Lewis I. Baurer, Appellant v. the Planning Group, Inc., et al, 669 F.2d 770 (D.C. Cir. 1981)

This appeal questions whether the term "security," as defined by the Securities Act of 1933¹  and the Securities Exchange Act of 1934,²  includes a short-term promissory note given in exchange for funds advanced in anticipation of securing a limited partnership interest. In light of the broad remedial purposes of the securities laws, which mandate sufficiently flexible construction to include "(n)ovel, uncommon, or irregular devices" which function as investments,³  we hold that the note involved here is a security.

Originally the defendants in this action included Lawrence Feldman and his controlled corporation (The Planning Group, Inc. (TPGI)) ; Jaclyn and Theodore Kramer; and 475 H Street, Inc. (of which Theodore Kramer was sole shareholder at all relevant times).⁴  Feldman's corporation, TPGI, acted as managing agent for 475 H Street, Inc.⁵ 

In the spring of 1978, Feldman began discussing with the appellant Lewis Baurer, the Kramers, and another couple, Ida and Robert Mantel, the formation of a limited partnership, to be known as "Citybank Associates," which would purchase and manage property located on 8th Street, S. E., in Washington, D. C. Subsequently, Feldman prepared and distributed to the potential partners two drafts of a partnership agreement.⁶  Following a pattern established in their previous transactions, Baurer tendered to Feldman a check made out to TPGI and received in exchange the following note, typed on TPGI stationery:

June 21, 1978

PROMISSORY NOTE

The undersigned promises to pay to the order of Lewis Baurer the sum of Fifteen Thousand Dollars ($15,000) on demand.

The loan signified by this instrument being in lieu of a capital contribution to City Bank Properties Associates, a District of Columbia limited partnership currently being organized. In the event that the parties are unable to reach agreement within thirty (30) days from date hereof on the terms of the partnership agreement, this note shall be due and payable in full. Maker reserves the privilege of making payment on principal at any amount at any time. It is understood that upon the execution of the Limited Partnership Agreement, the principal sum shall be deemed paid in full and the accrued interest will be due and payable.

Interest shall accrue at the rate of the flat sum of NONE to June 30, 1978 and 12% per annum from July 15, 1978.

THE PLANNING GROUP, INC.

By: /s/

LAWRENCE C. FELDMAN

President

For value received I hereby guarantee the payment of the principal and income of the foregoing note as they respectively come due and payable.

By: /s/

LAWRENCE C. FELDMAN⁷ 

In a previous transaction, Baurer had also advanced funds in exchange for a similar promissory note,⁸  and later, when the partnership agreement had been approved, signed a Subscription Agreement and Agreement and Certificate of Limited Partnership in Blue Line Avenue Properties Associates.⁹  This time, however, although Feldman succeeded in organizing a partnership-with 475 H Street, Inc. as general partner and the Mantels as limited partners,¹⁰  the partnership plan was not acceptable to Baurer. Baurer therefore demanded return of his funds in August, 1978.¹¹  Feldman was unable to comply, apparently because he had used Baurer's funds to pay TPGI's outstanding debts. Feldman, instead, executed an assignment to Baurer of a portion of the proceeds of any future sale of the 8th Street property which Citybank had been organized to manage.¹²  Baurer claims that he was subsequently assured by the Kramers, as well as by Feldman, that his funds would be returned when the property was sold. The Kramers, in turn, say that they were under the impression that TPGI had purchased an interest in Citybank and it was TPGI's interest in any sale proceeds of the property that Feldman had assigned to Baurer. According to the Kramers, they first learned that TPGI had failed to make a partnership contribution at the time of the actual sale of the property in November of 1978. Because TPGI owned no interest in the Citybank property, no distribution of the sale proceeds was made to TPGI or Baurer as its assignee. Instead the proceeds were divided between 475 H Street, Inc. and the Mantels.¹³ 

On April 13, 1979, after his demands for payment were denied, Baurer filed this action in the district court, alleging violations of the Securities Acts¹⁴  and various common law claims. The Kramers and 475 H Street, Inc., filed a motion to dismiss and subsequently a motion for summary judgment, which Feldman and TPGI later joined. The defendants argued for dismissal on the grounds that Baurer lacked standing to sue under the Securities Acts because he had never purchased a security. In reply, Baurer asserted that (1) he had entered into a contract to purchase a limited partnership interest which is a security, and (2) the promissory note was itself a security. In September, 1980, Judge Pratt granted the summary judgment motion of the Kramers and 475 H Street, Inc. and denied the summary judgment motion of Feldman and TPGI.¹⁵  He later denied Baurer's motion for reconsideration. In November, 1980, Judge Pratt approved an offer of confession of judgment of $15,000 plus interest by Feldman and TPGI (the Kramers' brief notes, however, that it is probable that Feldman and TPGI are judgment proof). Baurer pursued his claims against the Kramers and 475 H Street, Inc. by timely filing a notice of appeal from the grant of summary judgment in their favor.

Judge Pratt's order dismissing the claims against the Kramers and 475 H Street, Inc. stated only that Baurer had never acquired a partnership interest in Citybank, a question as to which he found "no genuine issue of material fact." Since, however, the order granted summary judgment to the appellees, it must also be interpreted as denying Baurer standing to sue under the Securities Acts for failure to have purchased a "security" and as dismissing Baurer's pendent common law claims on the merits.¹⁶  Baurer's main argument on appeal is that, despite having never consummated the Citybank partnership agreement, he is nonetheless a purchaser of a "security" and therefore entitled to sue under the Securities Act.

Baurer relies on the definitional sections of the Securities Acts to support his claim that the promissory note he received from Feldman is a security. Both the Securities Act of 1933, which establishes disclosure requirements in the offer and sale of securities in interstate and foreign commerce,¹⁷  and the Securities Act of 1934, which regulates securities exchanges and over-the-counter markets operating in interstate and foreign commerce,¹⁸  include "any note" within their definitions of a "security." But there are some differences in language between the two definitional sections. While the 1933 Act defines "security" to include any "evidence of indebtedness," 15 U.S.C. § 77b(1), the 1934 Act's definition omits this phrase, see 15 U.S.C. § 78c(a) (10). The 1933 Act exempts certain short-term notes from the Act's registration requirements, 15 U.S.C. § 77c(a) (3), although all notes, without exception, are subject to the Act's antifraud provisions. In contrast, the 1934 Act's definition of security, which controls the scope of its antifraud provisions, specifically excepts those notes with a maturity of nine months or less. 15 U.S.C. § 78c(a) (10).

A superficial reading of the two Acts would thus seem to bring this note clearly within at least the antifraud provisions of the 1933 Act but possibly, because of its short duration, beyond the scope of the 1934 Act. Since the bases of liability under the two Acts differ in scope and kind,¹⁹  and Baurer's complaint relied upon both Acts for jurisdictional purposes, we must decide whether this note is a security under both Acts. Other courts that have addressed the status of notes under either Act have concluded that Congress did not intend coverage of the Acts to depend solely upon the maturity of a note. Rather, despite different rationales, those courts have concluded that whether or not a note is a "security" under either Act depends on whether the instrument is an investment, as opposed to a commercial note. E.g., Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257 (9th Cir. 1976); Zabriskie v. Lewis, 507 F.2d 546, 550 (10th Cir. 1974); SEC v. Continental Commodities Corp., 497 F.2d 516, 523-27 (5th Cir. 1974); Lino v. City Investing Co., 487 F.2d 689, 694-95 (3d Cir. 1973); Sanders v. John Nuveen & Co., 463 F.2d 1075, 1079-80 (7th Cir.), cert. denied, 409 U.S. 1009, 93 S. Ct. 443, 34 L. Ed. 2d 302 (1972); SEC v. Diversified Industries, Inc., 465 F. Supp. 104, 107 (D.D.C. 1979); Oliver v. Bostetter, 426 F. Supp. 1082, 1085 (D. Md. 1977); Anderson v. Francis I. duPont & Co., 291 F. Supp. 705, 708 (D. Minn. 1968). Cf. 1 ALI, Federal Securities Code § 202(150) (B) (iii) comment (6) (a) ("This codifies the mercantile-investment dichotomy that is emerging as the least imperfect solution to a troublesome problem.") Even the Second Circuit, which has adhered to the "literal approach" (presuming that "any note" with a maturity date exceeding nine months is a security), inquires into the context of the transaction to determine whether that presumption has been rebutted. And, conversely, that same Circuit has expressed the view that "the mere fact that a note has a maturity of less than nine months does not take the case out of (the 1934 Act), unless the note fits the general notion of 'commercial paper.' " Zeller v. Bogue Electric Mf'g Corp., 476 F.2d 795, 800 (2d Cir. 1973), cert. denied, 414 U.S. 908, 94 S. Ct. 217, 38 L. Ed. 2d 146 (1973). (Friendly, J.) (dicta). But see Exchange Nat'l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1138 n.19 (2d Cir. 1976) (Friendly, J.) ("We leave for another day the status under the 1934 Act of a note with a maturity of nine months or less....").

We, too, find persuasive the reasoning that Congress intended to include investment notes of whatever duration within coverage of both Securities Acts and to exclude only commercial notes. Although the Supreme Court has not yet decided the question, we think our conclusion consistent with the Court's previously expressed approach toward construing a "security."

The primary purpose of the Acts of 1933 and 1934 was to eliminate serious abuses in a largely unregulated securities market. The focus of the Acts is on the capital market of the enterprise system: the sale of securities to raise capital for profit-making purposes, the exchanges on which securities are traded, and the need for regulation to prevent fraud and to protect the interest of investors ... Thus, in construing these Acts against the background of their purpose, we are guided by a traditional canon of statutory construction:

'(A) thing may be within the letter of the statute and yet not within the statute, because not within its spirit, nor within the intention of its makers.' Church of the Holy Trinity v. United States, 143 U.S. 457, 459 (12 S. Ct. 511, 512, 36 L. Ed. 226) (1892).

United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S. Ct. 2051, 2059, 44 L. Ed. 2d 621 (1975).

In short, the Court appears to be rejecting a "literal" approach toward defining a security in favor of one that looks to the statutory goal of protecting investors.

To exclude short-term notes that represent genuine investments from the coverage of the 1934 Act would serve no discernible statutory purpose. As both Acts are aimed at the protection of investors, "(c)ourts have shrunk from a literal reading that ... would produce a seemingly irrational difference in the scope of their antifraud provisions." Exchange Nat'l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1133 (2d Cir. 1976). Similarly, the Supreme Court has held that the definition of security under both Acts is "virtually identical," and the omission of "evidence of indebtedness" from the 1934 Act is without controlling significance. Tcherepnin v. Knight, 389 U.S. 332, 342, 344, 88 S. Ct. 548, 556, 557, 19 L. Ed. 2d 564. The Court relied in part on the Senate Report accompanying the 1934 Act which stated that "the definition of security was intended to be 'substantially the same' " under both Acts. 389 U.S. at 342 (quoting S.Rep.No.792, 73d Cong., 2d Sess. 14 (1934)). Further support for the view that it would be inappropriate to exclude all short-term notes, regardless of their nature or purpose, from the definition of a security in the 1934 Act, comes from the fact that the exclusionary language in the 1934 Act's definition closely tracks language of the 1933 Act exempting from the registration requirements "(a)ny note ... which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." 15 U.S.C. § 77c(a) (3). The only difference in the two sections is the 1934 Act's omission of the phrase "which arises out of a current transaction or the proceeds of which have been or are to be used for current transaction." Given the absence of any explanation in the legislative history for that omission,²⁰  other courts have reasonably construed the 1934 Act's exclusion of short term notes as coextensive with the narrow class of commercial instruments that Congress exempted from the 1933 Act registration requirements: "short term paper of the type available for discount at a Federal Reserve bank and of a type which rarely is bought by private investors." H.R.Rep.No.85, 73rd Cong., 1st Sess., 15 (1933).²¹  See, e.g., Zabriskie v. Lewis, 507 F.2d 546, 550 (10th Cir. 1974); Zeller v. Bogue Electric Mfg. Corp., 476 F.2d 795, 799-800 (2d Cir.), cert. denied, 414 U.S. 908, 94 S. Ct. 217, 38 L. Ed. 2d 146 (1973).²²  We agree.

We thus direct our inquiry to whether the promissory note Baurer received from Feldman, although of less than nine months duration, represents essentially an "investment" rather than a commercial transaction. Although Courts of Appeals "have devised somewhat different tests to determine whether a note constitutes a 'security,' " SEC v. Diversified Industries, Inc., 465 F. Supp. 104, 108 (D.D.C. 1979), we have previously relied on the Supreme Courts' formulation of "security" to draw the distinction between "a genuine investment and other transactions." Association of American R. R. v. U. S., 603 F.2d 953, 971 (D.C. Cir. 1979) (defining "security" under Interstate Commerce Act with reference to Supreme Court decisions under the Securities Act); United California Bank v. THC Financial Corp., 557 F.2d 1351, 1357 (9th Cir. 1977); Bellah v. First Nat'l Bank of Hereford, 495 F.2d 1109, 1115 (5th Cir. 1974). The test which "embodies the essential attributes that run through all of the Court's decisions defining a security," United Housing Foundation v. Forman, 421 U.S. 837, 852, 95 S. Ct. 2051, 2060, 44 L. Ed. 2d 621 (1975), is drawn from SEC v. W. J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946). It turns on "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." 328 U.S. at 301, 66 S. Ct. at 1104.²³  The Howey Court endorsed the long-standing definition of "investment" as "the placing of capital or laying out of money in a way intended to secure income or profit from its employment." 328 U.S. at 298, 66 S. Ct. at 1102. The Forman court further explicated the meaning of a security: "The touchstone 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." 421 U.S. at 852, 95 S. Ct. at 2060. See International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 561, 99 S. Ct. 790, 797, 58 L. Ed. 2d 808 (1979).

Although in our journey through the cases and treatises, we have not encountered a transaction precisely like this one, but cf. SEC v. Addison, 194 F. Supp. 709 (N.D. Tex. 1961) (in gratitude for loan of money to mining operation, borrower would at his discretion allow lenders to participate in "millions of profits"; held that notes exchanged were "securities"), we conclude that this note bears the hallmarks of a security for the following reasons.²⁴  First, the terms of the agreement, described in the promissory note itself, establish its investment character. It is apparent on the face of the note that Baurer was induced to advance money by the promise of an investment opportunity with Feldman and others. Furthermore, Baurer advanced his funds in reliance on Feldman's representation of "entrepreneurial" and "managerial" skills in putting together a profitmaking organization, see Citybank Associates Offering Memorandum, Exhibit D, filed with the district court January 8, 1980, at 9-15; the advance was an effort to facilitate the formation of the partnership. The arrangement was not dissimilar from a pooling agreement, "where the buyer furnishes the funds and the seller the skill for speculating in the stock or commodity markets under an arrangement to split any profits." 1 L. Loss, Securities Regulation 489 (2d ed. 1961). The investor in a pooling arrangement has a security even before contributed funds are actually used to purchase stocks. See Anderson v. Francis I. duPont & Co., 291 F. Supp. 705 (D. Minn. 1968).

One possible objection to the analogy is that Bauer did not expect profits to come solely from the efforts of others. The Supreme Court has so far declined to express its view on whether, to establish the existence of a security, profits need come solely from the efforts of others. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852 n.16, 95 S. Ct. 2051, 2060 n.16, 44 L. Ed. 2d 621 (1975). However, other Courts of Appeals have expressed support for the standard enunciated in SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir.), cert. denied, 414 U.S. 821, 94 S. Ct. 117, 38 L. Ed. 2d 53 (1973): "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." See, e.g., Martin v. T. V. Tempo, Inc., 628 F.2d 887, 889 (5th Cir. 1980); Aldrich v. McCulloch Properties, Inc., 627 F.2d 1036, 1039-40 (10th Cir. 1980); Miller v. Central Chinchilla Group, Inc., 494 F.2d 414, 416-17 (8th Cir. 1974). By this measure, the promissory note in this case represents an investment. While Baurer expected profits to flow in part from his own participation in the formation of the partnership, the "failure or success of the enterprise" depended largely on Feldman's drafting an acceptable partnership agreement, bringing together the investors in it, as he had done in the past, and taking over the task of purchasing and managing, through his controlled corporation TGPI, the investment property itself.

We believe our holding compelled by the concept of a security that Congress incorporated into the Securities Acts. That concept "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." SEC v. Howey Co., 328 U.S. 293, 299, 66 S. Ct. 1100, 1103, 90 L. Ed. 1244 (1946). To fail to recognize this note as a security would create a new and possibly replicable loophole in protecting investors through the Securities Acts.

Finally, defendants challenge Baurer's standing on the grounds that he is not a "purchaser" of a security because he never joined the limited partnership agreement. They rely on Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S. Ct. 1917, 44 L. Ed. 2d 539 (1975), which denies standing under the 1934 Act to one who is not a "purchaser" of securities. This argument must fail, however, as the note is itself a security and the exchange of funds for an investment note constitutes a purchase under the Securities Acts. As noted in Zabriskie v. Lewis, 507 F.2d 546, 552 (10th Cir. 1974), "In 15 U.S.C. § 78c(a) (14) sale and sell are said to 'each include any contract to sell or otherwise dispose of.' The promissory notes were clearly 'disposed of' here and value was given."

In view of the foregoing, the case is remanded to the district court. We decide only that Baurer has standing to sue under the Securities Acts and express no view as to whether he is entitled to recover from the Kramers and 475 H Street, Inc., under either or both of those Acts or common law. These determinations must await further proceedings and rulings in the district court defining the relationships among the various parties and the representations made in the course of those relationships.

Remanded.