any interest or instrument commonly known
as a "security," or any certificate of interest or participation in, temporary or
interim certificate for, receipt for, guarantee of, or warrant or right to
subscribe to or purchase, any of the foregoing.
15 U.S.C. §77b.(24)
Buried within the bowels of this monstrosity is the seemingly benign phrase "investment
contract." Amazingly, these two words have generated thousands of pages of legal debate over what
they mean. There are two principal tests used to determine if an "investment contract" exists. The
prevailing test was shaped from two key United States Supreme Court decisions - S.E.C. v. W.J.
Howey Co., (25) and United Housing Foundation, Inc. v. Forman. (26) This test (commonly known as the
Howey test) is universally applied at the federal level, and is also applied by most state courts when
addressing their respective blue sky laws. However, a minority of states apply the "risk capital" test.
While the risk capital test represents a minority view, it is nevertheless sufficiently important that
MLMs, and particularly start-up companies, must be aware of its operation and ramifications.
1. The Howey Test
The starting point in determining whether an MLM program constitutes an investment
contract under the federal securities statutes begins with the test set forth by the United States
Supreme Court in SEC v. W.J. Howey Co. The Howey Company owned a citrus orchard in Florida.
Another company, Howey-in-the-Hills Service, Inc. operated a service company that cultivated and
developed the orange groves and marketed the crops. Although separate entities, the two companies
were under common control and management. The Howey Company sold half of its orchard acreage
in small parcels to investors. Howey-in-the-Hills then sold service contracts to the investors pursuant
to which the company would cultivate and market the crops. Although the investors were free to
enter into a service contract with any provider they wished, 85% chose Howey-in-the-Hills to manage
their affairs. When the crops were harvested, they were pooled and the profits were divided among
the investors based on the amount of land they owned. Under these facts, the court held that this
arrangement constituted an investment contract. To reach this conclusion, the court utilized the
An investment contract is "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. ... 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 to use the money of others on the promise of profits.(27)
Thus, a four part test has been developed: 1) an investment of money; 2) in a common
enterprise; 3) the investor is led to expect profits; 4) the anticipated profits are to be derived from the
efforts of someone other than the investor. The original verbiage of the Howey Court's holding
provides that the investor's anticipated profits must come solely from the profits of others. However,
the fourth element described immediately above varies from the original verbiage of the Howey
Court's holding by removing the word "solely." Interpretation of the word "solely" generated
considerable debate among the courts because it was recognized that a minimal amount of effort by
the investor could cause a scheme to fall outside of the scope of the test. Therefore, the debate has
ultimately lead to a majority rule that provides a more expansive application of the test than the literal
definition would allow. In Securities and Exchange Commission v. Glenn W. Turner Enterprises,
Inc.,(28) the Ninth Circuit Court of Appeals refined the fourth prong of the test by holding:
[w]e adopt a more realistic test, whether the efforts made by those other than the
investor are the undeniably significant ones, those essentially managerial efforts which
affect the failure or success of the enterprise.(29)
While the four part test is seemingly straightforward, the reality is that courts have wrestled
with its application, and to this day, over fifty years since the Howey decision was issued, the various
Circuit Courts of Appeals remain divided over its interpretation. As applied to the multilevel
marketing industry, this has lead to inconsistent decisions. Therefore, a comprehensive analysis of
the application of the component parts of the Howey test is necessary.
a. An Investment of Money
Courts distinguish between a "payment of money" and an "investment of money." A
"payment of money" does not satisfy the first element of the Howey test, whereas an "investment of
money" does. An "investment" carries with it the possibility of a gain or loss, but the purchase of
a product or service is simply a sales transaction with no expectation of gain and no possibility of loss.
Consequently, courts have held that "An investment of money occurs when an investor commits his
money to an enterprise or venture in a manner that subjects himself to financial loss."(30) However, in
the MLM industry, distinguishing between an investment and a purchase can sometimes be difficult.
Most astute companies do not require prospective distributors to make an investment before
becoming eligible to participate in the company's compensation structure.(31) However, it is common
for companies to require personal sales quotas (i.e., minimum P.V. or B.V. requirements) before a
distributor is eligible for commissions. The personal sales quota is frequently satisfied by the
distributor purchasing his or her quota and personally consuming it. Companies challenged with
offering an unregistered security have argued that such purchases constitute the purchase of goods
or services rather than an investment. The Howey decision addresses this point, holding that merely
attaching a legitimate product or service to a program will not exempt it from the "investment of
money" prong of the test. Similarly, even if income is "guaranteed," the program will not avoid the
reach of Howey. On these points, the Court stated:
We reject the suggestion of the Circuit Court of Appeals, ..., that an investment
contract is necessarily missing where the enterprise is not speculative or promotional
in character and where the tangible interest which is sold has intrinsic value
independent of the success of the enterprise as a whole. The test is whether the
scheme involves an investment of money in a common enterprise with profits to come
solely from the efforts of others. If that test be satisfied, it is immaterial whether the
enterprise is speculative or non-speculative or whether there is a sale of property with
or without intrinsic value.(32)
More recent decisions have embraced the Howey Court's ruling that merely attaching a
nominal product sale to a transaction will not avoid the scope of the first prong of the test. In SEC
v. International Loan Network, Inc,(33) all distributors were required to purchase a $125.00 basic
membership. The entire fee was retained by ILN. The member received benefits and services
including discount shopping, discount travel and auto rental. A person could also join the $100, $500
and $1,000 clubs. By so doing, a member was also entitled to newsletters and seminars on money
management and other topics. At the $500 and $1,000 levels, a person became eligible to participate
in the company's property rights acquisition program, which offered real estate training courses.
Distributors would invite prospects to local ILN meetings. The president of ILN was the
primary speaker. There were three bonus programs that were the center of the SEC's claim: 1) The
Capital Fund Bonus System; 2) The Property Rights Acquisition Program; and 3) The Maximum
Consideration Program. Under the Capital Fund Bonus System, for each new member recruited, a
distributor would receive 50% of the new member's $100, $500 or $1,000 fee. Membership fees
were paid down 5 levels. The company promoted stacking by teaching people to come in, and then
enroll their wife and kids. Under the Property Rights Program, investors were told that for $1,000
investment, they would receive the option of $10,000 in real property or $5,000 in cash. Prospects
were told there was no recruiting necessary, and distributors flashed their checks during the
Under the Maximum Consideration Plan, a person must have achieved $3,000 in the Property
Rights Acquisition Program and must have placed an earnest money deposit on an agreement to
purchase real estate other than that for use as a personal residence. The top 10 producers of PRA
sales were guaranteed a minimum award of $5,000. Others were eligible for awards up to five times
their original PRA purchase price or real estate contract deposit.
Although the program was crafted so that there was technically no investment of money
necessary, in reality the investment element was satisfied because the way the program worked in
actual practice was to emphasize recruiting new distributors to become members:
Defendants have carefully crafted the Capital Fund program so that it does not fit the
Howey test precisely. The Independent Representative Agreement that must be
signed to participate in the program specifically states that one need not be an ILN
member in order to earn money through the program. If one need not be an ILN
member, then the program does not fit the first prong of the Howey test, requiring an
"investment of money." To the Court, the distinction is merely technical and appears
to be a deliberate attempt to avoid the application of the test. A reading of the
transcript of Melvin Ford's presentation at a recent President's Night, as well as the
testimony of those who have repeatedly heard him speak, makes it clear that the intent
is for a person to become a member first and then recruit new members. Thus, the
oft-repeated slogan, "you come in, then bring in your wife and your kids." Looking
to the substance, rather than the form, of the Capital Fund program, this Court holds
that the first prong of the Howey test has been met.(34)
dditionally, it is probable that many people are unaware that they can participate in
the Capital Fund Bonus System without first becoming an ILN member. The
Independent Representative Agreement is four pages long and contains 33 lengthy
provisions in relatively small type. The provisions stating that one need not be an ILN
member to be an Independent Representative is buried amongst these other
This position is also reflected in the Utah federal court's 1997 memorandum decision in the
class action case Capone v. NuSkin. In response to NuSkin's motion for summary judgment, the
Plaintiffs argued that the investment prong of the Howey test could be satisfied by de facto
mandatory purchases of products and sales materials, and through their expenditure of time in
promoting NuSkin. The court found that although product purchases were not mandatory by design,
there was sufficient evidence presented that a jury could conclude that product purchases were
nevertheless a prerequisite to meaningful participation in the compensation plan:
Plaintiff claims and the record suggests, that in order to effectively and meaningfully
participate in the Nu Skin marketing plan, it is necessary to purchase products every
month in order to meet the personal volume and group volume requirements. ...
Moreover, there is evidence which suggests that commissions are paid regardless of
whether the distributors actually retail the products they purchase. Distributors must
also pay a renewal fee of $24.00 (Canadian) each year.(36)
The message to take from these decisions is clear and unambiguous; an effort to avoid the first
prong of the Howey test by attaching a nominal product to the investment will not render the
transaction a "sale" rather than an "investment." In addition, if the products are legitimate, making
product purchases mandatory will also cause the program to satisfy the first prong of the Howey test,
as the courts will also view such purchases as an investment. It is therefore important that any
product purchases be optional. However, even "optional" purchases will satisfy the first prong of the
Howey test unless the company is able to present evidence that such purchases are truly optional. If,
despite what is printed in a company's literature, the reality is that distributors must personally
purchase products to participate in the compensation plan, the first prong will be satisfied. To combat
such a finding, the most compelling evidence a company can present is statistical data establishing that
a significant portion of their distributors do not make personal purchases on a regular basis, yet still
Finally, although the Howey decision specifies that an investment of money is required, the
S.E.C. has attempted to boaden the Howey test by arguing that an investment of a distributor's time
and personal effort will satisfy the first element of the test. This was the approach taken by the SEC
in the IHI case. The SEC relied on SEC v. Addison,(37) to support its argument that the "investment"
component of the investment contract test was satisfied under the modified plan because IHI
distributors were required to invest their time and services. The court did not state whether an
investment in services was sufficient to satisfy the "investment" requirement, although it did cite
Peyton v. Morrow Electronics, Inc.(38) as a basis for finding that services did not satisfy the "investment
of money" element. Rather, the court differentiated the Addison case from the modified IHI plan by
finding that distributors under the amended IHI plan, distributors did not expect profits from the
managerial efforts of others, whereas in Addison the investors did in fact anticipate profits based on
the managerial efforts of others. Consequently, in the MLM context, whether an investment of time
and effort will satisfy the first element of the Howey test remains open. However, we must anticipate
that a court would weigh heavily in favor of following the precise verbiage of the Howey test and find
that an investment of money is essential.
b. A Common Enterprise
The second element of the Howey test requires that a "common enterprise" exist between the
promoter and the investor. This element of the test has, without question, proven to be the most
perplexing to securities practitioners and courts alike. This is due to the fact that the Circuit Courts
of Appeals are divided on what constitutes a "common enterprise," and amazingly, over 50 years after
the Howey decision, the Supreme Court has not directly addressed the issue to bring uniformity to
the law. This division creates a substantial dilemma for MLM companies because acceptable conduct
in one jurisdiction presents an extreme risk in another. It is therefore incumbent upon companies to
devise compensation plans that take complete advantage of the more stringent approaches taken, and
to incorporate procedures that mitigate the potential for establishing commonality in those
jurisdictions that utilize more liberal approaches.
A common enterprise exists if there is "commonality" between the promoter and investor.
There are three principal approaches to determining if a commonality exists: 1) horizontal
commonality; 2) strict vertical commonality; and 3) broad vertical commonality. To further
compound the confusion, courts have not been uniform in interpreting what conduct constitutes strict
and broad vertical commonality. The final result is that if a company wants to operate its program
in a way that minimizes its exposure to being classified as a security, it must conduct a comprehensive
review of each of the commonality approaches.
i. Horizontal Commonality
Horizontal commonality requires a pooling of monies from various investors and a pro rata
sharing of profits from the pool.(39) A recent decision from the West Virginia District Court, U.S. v.
Holzclaw,(40) illustrates the operation of the horizontal commonality test in an pyramid case. In a
criminal action, the Defendants were allegedly selling an investment contract pursuant to a multilevel
sales program that sold gold certificates.
The Court, citing Mordaunt v. Incomco,(41) noted that the Circuit Courts of Appeals were split
on what constitutes a common enterprise. The court first defined the scope of horizontal, strict, and
broad vertical commonality. In conducting this exercise, the court noted that strict vertical
commonality existed under the facts of the case. However, the court rejected this approach, and
instead, relying on Marine Bank v. Weaver,(42) applied the horizontal commonality test, holding:
[a] common enterprise exists only when the transaction contemplates a multiplicity
of investors contemporaneously holding equipotential interests in the enterprise. This
standard requires and encompasses transactions with horizontal commonality. It
follows, and the Court FINDS, that the pyramid scheme in this case does not include
an investment in a "common enterprise" as required by Howey.(43)
An MLM attacked as a security stands the greatest chance of overcoming a securities claim
if the case is brought in a jurisdiction that applies the horizontal commonality approach. While it is
arguable that if distributors are required to purchase products on a monthly basis, their payments
constitute a pooling of assets. However, the distribution of profits from the pool will not be on a
pro-rata basis. Rather those individuals who have built a larger sales organization and moved more
product will be entitled to a larger share of the profits. Those individuals that were less successful
in building a business and moving product will receive a smaller portion of the profits, although their
product purchases will equal that of their more successful colleagues. Because of this discrepancy,
no pro rata distribution of profits exists, and the horizontal commonality test will not be satisfied.
Similarly, it is common for compensation plans to include "bonus pools" that are awarded to
their most productive distributors. While it is again arguable that the funds from which the bonuses
are paid constitute a "pool," the horizontal commonality test again is not satisfied because: 1) the
funds are distributed to a limited number of distributors rather than to all distributors on a pro-rata
basis; 2) payments are determined by each distributor's individual and group productivity rather than
on each individual's contribution to the pool; and 3) the "bonus pools" are based on a percentage of
the company's total pre-tax sales volume (i.e., a bonus pool may be comprised of 1% of the
company's total BV for the year). Since the bonus is a pre-tax expense for the company, it is not
sharing its profits with the distributors. Rather, the pool is a legitimate expense item for the company.
A word of caution, however, is necessary. Sometimes compensation plans are structured such
that distributors can enter the program at higher ranks (levels of participation) depending on the
amount of their initial purchase. For example, if a distributor can enter a program and qualify for
commissions at the "diamond" level by making an initial purchase of $200.00, but can also enter and
automatically qualify for higher commissions at the "double diamond" level by making an initial
purchase of $500.00, a court may find this scenario to satisfy the horizontal commonality test. The
mandatory purchase would constitute a pooling of assets, and the entitlement to higher commissions
based on the higher initial investment would constitute a pro rata payment of profits. It is therefore
prudent to avoid designing a compensation plan that offers distributors the opportunity to enter a
program at higher commission levels by making a greater initial purchase. Rather, all distributors
should be required to enter the program at the same level and with the same qualifications.
Advancement in rank, and entitlement to greater commissions, should be based exclusively on
ii. Strict (Narrow) Vertical Commonality
Under a true strict vertical commonality analysis, the requisite commonality will be found to
exist only if the profits and losses of the investors and the promoter are directly tied to one another.
That is, the profits of the parties rise and fall together. Brodt v. Bache & Co.(44) In Brodt, the plaintiff
set up a discretionary trading account with the defendant brokerage house. Pursuant to this
arrangement, the brokerage house could withdraw and invest funds from the plaintiff's account at its
discretion. The plaintiffs lost all of their money, and sued Bache & Co. claiming that the discretionary
trading account constituted an investment contract. The Ninth Circuit Court of Appeals found that
the transaction was not an investment contract because neither horizontal nor vertical commonality
existed. Under the vertical commonality analysis, the court reasoned that commonality was absent
because the profits of the investor and the promoter did not rise and fall together.
"... the success or failure of Bache as a brokerage house does not correlate with
individual investor profit or loss. On the contrary, Bache could reap large
commissions for itself and be characterized as successful, while the individual
accounts could be wiped out. Here, strong efforts by Bache will not guarantee a
return nor will Bache's success necessarily mean a corresponding success for Brodt.
Weak efforts or failure by Bache will deprive Brodt of potential gains but will not
necessarily mean that he will suffer serious losses. Thus, since there is no direct
correlation on either the success or failure side, we hold that there is no common
enterprise between Bache and Brodt.(45)
V.C. will not exist if a pure strict vertical commonality test is applied to an MLM. This is due
to the fact that each individual distributor's profits are independent from those of the MLM company.
For example, a distributor may be unsuccessful in his or her sales and recruitment efforts, and
ultimately realize a net loss after business expenses are taken into account. The company, however,
could very easily turn a profit during the same time period. Similarly, a company may have a down
year, whereas individual distributors may find that despite the company's problems, they generate a
profit. In either scenario, the profits and losses of the distributors and the investors do not rise and
fall in sync with one another, so true strict vertical commonality will not exist.
To make things a bit more complicated however, there is a hybrid strict vertical commonality
test. Under this test, commonality will exist if the investors' and promoter's profits fluctuate
together, but unlike a pure strict vertical commonality test, it is not necessary that their losses be
similarly linked.(46) As applied to MLMs, the infamous SEC v. Glenn W. Turner Enterprises, Inc.(47)
decision illustrates that application of this hybrid strict vertical approach. Therein, the court stated
that "A common enterprise is 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."(48) The
subtle distinction between this approach versus that taken in Brodt is that the Turner decision does
not provide that the investor's failure must fluctuate with that of the promoter. Consequently, the
distributors' risk of loss is independent of that of the company.
The hybrid strict vertical commonality approach is more difficult for an MLM to overcome
than a pure vertical commonality test. Generally, if a company's sales force is successful, the
company will also be successful. After all, this is what everyone strives for. However, to best
overcome an hybrid strict vertical commonality challenge, the company must show that it has incurred
losses during the same time frame during which distributors were profitable. If a company cannot
make such a showing, it may attempt to prove that the two do not fluctuate with one another by
introducing evidence that the company's profit margins differ from the profit margins of the
distributors during the relevant time frame. The greater the discrepancy, the stronger the argument
that the test is not satisfied.
iii. Broad Vertical Commonality
The "broad vertical commonality" approach is the third method used to determine if a
common enterprise exists. This test is the most difficult to overcome, but it is also the most
controversial. Despite the criticism that has been leveled, it remains an accepted approach in the Fifth
Under the broad vertical commonality, a common enterprise will be established if the fortunes
of all investors are tied to the efforts. As fortunes would have it, one of the leading cases applying
the broad vertical commonality test is also an MLM case. In S.E.C. v. Koscot Interplanetary, Inc.,(49)
the distributors did not engage in sales and recruiting efforts. Rather, they simply gathered what
amounted to "warm bodies" and brought them to "opportunity meetings." Once the prospects were
at the meetings, company employees would conduct the meeting and perform the sales and enrollment
functions. Thus, all distributors had to do was show up at the meetings with their prospects, and, of
course, purchase excessive quantities of merchandise each month. Against these facts the court held:
"The requisite commonality is evidenced by the fact that the fortunes of all investors are inextricably
tied to the efficacy of the Koscot meetings and guidelines on recruiting prospects and consummating
This test is the most difficult to overcome because it is not tied to any quantifiable figures such
as profits and losses. Rather, it is dependent upon a broader concept of the efficacy of the promoter's
efforts. Determination of whether distributors' efforts are tied to the efficacy of the promoter's
efforts will entail a fact intensive inquiry. However, for obvious marketing reasons, most MLM
companies promote their programs in a fashion that emphasizes how much the company does for the
distributors, and how little the distributors are required to do. The company's own literature provides
ample evidence that their management and operation of the enterprise will ensure the distributors'
success. While this is a very logical approach from a marketing perspective, from a legal perspective
it is problematic because it makes it easy for a regulator to prove that the distributors' efforts are
dependent upon the efficacy of the MLM company's marketing efforts.
An MLM case that illustrates the application of both the strict and broad vertical commonality
approaches is SEC v. International Loan Network, Inc.(51) In that case, the court found that
distributors were taught to enroll in the program themselves, and then to rapidly build their downline
organization by enrolling their spouse and children (a practice commonly known in the industry as
"stacking"). Strict vertical commonality existed because distributors' success was based on their
downline members' stacking practices rather than on legitimate sales and recruitment efforts in which
the upline distributors participated. (I suspect there was also a significant number of dogs, cats and
goldfish that somehow acquired tax I.D. numbers and were also enrolled). The court also found that
broad vertical commonality existed because the company's promotional materials emphasized the
success of the organization as a point of reliance for prospective distributors. On the strict and broad
vertical commonality issues, the court held:
The profits of investors in the Capital Funds Bonus System are directly related to the
fortunes of other investors; it is through the constant recruitment of new members in
one's 'downline' that income is earned. If the people directly recruited by an
Independent Representative do not vigilantly spread the word, "you come in, then you
bring in your wife and your kids," then that Independent Representative will not earn
much income through the program. Additionally, investors' profits are linked to the
success or failure of ILN as a whole because it is the ability to proclaim the
organization's success that is the central selling point of the program.(52)
The broad vertical commonality approach has received extensive criticism from the courts in
jurisdictions that do not follow it. The problem lies in the fact that there is no real difference between
the broad vertical commonality test and the fourth prong of the Howey test (i.e., the investor
anticipates profits based on the efforts of others). If the broad vertical commonality test is applied,
there is no reason to apply the fourth prong of Howey because the result will always be the same.
Had the Supreme Court in Howey intended broad vertical commonality to satisfy the common
enterprise element of the test, the Court would not have added the fourth element of the test. In fact,
this point is illustrated by the International Loan Network case because the court relied on the same
evidence to find that the second and fourth prongs of the Howey test were satisfied.
In Long v. Shultz Cattle Company, Inc.,(53) the Fifth Circuit Court of Appeals acknowledged
the criticism leveled against the broad vertical commonality approach. The court noted that the case
did not present proper facts that would enable it to consider formally rejecting the broad vertical
commonality test because the program at issue satisfied the commonality requirement no matter
which test was applied. However, the court did state that it would consider taking a fresh look at the
issue in a case that presented appropriate facts .(54) This is extremely significant to the MLM industry
because it was the Fifth Circuit that issued the Koscot decision.
In Revak v. SEC Realty Corp.,(55) the Second Circuit succinctly pointed out the deficiencies of
the broad vertical commonality approach. The court rejected the approach because it merges the
second and fourth prongs of the Howey test into a single test:
If a common enterprise can be established by the mere showing that the fortunes of
investors are tied to the efforts of the promoter, two separate questions posed by
Howey - whether a common enterprise exists and whether the investors' profits are
to be derived solely from the efforts of others - are effectively merged into a single
inquiry: "whether the fortuity of the investments collectively is essentially dependent
upon promoter expertise.(56)
Despite the criticism leveled at the broad vertical commonality test, it nevertheless presents
significant problems for the MLM industry. This is largely attributable to the Koscot decision because
it involved a company utilizing a multilevel compensation plan. Unfortunately, courts are oftentimes
unwilling to inquire into the differences between the Koscot program and the MLMs they find in their
courtrooms. Rather, it is tempting for courts to take the easy approach and pigeon-hole all MLMs
in the same category as Koscot, and therefore apply the same commonality test.
c. The Investor is Lead to Anticipate Profits
The third prong of the Howey test requires that the investor be lead to anticipate "profits."
However, a debate similar to that concerning the term "investment" has arisen. Indeed, the issue is
quite similar since the question may arise whether an investor is simply purchasing a commodity for
personal use, or if he is purchasing a commodity with the anticipation of making a profit on its
purchase. This dilemma is illustrated by the facts in United Housing Foundation, Inc. v. Forman,(57)
Therein, the plaintiffs were residents of a low income housing cooperative in New York City. To
occupy one of the housing units, residents were required to purchase shares of what was loosely
called "stock." When rents were increased due to cost overruns on the housing project, a group of
plaintiffs sued the housing foundation claiming that the "stock" they purchased constituted an
investment contract security. The court was required to determine if the residents were purchasing
a home to live in, and thus a commodity, or if they were purchasing an apartment for investment
purposes, and therefore a security. The court phrased the issue as follows:
By profits, the Court has meant either capital appreciation resulting from the
development of the initial investment, ..., or a participation in earnings resulting from
the use of investors' funds, ... . In such cases the investor is "attracted solely by the
prospects of a return" on his investment. Howey, supra, at 300. By contrast, when
a purchaser is motivated by a desire to use or consume the item purchased - "to
occupy the land or to develop it themselves," as the Howey Court put it, - the
securities laws do not apply.(58)
The Court found that under the facts as presented in the case, the purchasers of the apartment
units had intended to purchase a home for residential purposes rather than for purposes of receiving
There is no doubt that purchasers in this housing cooperative sought to obtain a
decent home at an attractive price. But that type of economic interest characterizes
every form of commercial dealing. What distinguishes a security transaction - and
what is absent here - is an investment where one parts with his money in the hope of
receiving profits from the efforts of others, and not where he purchases a commodity
for personal consumption or living quarters for personal use.(59)
This decision would find great favor among the multilevel marketing industry if the Court had
left its holding in these terms. However, the Court was careful to point out that in some situations
the purchase of a commodity may also be a purchase for investment purposes: "In some transactions
the investor is offered both a commodity or real estate for use and an expectation of profits. ... The
application of the federal securities laws to these transactions may raise difficult questions that are
not present in this case."(60)
While the Supreme Court did not address this point, lower courts in MLM cases have not
been so hesitant. In Bell v. Health-Mor, Inc, .(61) the company was selling vacuum cleaners door-to-door. The defendants argued that the distributors' purchase of the machines was the purchase of a
product, whereas the plaintiffs argued they were investments. The court rejected the defendant's
Finally, the mere transfer of a tangible commodity does not preclude the existence of
a security. For example, in S.E.C. v. Glenn Turner Enterprises, ..., the purchasers in
the pyramid scheme received course materials such as cassettes and books. Yet, this
did not prevent the recruitment aspects of the program from being held to be
securities. Plaintiffs in this case claim that, in addition to a vacuum cleaner, they were
buying an income opportunity, the right to supply names of other prospective
"purchasers" for lucrative profits. As Koscot and Glenn Turner Enterprises teach,
that income opportunity can be considered independently of any sale of a product or
service which might have been made.(62)
Similarly, in People v. Cooper,(63) the Michigan Court of Appeals analyzed a program in which
a participant was required to purchase $20.00 of skin lotion each month, whether they needed it or
not, in order to remain active in the company's compensation plan. Recruits were told that it was
only necessary to sponsor new participants on their second level, and that the company would do the
rest. The prosecution claimed that the defendants were operating a pyramid and offering an
investment contract. The Defendants argued that their marketing plan was legal because bonuses
were based on sales of product. The court, however, found that the lotion was a mere token, and the
primary focus of the plan was the recruitment of new members.
In analyzing these cases, it becomes clear that if an MLM requires its distributors to purchase
a specific quota of merchandise, the likelihood that the company will prevail on a defense that the
distributors are purchasing a commodity rather than making an investment is substantially eroded.
This is particularly true as the amount of the required purchase increases. If, on the other hand, there
is no mandatory purchase requirement, and distributors purchase modest quantities of merchandise
for personal use, there is a compelling argument that distributors are purchasing the products with
the intent of purchasing a commodity. This position will be further buttressed if the company can
present strong testimonial evidence from its distributor/customers that the purchases were not made
with the expectation of making a profit from the sale.
d. The Investor Anticipates Profits Based on the Efforts of Others
The fourth prong of the Howey test requires a finding that the investors anticipate profits
based on the efforts of others. When studying court decisions relating to investment contracts, it
quickly becomes apparent that this element is the most carefully scrutinized prong of the analysis.
In fact, in MLM cases it is not unusual for a court to skip or gloss over the first three elements of the
test and focus its attention on the fourth element. Consequently, it is of utmost importance that
MLMs carefully design and implement their compensation and marketing plans to avoid leading
distributors to anticipate profits based on the efforts of others. While this may seem antithetical to
the fundamental premise of MLM, which is to earn a profit based on your downline's sales, careful
planning and marketing will enable a company is to wend its way through the morass of confusion.
Fortunately, history is our best teacher, and there is no shortage of MLM decisions addressing the
fourth prong of Howey. In addition, since the inquiry will necessarily be fact specific, a review of the
facts of several key securities cases will shed light on the manner in which the courts apply the fourth
prong of Howey.
S.E.C. v. Glenn W. Turner Enterprises, Inc..(64)
The launching point for a discussion on the fourth prong of the Howey test must begin with
a comprehensive analysis of S.E.C. v. Glenn W. Turner Enterprises, Inc. This decision, which
happened to involve an MLM, is critically important because it was the decision that moved the
courts away from focusing on the literal language of the Howey court's requirement that an investor
anticipate profits solely as a result of the efforts of others. The Glenn Turner decision is the leading
case implementing a more flexible analytical approach that directs the inquiry into the nature and
scope of the efforts of the promoter or other third party to ascertain if those efforts are the essential
managerial efforts necessary to make the program successful.
Turner operated the infamous Dare to Be Great program. Distributors would bring recruits
to company run functions. The company would put on a real hype-show, complete with the hard-sell,
trying to get recruits to join the program and buy extremely expensive self-motivation courses. They
would flash large sums of cash, drive expensive cars and park them conspicuously in front of the
building, and chant money hymns. Company speakers would tell of the riches that awaited those who
enrolled in the program. Although the "sale" (the enrollment) was occasionally closed by a
distributor, it was usually closed by company employees who were specialists in the hard sell.
Although no express guarantees of success were made, and it was stated that the purchaser must
expect to work, the impression left with prospects was that of "near inevitability of success to be
achieved by anyone who purchases a plan and follows Dare's instructions."(65)
Faced with these facts, the Ninth Circuit had little difficulty finding that the program
constituted an investment contract.(66) While the defendants argued that the distributor's efforts of
gathering prospects to attend the meetings defeated the SEC's claim because the effort put forth was
not "solely" that of the company, the court nevertheless held that the third prong of the Howey test
The statutory policy of affording broad protection to the public, and the Supreme
Court's admonitions that the definition of securities should be a flexible one, the word
"solely" should not be read as a strict or literal limitation on the definition of an
investment contract, but rather must be construed realistically, so as to include within
the definition those schemes which involve in substance, if not form, securities. ...
Strict interpretation of the requirement that profits to be earned must come "solely"
from the efforts of others has been subject to criticism. ... Adherence to such an
interpretation could result in a mechanical, unduly restrictive view of what is and what
is not an investment contract. It would be easy to evade by adding a requirement that
the buyer contribute a modicum of effort. Thus the fact that the investors here were
required to exert some efforts if a return were to be achieved should not automatically
preclude a finding that the Plan or Adventure is an investment contract. To do so
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.(67)
The definition of the "essential managerial efforts" is of critical importance. The court held:
What [the investor] buys is a share in the proceeds of the selling efforts of Dare.
Those efforts are the sine qua non of the scheme; those efforts are what keeps it
going; those efforts are what produced the money which is to make him rich. In
essence, it is the right to share in the proceeds of those efforts that he buys.(68)
United Housing Foundation v. Forman
The Supreme Court has also deemed it appropriate to amend the provision of the Howey test
which requires that the investor anticipate profits solely from the efforts of others. In United Housing
Foundation v. Forman, the Court refined the Howey test in a manner that more closely reflects the
approach initiated by the Ninth Circuit in Glenn W. Turner:
The touchstone [of an investment contract] is the presence of an investment in a
common venture premised on a reasonable expectation of profits to be derived from
the entrepreneurial or managerial efforts of others... (69)
By modifying the Howey test in this fashion, the Supreme Court focused on the quality of the
efforts of others, and effectively read the word "solely" out of the Howey test.
SEC v. Koscot Interplanetary, Inc.(70)
One year after the Glenn W. Turner decision was issued by the Ninth Circuit, the Fifth Circuit
handed down its ruling in SEC v. Koscot Interplanetary, Inc. Like Dare to Be Great, Koscot was
also a program run by Glenn W. Turner Enterprises. Although it sold cosmetics rather than
"Adventures," it followed a similar pattern of hype and high pressure. Under the Koscot program
however, the distributors played a greater role in closing the sale to the prospect than did distributors
in the Dare to Be Great program. The court nevertheless found this to be a ministerial function that
did not overcome the fourth prong of the Howey test:
The act of consummating a sale is essentially a ministerial not managerial one, ... , one
which does not alter the fact that the critical determinant of the success of the Koscot
Enterprise lies with the luring effect of the opportunity meetings. ... [I]nvestors are
cautioned to employ the 'curiosity approach' in attracting prospects. Once
attendance is siecured, the sales format devised by Koscot is thrust upon the prospect.
An investor's sole contribution in following the script is a nominal one. Without the
scenario created by the Opportunity Meetings and Go-Tours, an investor would
invariably be powerless to realize any return on his investment.(71)
As guidance for legitimate companies, the court provided: "[W]e acknowledge that a
conventional franchise arrangement, wherein the promoter exercises merely remote control over an
enterprise and the investor operates largely unfettered by promoter mandates presents a different
question than the one posed herein. But the Koscot scheme does not qualify as a conventional
SEC v. International Loan Network, Inc.(73)
The court in SEC v. International Loan Network, Inc., again found that the "efforts of others"
prong of Howey was satisfied because the company promoted and allowed its distributors to engage
Without a doubt, to earn money through the Capital Fund program requires some
effort on the part of the investor. If an investor does not recruit a single new ILN
member, that person will receive absolutely no income through the program.
However, only a minimal effort is needed in order to earn substantial income through
the program. As Melvin Ford repeatedly says: "you come in, then you bring in your
wife and your kids." If each of them recruits one person, who recruits one person,
who recruits one person, an investor will already have a five-level "downline."
Moreover, to be credited with recruiting a new member may involve as little as
inviting someone to an ILN meeting or President's Night. If the ILN marketing
representatives or Melvin Ford himself are successful in persuading the potential
recruit to join, the person who extended the invitation, otherwise known as the
"sponsor," will be credited as having made the recruitment and will earn income from
In view of the court's reliance on the stacking practice, no MLM should promote this
practice, nor tolerate the practice by distributors. It is simply a practice that will cause the company
significant trouble if a securities claim is ever leveled against it.
U.S. v. Holtzclaw(75)
Amid these difficult decisions, however, is U.S. v. Holtzclaw. In this case, the defendant was
involved in a multilevel program called "Sell America," which sold gold coin certificates. He enrolled
the pastor of a church, who viewed the program as an opportunity to generate revenues for the
church. The pastor invested $200,000.00 of the church's money, and during his sermons he
encouraged individual members of the congregation to participate. The court had no difficulty finding
that the program was a pyramid, but did not find that it was a security because the third and fourth
elements of Howey were not satisfied. The third element was not satisfied because the court rejected
the vertical commonality approach, and applied the horizontal commonality test. With regard to the
fourth element of the test, the court's decision was based on the fact that the gold contracts sold
through the program were sold by the participants rather than the Sell America company. Because
the sales function was "the most essential function," and was not performed by the promoter, the
fourth prong of the Howey test was not satisfied:
Unlike the situation in Glenn Turner and Koscot, Sell America does not make a
presentation. See Glenn Turner, 474 F.2d at 482 (1973) (noting that sales "efforts
are the sine qua non of the scheme" and that those sales efforts were not made by the
investor); Koscot, 497 F.2d 473 (noting that the sales meetings were the most
important element of the scheme and that those meetings ran "according to a
preordained script, the deviation from which would occasion disapprobation"). In
Sell-America's "3-B" program all of the essential efforts are performed by the
investors themselves. Indeed, as described in the brochure, the earnings under the
"Unitary Marketing Plan" are based solely upon your own efforts and abilities.(76)
The Holtzclaw decision provides MLM industry members with an emphatic reminder that it
is critical to ensure that distributors, and not the company, perform the functions associated with
recruitment, enrollment, and sales. At this juncture, however, marketing and legal considerations
violently collide. Clearly, from a marketing perspective, providing a "plug-n-play" system that is
easily duplicatable and leaves distributors with few responsibilities and a turn-key sales and enrollment
system is the optimum program. From a legal perspective, however, this is far from ideal.
Bell v. Health-Mor, Inc..(77)
This point is again illustrated by Bell v. Health-Mor, Inc. In Bell, the Defendant was selling
vacuum cleansers through a referral sales program pursuant to which the buyer received a certificate
that entitled him to $10.00 for the name of each potential customer he submitted to the defendant if
the referred customer submitted to a sales demonstration conducted by the defendant. The defendant
argued that the $10.00 referral fee was not dependent upon the consummation of a sale, but simply
on securing the appointment. The court stated that this fact could nullify the common enterprise or
the significant effort elements of the Howey test if the individual who was receiving the referral fee
engaged in securing the prospective customer's appointment:
In this regard, the central inquiries are what were the significant efforts in producing
the $10 fee and who made those efforts. The payment of the $10 fee was dependent
upon a qualified customer's submitting to a sales demonstration. Thus, the significant
effort in earning the fee was prompting the potential vendee to witness a
demonstration, or, in other words, selling the sales demonstration and making the
necessary appointment. If the efforts were made by plaintiffs, then there would be no
security involved and the action would be subject to dismissal.(78)
SEC v. International Heritage, Inc.
The same analytical approach has been followed by the courts in more recent decisions. In
the IHI case, the court found that the fourth prong was satisfied based upon the sales aids and
materials prepared by the company as well as the meetings and events that the company sponsored:
[U]pper-level management of IHI implemented widespread promotional programs
which included live conferences, telephone conferences, meetings, and training events.
The Retail Sales Career Kit purchased by each representative included brochures,
video presentations, audio cassettes, and flip chart presentations which explained
IHI's marketing program and were used to advertise IHI's program to prospective
participants. An IHI representative only had to find a listening ear, while IHI
promoters retained immediate control over the managerial conduct of the enterprise.
Representatives only had to find two recruits. Representatives testified that they
understood their sales organization would grow simply by duplication. After finding
two recruits, investors would profit by the geometric progression of the process of
recruitment, and the success of a representative's investment was inextricably tied to
the efforts of IHI promoters.(79)
This decision is extremely important for the MLM industry because it demonstrates a new
element that the courts will analyze when conducting a Howey analysis. This element, which is
commonly referred to as "spillover," occurs when a compensation plan is designed so that a
sponsoring distributor is forced to place new recruits somewhere other than on his front line. This
is quite common in binary compensation plans (IHI operated a binary) because each sponsoring
distributor has only two front line positions, so if a distributor recruits three, or if the distributor's
front line has already been filled by another distributor's efforts, the distributor must place the new
recruit front line to someone else in his downline. From a marketing perspective, this again is very
attractive, because the compensation plan channels each distributor's growth so that it benefits others.
However, this approach leads distributors to believe they will be successful based upon the efforts
of others. If a program promotes its program by emphasizing the benefits of spillover, legal and
marketing concerns will have a full-speed, head-on collision. Undoubtedly, this is one of the dangers
inherent in binary plans, since the marketing temptation to highlight the spillover factor is significant.
Capone v. NuSkin
In another recent case, Capone v. Nu Skin, the court considered marketing factors emphasized
by Nu Skin that went beyond factors traditionally considered by prior courts:
The court is of the view that a reasonable jury could conclude from the relevant
evidence that plaintiff reasonably expected to receive significant profits from the
efforts of others as defined in Howey and Forman, supra. Indeed, it appears to the
court that, in marketing this program, defendants place great emphasis on distributors
duplicating themselves, receiving commissions from the sales of others, making big
money from building a sales force, becoming financially independent and the like.
Moreover, Nu Skin represents that distributors do not have the 'traditional headaches
of being in your own business.' A transcript of the Nu Skin "Opportunity of a
Lifetime" video tape represents:
There is no payroll. Because Nu Skin does all of that for you. They
pay, not only yourself, but everyone in your network. There is no
accounts receivable. Everything is done through credit cards and
watts lines and cash. There is no bookkeeping. Nu Skin does all the
bookkeeping for you. 50% of the downtime of all of the small
businesses is bookkeeping and there is no inventory, huge amounts of
inventorying because they drop ship directly, all the people in your
network. So you have a very exciting business where really, you only
have to do two things and that is get people on the product and get
people on the opportunity.(80)
The court's analysis strikes at the heart of the MLM method of doing business. Indeed, the
same marketing methods utilized by Nu Skin are common practices among many other companies
in the industry. Promoting the business aspects of a program by emphasizing that the company will
handle many of the administrative tasks is such a common theme in MLM that it is rare for a company
not to promote this benefit.
A closer inspection of the Nu Skin decision however, reveals that in addition to focusing on
Nu Skin's representations that distributors can earn commissions based on the efforts of others, the
court also focused on activities that the Glenn W. Turner court did not consider to be elements that
would satisfy the fourth prong of Howey. The Turner court held that selling efforts are the sine qua
non of the business. These are the functions that are critical to the operation of the business, and
therefore must be performed by the distributors rather than the company in order to avoid the
violating the Howey test. The Nu Skin court, however, recognized that it was the distributors'
function to "get people on the product and get people on the opportunity." If indeed this was the
function of the distributors, then Nu Skin was complying with the mandates of the Glenn W. Turner
decision because these are the sales functions that the Ninth Circuit identified as critical to the success
of the business. Unfortunately, the Nu Skin court focused on the administrative and ministerial
functions that the company performed on behalf of distributors as evidence that the Howey test could
Piambino v. Bailey(81)
Piambino v. Bailey arose from the Bestline Products, Inc. class action securities litigation.
Bestline operated a multilevel marketing plan with three levels. At the first level were "local
distributors" who sold Bestline's products directly to the public. The middle level were "Direct
Distributors." One became a direct distributor by first becoming a local distributor and selling
approximately $5,000.00 worth of products per month. One could also become a direct distributor
pursuant to the company's "prepurchase plan." Under the prepurchase plan, a local distributor could
become a direct distributor by paying $3,400.00 in cash, for which the distributor would receive
products with a retail value of $5,000.00. Direct distributors were not required to sell products to
the consuming public or even to local distributors whom they sponsored. They could, of course,
sponsor new local and prepurcahse direct distributors. If a direct distributor recruited two new direct
distributors, he moved up to the third level, called the "general distributor" level.
The district court had found that the Bestline program constituted a security, and awarded
summary judgment to the plaintiffs. The case was appealed to the Fifth Circuit Court of Appeals.
In its analysis of the program, the Fifth Circuit found many components of the Bestline program that
mirrored the approach taken by other pyramid schemes that had been found to be investment
contracts. Among these, the court noted:
• The lure of big profits came from the opportunity to recruit others rather than from the
opportunity to sell Bestline products.
• The company urged distributors to hold monthly "opportunity meetings," and to follow a
preordained script provided by the company.
• If a distant prospect signed up for a distributorship, the referring friend became his sponsor
and received a share of the commissions paid on the products purchased from Bestline by the
distant prospect, even if the referring friend took no part in the actual recruitment other than
inviting him to the opportunity meeting.
• Prepurchase direct distributors were required to make large initial purchases to qualify for
• Commissions were paid to upline distributors on the large purchases of the prepurchase direct
distributors even if the prepurchase distributor made no effort to sell the products to the
• Prepurchase distributors did not need to retail the products they purchased. Rather, they
could concentrate on the "wholesale" part of the business and try to recruit new prepurchase
direct distributors whose initial purchases could be applied toward fulfilling his or her own
requirements for becoming a General Distributor.
The court's comments displayed a high degree of skepticism that the Bestline program was
legal. Nevertheless, because the court was reviewing the district court's summary judgment and was
not reviewing the case on the merits, it was incumbent upon the Fifth Circuit to review the facts in
the light most favorable to the defendants. To overturn the district court's summary judgment, it was
only necessary to find a disputed material fact. In its analysis, the court found that there was a
disputed material fact in issue. Despite all of the indicia of a pyramid and a security, the Bestline
program did emphasize that it was necessary for prospects to work. In addition, the company's
meetings did emphasize the necessity of retail sales and the saleability of the products. (On this point,
the court lacked evidence to ascertain what part of the company's total sales were made to consumers
and what part remained in the hands of the various classes of distributors.) The summary judgment
was therefor reversed and the case remanded to the district court for further factual findings.
2. The Risk Capital Test
While many state Blue Sky laws are modeled closely after the federal acts, the state courts
are not bound to follow the decisions of the federal courts when interpreting their respective state
statutes. Consequently, a minority of states have rejected the Howey test in lieu of a more flexible
approach known as the "risk capital test." The concern of the states is that the Howey requires that
courts analyze an investment contract mechanically, based on a narrow concept of investor
participation. It is the position of the states adopting the risk capital test that the courts adapting the
Howey test fail to consider the more fundamental question whether the statutory policy of affording
broad protection to investors should be applied even to those situations where an investor is not
inactive, but participates to a limited degree in the operation of the business.(82)
Thus, with this underlying rationale, the court in State of Hawaii v. Hawaii Market Center,
Inc., held that:
[a] sounder approach to securities regulation requires that courts focus their attention
on the economic realities of security transactions: that is, '[t]he placing of capital or
laying out of money in a way intended to secure income or profit from its
employment' in an enterprise.(83)
In this regard, the court determined that:
The salient feature of securities sales is the public solicitation of venture capital to be
used in a business enterprise. ... The subjection of the investor's money to the risks
of an enterprise over which he exercises no managerial control is the basic economic
reality of a security transaction.(84)
In the Hawaii Market Center case the defendants intended to open a retail store that would
sell merchandise only to members. To raise capital for financing, the company recruited "founder-members." The number of founder-members was limited to 5000. Prospective founder-members
attended recruitment meetings where a company speaker explained how members would become
eligible to earn immediate income before the store became operational, and future income after it
became operational. A person became a founder-member "distributor" by purchasing either a sewing
machine or cookware set from the company for $320.00. Each item had a wholesale value of $70.00.
A person could become a "supervisor" by executing a founder-member contract and purchasing a
sewing machine and a cookware set for a total price of $820.00. A supervisor was entitled to earn
override commissions on sales made by his downline distributors.
To protect against the shortcomings of the Howey test, and to effectuate the above stated
purposes, the Hawaii Supreme Court set forth the following test to determine if an investment
(1) An offeree furnishes initial value to an offeror, and (2) a portion of this initial
value is subjected to the risks of the enterprise, and (3) the furnishing of the initial
value is induced by the offeror's promises or representations which give rise to a
reasonable understanding that a valuable benefit of some kind, over and above the
initial value, will accrue to the offeree as a result of the operation of the enterprise,
and (4) the offeree does not receive the right to exercise practical and actual control
over the managerial decisions of the enterprise.(85)
Applying the test to the facts, the court found that the prices of the products were so inflated
that the investment by distributors constituted "risk capital":
The terms of the offer and the inducements held out to the prospects clearly indicate
that the substantial premiums paid by founder-members to HMC are given in
consideration for the right to receive future income from the corporation. These
overcharges constitute the offerees' investments or contributions of initial value, such
value being subjected to the risks of the enterprise.
The court found that the investor's initial value was subjected to the risks of the
enterprise based on the following finding::
- The recruitment fee paid to distributors and supervisors rests on the
promoters' ability to sell the success of the plan to prospective members.
- Members who choose to rely solely on the payment of commissions based on
sales receive no return on their investment unless the store functions
successfully. This latter point is particularly important because recruitment
of members increases geometrically. Therefore, since membership is limited
to five thousand, a very large percentage of founder-members will be totally
dependent on sales commissions to recover their initial investment plus
income. It is thus apparent that the security of the founder-members'
investments is inseparable from the risks of the enterprise.
- The promise of a valuable return on the offeree's investment element of the
test was satisfied by the commissions that the members anticipated. The court
stated that it was irrelevant that the benefits were not "profits" shared
between the company and the members. The valuable benefit need not be a
- The founder-members possessed none of the incidents of managerial control
that would preclude the finding of a security. They had no power to influence
the utilization of accumulated capital. Nor did they have any authority over
those decisions that will affect the operation of the store if it was successfully
established. They were powerless to protect their original investment.(86)
The risk capital test was again applied against a multilevel program in State of Tennessee v.
Brewer,(87) In Brewer, the defendants started a private wholesale store that sold products to members
of the wholesale club. Members were compensated through a multilevel compensation system. The
initial capital for purchasing and stocking the building was to be secured by selling "specialty"
merchandise such as cookware, vacuum cleaners, and jewelry to members who sought to join the
wholesale club. Each of the specialty products was initially priced at $995.00, although the actual
wholesale value of the products was approximately $200.00. From each sale, approximately $438.00
was applied to operating expenses, $182.00 was applied to overrides, $175.00 was applied to
commissions, and approximately $200.00 went to cover the cost of the product. Members were
advised that the price of the specialty products had such a significant markup in order to facilitate the
purchase of a building and inventory for the store.
To become members of the wholesale club, individuals were only required to bring guests to
the meetings. The company was responsible for all of the product marketing. Individuals could not
become members of the club by purchasing specialty products in their own names, but the company
advised several people that they could evade the rule by simply making up a hypothetical name under
which products could be purchased.
The Tennessee Supreme Court identified the purpose of the risk capital test: "Under the risk
capital test the focus is not so much on whether the investors derive their profits solely from the
efforts of others, but rather on whether the promoter is relying on the investors for a substantial
portion of the initial capital necessary to launch the enterprise."(88) The court then distinguished the
differences between the risk capital and the Howey-Forman tests:
The first prong of the Hawaii Market test is nothing more than the investment concept
of the Howey-Forman test. The second prong adopts the concept of risk capital,
whereas Howey-Forman focuses on the existence of a common venture, i.e., vertical
or horizontal commonality. The third prong of Hawaii Market utilizes the more
liberal concept of the expectation to receive a "benefit" instead of the slightly more
restrictive concept of "profits" found in Howey-Forman. Lastly, the fourth prong
makes explicit, in layman's terms, the Howey-Forman principle that the investor
exercises no managerial control.(89)
There is clearly an overlap between the risk capital and Howey tests. The differences, while
subtle, are significant. Most notably, the risk capital test avoids much of the confusion surrounding
the commonality component of the Howey test. Arguably, a company that offers and enforces a
strong inventory repurchase policy will be able to overcome an attack under the risk capital test
because there is no risk of loss. For a start-up company, however, this is difficult to do since the
company lacks a track record of providing refunds to terminating distributors.
B. Pyramids as Securities
Despite its lack of precision and uniformity of application, the Howey test remains the
principal standard by which an MLM program will be judged to determine if it violates the securities
laws. However, in Webster v. Omnitrition, the Ninth Circuit evaluated the Omnitrition plan under
the federal securities laws without engaging in a Howey analysis. The district court found that the
Omnitrition program was not a security because distributors did not earn commissions primarily based
on the efforts of others, and therefore the Howey test was not satisfied. Nevertheless, on appeal, the
Ninth Circuit simply sought to determine if a jury could find that the program was a pyramid. If the
program was pyramid, the court stated that it constituted a fraud for purposes of §12(2) of the
Securities Act of 1993 and §10 of the Securities Exchange Act of 1934.(90) The Court of Appeals did
not even address the Howey test. Therefore, a discussion of the Omnitrition decision is necessary.
The Ninth Circuit's approach, while a novel development at the federal level, is not wholly
unprecedented when the compared to the approach taken by a limited number of states. New York
for example, has passed legislation that a chain distribution plan (a pyramid) is per se a security. The
§ 359-fff. Chain distributor schemes prohibited
1. It shall be illegal and prohibited for any person, partnership, corporation, trust or
association, or any agent or employee thereof, to promote, offer or grant participation
in a chain distributor scheme.
2. A chain distributor scheme shall constitute a security within the meaning of this
article and shall be subject to all of the provisions of this article.(91)
A comprehensive analysis of pyramid law is beyond the scope of this article. However, one
must at the very least understand that pyramid law is a weapon in any regulator's or plaintiff's arsenal.
While the Omintrition Court's approach is subject to criticism for its failure to conduct a Howey
analysis, the decision will nevertheless certainly be cited by the prosecuting party in a securities
action against an MLM. The reason is two-fold. First, a determination that a securities violation has
occurred creates a broader array of damages and criminal liability than are available under a pyramid
cause of action. Secondly, in jurisdictions that apply the horizontal or strict vertical commonality
tests, it is substantially easier to prove that a program constitutes a pyramid over proving that a
program is a security.
C. Wrapping it Up
At the outset of this article it was pointed out that the principals of law that are utilized to
prosecute MLMs as securities are not new. In fact, the road map for the court's to follow was set
forth by the SEC in 1971 in SEC Release No. 9387 (92). Therein, following a Howey analysis, the SEC
expressed its opinion that multilevel distributorships that are offered through pyramid sales plans
often involve the offering of an investment contract or a participation in a profit sharing agreement,
which are securities within the meaning of Section 2(1) of the Securities Act of 1933. The SEC
elaborated on this point by stating:
Where, ... prospective participants are led to believe that they may profit from
participation in these distribution programs without actually assuming the significant
functional responsibilities that normally attend the operation of a franchise, in the
Commission's opinion there is the offer of a security. Even where a specific offer is
not made, if in the actual operation of a distributor-ship program profits are shared
with or other forms of remuneration are given to persons who have provided funds
to the enterprise - purportedly for a franchise or other form of license - but those
persons do not in fact perform the functions of a franchisee, there would appear to be
an investment contract.
It must be emphasized that the assignment of nominal or limited responsibilities to the
participant does not negative the existence of an investment contract; where the duties
assigned are so narrowly circumscribed as to involve little real choice of action or
where the duties assigned would in any event have little direct effect upon receipt by
the participant of the benefits promised by the promoters, a security may be found to
exist. As the Supreme Court has held, emphasis must be placed on economic reality.
The SEC also emphatically stated that it will look to the substance of a program over form.
After citing Securities and Exchange Commission v. C.M. Joiner Leasing Corp.,(93) and the Howey
decision, the Commission expressed its opinion that:
The term "security" must be defined in a manner adequate to serve the purpose of
protecting investors. The existence of a security must depend in significant measure
upon the degree of managerial authority over the investor's funds retained or given;
and performance by an investor of duties related to the enterprise, even if financially
significant and plainly contributing to the success of the venture, may be irrelevant to
the existence of a security if the investor does not control the use of his funds to a
significant degree. The "efforts of others" referred to in Howey are limited, therefore,
to those types of essential managerial efforts but for which the anticipated return
could not be produced.
Of course, not wanting to limit its arsenal, the SEC also stated that the Risk Capital test as
set forth in Hawaii Market Centers applies under federal securities laws. However, subsequent
federal court decisions have elected not to apply the risk capital test to the federal statutes. The
United States Supreme Court has had the opportunity to adopt the risk capital test, but has declined
to do so. In United Housing Foundation, Inc. v. Forman, the Supreme Court indicated its reluctance
to apply the risk capital test:
Even if we were inclined to adopt such a "risk capital" approach we would not apply
it in the present case. Purchasers of apartments in Co-op City take no risk in any
significant sense. If dissatisfied with their apartments, they may recover their initial
investment in full. (94)
Thus, while the federal courts have not embraced the risk capital test, the SEC Release
nevertheless identifies it as an issue that the MLM industry must be aware and vigilant.
Finally, the Commission explains that pyramid schemes are subject to prosecution under the
Securities Acts because they are inherently fraudulent:
Since there are a finite number of prospective participants in any area, however, those
induced to participate at later stages have little or no opportunity for recruitment of
further persons. It is patently fraudulent to fail to disclose these factors to prospective
While lacking detail and precise guidance, the SEC Release nevertheless was foretelling in that
as far back as 1971 it identified the principal means by which an MLM program could be classified
as a security - under a Howey analysis, under the risk capital test, and under a pyramid analysis. With
almost 30 years of case law following the SEC Release, we are certainly in a better position to
identify certain measures that MLM's should employ to avoid classification as a security.
IV. PRACTICE POINTERS
The foregoing discussion presents a great deal of information that is not particularly easy to
digest. But we can glean some important points that MLMs can build into their programs and
practices to avoid the problems associated with securities laws.
A. Avoid Mandatory Investments
Avoiding the first prong of the Howey test entails ensuring that there is no investment of
money required to become eligible to earn a commission. In this regard, compensation plans should
be set up so that a distributor can be successful even if they do not purchase any product. If a
program has a minimum sales volume requirement, distributors must be able to satisfy their quota
through retail sales to their customers. There are two methods to provide for retail sales to customers
wherein the distributor does not need to put up any of his or her own money. First, the distributor
can take and place a customer's order and submit the customer's check or credit card to the
company. Secondly, a more effective and efficient method is a direct customer program. Pursuant
to these programs, a distributor can enroll customers who can contact and place orders directly with
the company. The customer is coded to the distributor that signed him up, so the distributor is
entitled to a commission from the customer's purchase. In both situations the distributor did not
carry inventory or invest his or her money. In either case, the company should clearly and
conspicuously explain this option to distributors. If it is a feature of the plan, but buried in the
description or not pointed out in the presentation, regulators will treat the alternative as though it
does not exist.
Introductory sales kits, or "starter kits" as they are often called, is also an area where a
company must be careful to ensure that it does not require a mandatory investment. It is common
for companies to require the purchase of a starter kit to become a distributor. It makes perfect sense
to require this, since it will contain the information distributors need to become familiar with the
business and the company's products or services. But giving the kits away would cost every
company a fortune. Therefore, in addition to making the kits subject to the inventory repurchase
provisions discussed above, the company should also sell the kits at its cost. While technically this
would be deemed an investment, in the International Heritage case the court allowed the company
to continue to require the purchase of a starter kit so long as it was sold at cost. While this may not
satisfy every court, there are compelling arguments why the kit, if sold at cost and subject to a refund
policy, should not satisfy the investment criteria. Principal among these arguments is that with these
elements in place, the distributor is not subject to the risk of loss. In addition, he or she will not be
anticipating profits from the investment in the kit. Rather, the anticipated profits will be derived from
sales efforts. The kit itself is not an asset from which the distributor will anticipate generating an
A company should also be careful not to sell its products at inflated prices. As the Hawaii
Market Center case illustrates, a court can find that such a pricing strategy constitutes risk capital.
In addition, it will also be deemed an investment under the Howey test since it is evident that the
reason the purchaser is willing to pay a substantial premium over the legitimate price of the product
is so that he or she can participate in an income opportunity.
B. Implement and Enforce a Strong Inventory Return Policy
From a legal perspective it would be ideal if no distributor ever personally purchased
inventory or products to meet sales requirements, but this is unrealistic from a marketing standpoint.
The common approach is for distributors to buy their inventory and use or resell it to personal
customers. This is logical from a marketing perspective because: 1) customers want to see the
product before buying it; and 2) the distributor must first purchase the product to become familiar
with what she is selling. Therefore, the company should ensure that it has a generous inventory
repurchase policy. The industry standard is that upon a distributor's cancellation of his or her
distributorship, the company will repurchase all of a distributor's resalable inventory at a rate of not
less than 90% of the original purchase price. This repurchase policy extends for one year from the
date of the purchase. This same repurchase policy should also apply to sales aids and starter kits
purchased by distributors. If a company is willing to repurchase any goods that a distributor has in
inventory upon the distributors termination, the argument that the purchase constitutes risk capital
is diluted because the distributor's money is not at risk. In addition, under the Howey test, it is
arguable that a distributor has not committed his funds to the enterprise, so there is no investment.
C. Avoid Inventory Loading and Excessive Prices
Common sense must also be heeded (unfortunately, common sense all too often is the first
thing to go out the window when the greed factor is present). Companies must keep their sales
quotas at a reasonable level. If a company requires its distributors to sell $2,000.00 worth of product
each month it will be in a much more precarious position than a company that requires its distributors
to sell $100.00 of product per month. Again, someone who shells out $2,000.00 is at a much greater
risk of loss, even with a strong inventory repurchase policy. After all, even if the company issues a
90% refund, the distributor would be out $200.00 a month's inventory versus $10.00 under a
program that only called for a $100.00 quota. Moreover, it is much more likely that a distributor and
her family could personally use $100.00 worth of products in a month, and therefore argue that they
were buying products rather than investing money. As the sales quota figure climbs, however, this
argument is dramatically weakened.
D. Distributors Must Perform the Critical Functions
With the understanding that the law requires that distributors must perform the critical
functions, the question arises: "What are the critical functions that must be performed by distributors,
and which functions constitute permissible support offered by the company? In response, the Glenn
W. Turner decision makes it crystal clear that the distributors must perform the sales and enrollment
functions. In the words of the court, these functions are the sine qua non of the business. Therefore,
no company should ever present its program with the claim that the company, the structure of the
compensation plan, or the prospect's upline, will do the work for them. Similarly, if a company learns
that a distributor is recruiting new participants with the pitch: "Just get in and I'll put people in for
you," the company's compliance department should move quickly to teach the distributor why this
is an improper method of promoting the program. If the distributor nevertheless fails to heed the
warning, disciplinary action should be taken.
On the topic of the "critical functions," the Capone v. Nu Skin decision warrants discussion
because the court considered non-sales and enrollment functions that were performed by the company
on distributors' behalf as evidence that the company was performing the critical functions. The court
specifically cited claims in the company's Opportunity of a Lifetime video that represented the
company takes care of book keeping, inventory and shipping. Under the Glenn W. Turner analysis,
these representations should not constitute evidence that the program is a security since the
referenced activities are not the functions which the Glenn W. Turner court deemed the sine qua non
of the business. Despite the criticism that can be leveled at the court for this decision, it provides
guidance to MLMs that the emphasis should be on the totality of the distributors' efforts that are
necessary to make the business successful, and not to overemphasize the assistance the company will
provide on distributors' behalf.
The danger that a program may be presented as a security does not only arise from
representations made by the MLM companies. Distributors too can make inappropriate
representations that create the same problems. Have you ever heard the recruiting pitch: "Just get
in and I'll put people in for you." If a distributor presents a program in this fashion, the new recruit
is being lead to believe that his upline will do the work for him. If this practice becomes widespread
within the company's distributor base, there is a great risk that the entire program will be challenged
as a security. It is therefore important that distributors refrain from representing that they will build
a downline for someone else.
It is an inherent feature under some types of compensation structures that the upline will
recruit distributors for their downline. Under binary plans and forced matrices for example, each
distributor has only a limited number of first level distributors. If their first level is filled, subsequent
recruits must be placed at lower levels, thereby benefitting their downline. This is known as a
"spillover" feature. While it is extremely tempting to emphasize spillover when recruiting new
distributors, doing so leads the prospect to believe that their success will be based on the efforts of
others. Therefore, MLMs that use these types of compensation plans should de-emphasize the
spillover feature and implement stringent personal retail sales and recruiting requirements to ensure
that distributors are not lead to anticipate profits from spillover. These requirements must also be
ongoing. This is in contrast to the common binary pitch that all one must do is "Get two and your
through!" From a legal standpoint, the sales requirements should be ongoing.
Similarly, no company should promote stacking, or allow its distributors to do so. The
International Loan Network decision is a crystal clear example of the pitfalls associated with the
practice. Boiled down to its essentials, stacking is simply another method of gathering warm bodies
to invest in the program. The funds invested by the family members drive the profits for the others,
and a court will perceive a stacked downline as investment income rather than income from the
legitimate sales efforts of each upline family member.
It is of course to the company's and the distributors' benefit if the company produces high
quality sales, training, recruiting, and instructional materials. It is key, however, that the company
not represent to distributors that "these materials will do the work for you." It is a great marketing
pitch, but it is fraught with risk because it can easily be inferred that the company is simply telling
distributors to assemble warm bodies in front of the television, and the company produced video tapes
and other materials will do the rest. Thus, while it is appropriate to use these tools, distributors must
understand that they have a critical role in the sales and recruitment process, and that they must not
rely on the company's materials to perform these functions for them. Again, this is an area where the
legal and marketing considerations will collide. Ultimately, finding the appropriate balance is more
art than science since this is truly a tight-rope balancing act.
E. Distributors Should Have Ongoing Sales and Managerial Responsibilities
One of the common goals of distributors is to develop a residual income. If improperly
presented, residual income can be confused with passive investment income. Residual income means
that the distributor does the initial work and continues to get paid for those efforts into the future.
However, this does not mean that a distributor can abandon the business altogether. She must
continue to service customers, and work with her downline. Passive investment income, on the other
hand, means that the distributor makes a financial investment, but the managerial work is done by
someone else. To avoid confusion between "residual" and "passive" income, distributors should have
ongoing responsibilities throughout their MLM career. As with any other business, the nature of a
distributor's responsibilities will change as he gains experience. In the early stages of an MLM
business, a distributor may spend most of her time recruiting and selling. As she becomes more
successful and experienced, she will spend the majority of her time consulting with select leaders
within her downline and conducting large group meetings in conjunction with downline members.
This presents a dilemma for MLM companies because, as independent contractors, the
company cannot dictate that distributors must perform a specific number of meetings every week,
month, or year. This must be left up to the individual distributor's discretion. However, if
distributors are taught why it is important to have ongoing training, consulting, and managerial
contact with a downline, and this ethic is instilled in the group, it will be very difficult for a regulator
to assert that the company is actually promoting a passive investment income rather than an
opportunity for residual income.
E. Do Not Finance a Company by Selling Top Positions
One of the biggest, yet most common, mistakes that start-up MLMs make is to sell their top
positions to generate investment capital to get the business off the ground. This practice clearly
constitutes a sale of a security under the risk capital test (it usually also constitutes the sale of a
business opportunity and franchise, but these laws are beyond the scope of this article). In fact, I
have even seen established MLMs sell top positions to acquire a cash infusion. While it may be more
difficult to generate financing through venture capital avenues, start up companies must not succumb
to the temptation of selling positions.
Companies in the "prelaunch" phase must also be careful not to violate the risk capital test.
Often, start-up companies in the prelaunch phase take in money to reserve positions in a downline
before the company actually launches, and before products and services are ready for the consumer.
The funds derived from these positions is then invested in the company. Again, as with selling the
top positions, this practice unquestionably violates the risk capital test, and therefore should be
avoided at all costs.
E. Income Guarantees and Projections
Income guarantees are problematic from a securities analysis because they lend themselves
to the argument that the investors are lead to anticipate profit. They are often presented as offering
a return on an investment rather than a return based on a distributor's sales efforts. A court will
consider "the expected return as compared to the effort involved to be a significant factor in
determining whether what is acquired is payment for services or is in the nature of an investment in
defendants' enterprises. " S.E.C. v. Bull Investment Group, Inc.(95)
F. Pyramid Traps and Pitfalls
Many of the pointers in this section are applicable to avoiding pyramid problems. However,
a comprehensive discussion of pyramid issues would entail a separate article of equal length to this
one. This discussion will therefore be reserved for another day. Some quick tips, however, are:
- The primary emphasis of the program must be on generating sales to end user
consumers, not on recruitment of new participants into the compensation plan;
- Be careful not to offer a plan pursuant to which commissions are actually "recruitment
based bonuses." That is, the sale of products and services must not be so
intermingled with recruitment of new distributors that the two elements are
inseparable. If sales and enrollments are so closely tied to one another, the sale of
goods or services will be attacked as merely a camouflage for a commissions based
on recruitment of new distributors;
- Do not require unrealistic monthly volume quotas. From a regulator's standpoint, less
is always better. If you have a $2,000.00 monthly personal volume requirement, it is
unrealistic to expext distributors to actually retail this amount every month, and there
is little hope of winning on the basis that personal consumption of the product by
distributors is appropriate.
- Implement a strong (at least 90%) inventory and sales aid repurchase policy for
- Do not operate a pay-to-play program. With the exception of an at cost sales kit,
distributors' personal purchases must always be discretionary;
- NEVER, NEVER, NEVER, pay a commission out of a sign up fee. Commissions
must only be paid from the sale of consumable products or services to end consumers;
- Do not allow distributors to stack their organizations (i.e., enroll phantoms, their
minor children, the dog, the cat, etc.). Make sure their downline recruits and
customers are real people, not ghosts. Allowing stacking is simply a camouflage for
a head hunting and inventory loading program;
- Enforce the companies policies against inventory loading;
- Avoid income projections;
- Paying multilevel commissions on the sale of training programs is fraught with risk
and should be avoided. While it is appropriate to pay someone who personally trains
another distributor, paying training commissions to the trainer's upline will cause
- Avoid "self funding" programs. If a program is represented as one in which the
distributors' subsequent inventory purchases are paid for through deductions from his
commission checks, it is highly probable that the true source of the commissions is
derived from the purchases of the new participants. Such programs are driven by
recruiting rather than product sales, and will run afoul of anti-pyramid laws.
Spencer Reese is a partner in the law firm of Grimes & Reese. He is a graduate of the Washington University School
of law and is a member of the Idaho, Missouri and Colorado bars. He was formerly in-house counsel for Melaleuca,
Inc., a multilevel marketing company with sales in excess of $300 million. Mr. Reese's current practice includes
representing and advising multilevel marketing companies on all aspects of their business, including consumer
protection, advertising law, litigation, contracts, marketing plan design, regulatory compliance, trademark law, FDA
law, policy development and distributor compliance. Grimes & Reese is a supplier-member to the Direct Selling
Association and the Professional Association of Network Marketers. Visit the firm's website at www.mlmlaw.com.
Mr. Reese can be contacted at (208) 522-2600 or via e-mail at firstname.lastname@example.org.
15 U.S.C. § 77e(a) provides:
"Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly - (1)
to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use
or medium of any prospectus or otherwise; or (2) to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments
of transportation, any such security for the purpose of sale or for delivery after sale."
15 U.S.C.§77e(c) provides: "It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or
communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security,
unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or ... any
public proceeding or examination under section 8 (15 U.S.C. § 77h).
S.E.C. v. Continental Tobacco Co. of South Carolina, 463 F.2d 137, 155 (5th Cir. 1972).
4. 3. See U.S.C. §77o(1), which provides: "It shall be unlawful for any broker or dealer ... to induce or attempt to induce the purchase 15 or sale of, any
security ..., unless such broker or dealer is registered in accordance with subsection (b) of this section."
15 U.S.C. §77x.
579 NW 2d 144, 254 Neb. 18 (1998).
739 F.2d 1057 (6th Cir. 1984).
739 F.2d at 1067.
739 F.2d at 1068. The court remanded the case to the district court, however, for further findings on whether the manager's activities were a substantial
factor in the sales made to all plaintiffs.
739 F.2d at 1068.
11. 254 Neb. at 24 - 25.
The fraud provisions of the Securities Act provide:
(a) It shall be unlawful for any person in the offer or sale of any securities by the use of any means or instruments ... in interstate
commerce or by the use of the mails, ... (1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property
by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statement
made, in the light of the circumstances under which they were made, not misleading, or (3) to engage in any transaction, practice,
or course of business which operates or would operate as a fraud or deceit upon the purchaser.
15 U.S. C. §77q(a)
The Exchange Act provides:
It shall be unlawful for any person, ..., by the use of any means or instrumentality of interstate commerce or of the mails, ..., (b) To
use or employ, in connection with the purchase or sale of any security ..., any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or
for the protection of investors.
15 U.S.C. §78j.
The most often used of the "rules and regulations" established by the S.E.C. pursuant to the preceding statute is Rule 10b-5, which provides:
It shall be unlawful for any person, ..., by the use of any means or instrumentality of interstate commerce, ..., (a) To employ any device, scheme,
or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to
make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any
act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the
purchase or sale of any security.
17 C.F.R. §240.10b-5.
See e.g. S.E.C. v. International Loan Network, Inc., 770 F.Supp. 678, 694 (D.C. 1991); S.E.C. v. The Better Life Club of America, Inc., 995 F.Supp.
167 (D.C. 1998).
417 F.Supp. 1225 (E.D.N.Y. 1976).
417 F.Supp. at 1244 - 45.
417 F.Supp. at 1247.
15 U.S.C. §77q(a)(2) of the Securities Act makes it illegal "to obtain money or property by means of any untrue statement of a material fact or any
omission to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not
misleading." Section q(a)(3) makes it illegal "to engage in any transaction, practice, or course of business which operates or would operate as a fraud or
deceit upon the purchaser." It is not necessary to prove scienter under these section of the anti-fraud provisions. S.E.C. v. International Loan Network,
Inc., 770 F.Supp. 678, 694 (D.C. 1991); S.E.C. v. The Better Life Club of America, Inc., 995 F.Supp. 167 (D.C. 1998).
Aaron v. S.E.C., 446 U.S. 680, 686 (1980).
See e.g., S.E.C. v. Carriba Air, Inc., 681 F.2d 1318, 1324 (11th Cir. 1982).
79 F.3d 776 (9th Cir. 1996).
770 F.Supp. 678 (D.C. 1991).
Id. at 694.
Id. at 694.
24. The definition of a "security" under the Securities Act and the Securities and Exchange Act are virtually identical. Techerepnin v. Knight, 389 U.S.
332, 335 - 36 (1967), so the courts have interpreted them in like fashion.
328 U.S. 293 (1946).
421 U.S. 837 (1975).
27. 328 U.S. at 298-99.
28. 474 F.2d 476 (9th Cir. 1973).
29. 474 F.2d at 482.
30. S.E.C. v. International Mining Exchange, Inc., 515 F.Supp. 1062, 1068 (D.Colo. 1981), quoting Stowell v. Ted S. Finkel Investment Services, Inc.,
489 F.Supp. 1062, 1068 (D.Fla. 1980). See also: S.E.C. v. Comcoa Ltd., 855 F.Supp. 1258, 1260 (D. Fla. 1994; Wooldridge Homes, Inc. v. Bronze
Tree, Inc., 558 F.Supp. 1085, 1986 (D. Colo. 1983); Kolibash v. Sagittarius Recording Co.,626 F.Supp. 1173 (S.D. Ohio 1986).
31. A common exception to the "no required purchase" rule is that a "starter kit" of introductory sales materials must be purchased by a distributor so long
as: 1) the company makes no profit on the sale of the kit; and 2) it is refundable upon its return to the company if the distributor terminates). In fact, the
IHI court allowed the company to continue to require its distributors to purchase an" at cost" sales kit for $100.00 as a prerequisite to becoming a
distributor. The court did not classify this expenditure as "an investment" sufficient to satisfy the first prong of the Howey test.
32. 328 U.S. at 301.
33. 770 F.Supp. 678 (DC 1991).
34. Id. at 691.
35. Id. at 691, note 13.
36. Capone v. NuSlin Canada, Inc., Case No. 93-C-0285-S, Memorandum Decision, March 27, 1997.
37. 194 F.Supp.709 (N.D. Tex. 1961).
38. 587 F.2d 413 (9th Cir. 1978).
39. Revak v. SEC Realty Corp., 18 F.3d 81, 87-88 (2d Cir. 1994); Coan v. Bell Atlantic Systems Leasing International, Inc., 813 F.Supp. 929, 936
(D. Conn. 1990); New York v. First Meridian Planning Corporation, 201 A.D.2d 145, 152 (1994).
40. 950 F.Supp. 1306 (D. W.V. 1997).
41. 469 U.S. 1115 (1985).
42. 455 U.S. 551 (1982)
43. 950 F.Supp. at 1316.
44. 595 F.2d 459 (9th Cir. 1978). See also: Hector v. Wiens, 533 F.2d 429 (9th Cir. 1976); Mechigian v. Art Capital Corp, 612 F.Supp. 1421 (N.Y.
1985, later proceeding, 639 F.Supp. 702.)
45. 595 F.2d at 461.
46. xU.S. v. Carman, 577 F.2d 556 (9th Cir. 1978); El Khadem v. Equity Securities Corp., 494 F.2d 1224 (9th Cir. 1974).
47. 474 F.2d 476 (9th Cir. 1973).
48. 474 F.2d at 482, note 7.
49. 497 F.2d 473, 479 (5th Cir. 1974).
50. 497 F.2d at 479.
51. 770 F.Supp. 678 (DC 1991).
52. 770 F.Supp. at 692.
53. 896 F.2d 85 (5th Cir. 1990).
54. 896 F.2d at 88.
55. 18 F.3d 81 (2d Cir. 1994).
56. 18 F.3d at 89, Quoting SEC v. Continental Commodities Corp., 497 F.2d 516, 522 (5th Cir. 1974); See also: Savino v. E.F. Hutton & Co., 507
F.Supp. 1225 (N.Y. 1981); Mechigian v. Art Capital Corp., 612 F.Supp. 1421 (N.Y. 1985); Kaplan v. Shapiro, 655 F.Supp. 336 (N.Y. 1987); Shotto
v. Laub, 635 F.Supp. 835 (MD 1986).
57. 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975).
58. 421 U.S. at 853.
59. 421 U.S. at 858
60. 421 U.S. at 853, note 17.
61. 549 F.2d 342 (5th Cir. 1977).
62. 549 F.2d at 345-46.
63. 166 Mich. App. 683, 421 N.W.2d 177 (1986).
64. 474 F.2d 476 (9th Cir. 1973).
65. Id. at 479.
66. Unlike the Court of Appeals, the trial court found that the plans sold by Dare fell into three categories of securities. In addition to constituting an
investment contract, the district court also found that the program constituted "certificates of interest" and "profit sharing agreements." The district court
It would seem that its plain meaning encompasses these transactions. What the investors receive, after all, is a right to a cut of the
profits from other investors. In the opinion of this Court, it is immaterial that the entire profits in Dare to be Great are not divided
up among all the investors and that they are only entitled to the profit from a particular designated source. In other words, an
agreement to share some profits is within the meaning of the statutes as well as an agreement to share all profits.
384 F.Supp. 766, 776 (D. OR 1972). The Court of Appeals, however, found that the plan was an investment contract, so it did not inquire into the other
xNote however, that the district court in SEC v. Interplanetary, Inc., 365 F.Supp. 588 (Koscot was another program operated by Glenn W.
Turner Enterprises), held that the Koscot plan was not a profit sharing arrangement because a successful recruiting distributor received a fixed fee rather
than a share of Koscot's profits. 365 F.Supp. 590 - 91. The Fifth Circuit did not disturb this holding in the Koscot appeal, but rather, reversed only the
district court's holding on the investment contract issues. (See SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (1974)).
67. 474 F.2d at 482.
68. Id. at 842.
69. 421 U.S. 837 at 852.
70. 497 F.2d 473 (5th Cir. 1974).
71. Id at 485.
72. Id. at 485.
73. 770 F.Supp. 678 (DC 1991).
74. Id at 692.
75. 950 F.Supp. 1306 (D. W.V. 1997), affirmed 131 F.3d 137 (1997).
76. Id. at 1317.
77. 549 F.2d 342 (5th Cir. 1977).
78. 549 F.2d at 346.
79. SEC v. International Heritage, Inc., U.S. District Court, N.D. GA, Case No. 1:98-CV-803, Memorandum Opinion and Order, April 3, 1998.
80. U.S. Disctirct Court for the District of Utah, Case No. 93-C-0285, Memorandum Decision dated March 27, 1997.
81. 610 F.2d 1306 (5th Cir. 1980).
82. State of Hawaii v. Hawaii Market Center, Inc., 485 P.2d 105, 108 - 09 (1971); 52 Haw. 642.
83. Id at 109 Citing State v. Gopher Tire & Rubber Co., 177 N.W. 937, 938 (1920); 146 Minn. 52.
85. Id. at 109.
86. 485 P.2d 105 at 110-11.
87. 932 S.W. 2d 1 (Tenn. 1996).
88. 932. S.W.2d at 11.
89. 932 S.W.2d at 13-14.
90. 79 F.3d at 781.
91. NY GEN BUS § 359-fff.
92. 36 Fed. Reg. 23289 (1971).
93. 320 U.S. 344 (1943).
94. 421 U.S. at 857. The risk capital approach was also rejected in SEC v. Koscot Interplanetary, Inc., 365 F.Supp. 588 (GA 1973) Reversed on other
grounds, 497 F.2d 473...
95. 1975 U.S. Dist. Lexis 13449; Fed. Sec. L. Rep. (CCH) ¶ 95,010 (D. Mass. 1975).
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