## Facts

- ETS Payphones, Inc. sold payphones to individuals through independent distributors.
- Buyers purchased a payphone and entered a sale-and-leaseback arrangement in which ETS leased the payphone back for a fixed monthly payment, marketed as a fixed 14% annual return.
- ETS’s payphones did not generate enough operating revenue to make promised payments; ETS relied on funds from new purchasers to meet obligations.
- After ETS filed for bankruptcy protection, the Securities and Exchange Commission (SEC) brought a civil enforcement action alleging violations of registration and antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and Rule 10b-5.
- The district court held the arrangement was an “investment contract” and therefore a “security.”
- The Eleventh Circuit reversed, reasoning that an “investment contract” required capital appreciation or participation in earnings and that a contractual entitlement to payment defeated the “efforts of others” element.

## Issues

1. Whether an arrangement promising a fixed return can satisfy the “profits” element of the Howey test and qualify as an “investment contract.”
2. Whether a contractual guarantee of payment prevents profits from being derived “solely from the efforts of others” under Howey.
3. Whether excluding fixed-return schemes from “investment contracts” would improperly narrow the scope of federal securities laws.

## Decision

- The Supreme Court unanimously reversed the Eleventh Circuit and remanded.
- The Court held that a promised fixed return can constitute “profits” under Howey.
- The Court rejected a rule limiting “investment contracts” to schemes offering capital appreciation or participation in enterprise earnings.
- The Court held that a contractual entitlement to payment does not, by itself, negate reliance on the promoter’s efforts where investors depend on the promoter’s managerial or entrepreneurial conduct to generate the promised returns.

## Legal Principles

- “Security” under the federal securities laws includes an “investment contract,” analyzed under SEC v. W. J. Howey Co.
- Under Howey, “profits” means the income or return sought by investors and can include dividends, periodic payments, or increased value; it is not limited to residual participation in issuer earnings.
- The definition of “investment contract” does not turn on whether returns are fixed or variable; fixed-return schemes may be covered if Howey’s elements are met.
- The “efforts of others” inquiry focuses on economic reality—whether investors are led to expect returns from the promoter’s efforts—rather than the presence of a contractual promise or guarantee.
- Interpreting “investment contract” to exclude fixed-return schemes would allow easy evasion of registration and antifraud rules and would conflict with the protective purpose of the securities statutes.

## Conclusion

The Court held that an investment scheme promising a fixed rate of return can be an “investment contract” and therefore a “security” if it satisfies Howey, making fixed-return sale-and-leaseback offerings potentially subject to federal registration and antifraud requirements.


Securities & Exchange Commission v. Edwards, 540 U.S. 389 (2004)