## Facts

- The Securities and Exchange Commission (SEC) sought to enjoin Koscot Interplanetary, Inc., a cosmetics marketing company, from offering and selling positions in a multi-level recruitment program without complying with federal securities laws.
- Koscot’s program used multiple levels (including “beauty advisor,” “supervisor/retail manager,” and “distributor”) tied to increasing entry payments (approximately $1,000 for supervisor and $5,000 for distributor).
- Participants received product discounts and, more importantly, were promised substantial returns from recruiting new participants who paid to purchase higher-level positions.
- Koscot used centrally organized, scripted promotional presentations to induce purchases of these positions by emphasizing high profit potential.
- Participants’ meaningful role after joining was limited; profitability depended largely on Koscot’s organization, training, promotion, and continued expansion of the recruitment chain rather than participants’ independent managerial skill.
- The district court denied injunctive relief, concluding the program did not involve “securities” and thus was outside the registration and antifraud provisions invoked by the SEC.
- The SEC appealed.

## Issues

1. Whether the sale of paid positions in Koscot’s recruitment-driven marketing program constituted the offer and sale of “investment contracts,” and therefore “securities,” under the Securities Act of 1933 and the Securities Exchange Act of 1934.
2. Whether the “profits to come solely from the efforts of others” element of the Howey test must be applied literally in evaluating MLM or pyramid-type arrangements.

## Decision

- The Fifth Circuit reversed the district court and remanded.
- The court held that Koscot’s offers and sales of positions in the pyramid promotion scheme were “investment contracts” and therefore “securities.”
- The court rejected a rigid, literal reading of Howey’s “solely from the efforts of others” language and applied a functional analysis centered on the promoter’s essential managerial efforts.
- Because the positions were securities, the transactions were subject to federal registration requirements and the antifraud provisions applicable to securities offerings.

## Legal Principles

- An “investment contract” exists where there is (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits derived from the efforts of others.
- “Solely from the efforts of others” is not applied as a strict literal requirement; the relevant inquiry is whether the efforts of others are the essential managerial efforts that determine the enterprise’s success or failure.
- A recruitment-based program framed as a distributorship may still be a security when the principal inducement is the right to recruit and share in payments from new participants, and when the promoter retains centralized control over the system producing expected profits.

## Conclusion

The Fifth Circuit concluded that Koscot’s paid MLM positions were investment contracts because participants invested money in a common enterprise with an expectation of profits primarily dependent on Koscot’s essential managerial and promotional efforts, bringing the scheme within federal securities registration and antifraud rules.


Sec. & Exch. Comm'n v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974)