University of Arkansas School of Law
NatAgLaw@uark.edu $ (479) 575-7646
An Agricultural Law Research Article
Horse Syndicates as Securities Under Blue Sky Laws

John Coleman Ayers

Originally published in the KENTUCKY LAW JOURNAL 74 KY. L.J. 856 (1986)
www.NationalAgLawCenter.org
Horse Syndicates as Securities

Under Blue Sky Laws

INTRODUCTION
Currently, all fifty states and the District of Columbia have some form of securities laws, each basically paralleling the fed eral securities acts of and 1934. 2 Although the merits of these state "blue sky laws"3 are constantly debated,4 neither critics nor proponents can realistically deny the increased com plexity in business deals attributable to these laws. 5 Basically, an
I 15 U.S.c. 77a-77bbbb (1976 & Supp. 1980).
, Id. 78a-78kk (1976 & Supp. 1980).
J Although the origin of this term of endearment is uncertain, Professors Loss and Cowett, among others, cite the following historical passage: The State of Kansas, most wonderfully prolific and rich in farming prod ucts, has a large proportion of agriculturists not versed in ordinary business methods. The State was the hunting ground of promoters and fraudulent enterprises; in fact their frauds became so barefaced that it was stated that they would sell building lots in the blue sky in fee simple. Metonymically they became known as blue sky merchants, and the legislation intended to prevent their frauds was called Blue Sky Law. Mulvey, Blue Sky Law, 36 CAN. L.T. 37 (1916). For arguments generally favorable to blue sky laws, see Brainin and Davis, State Regulation of the Sale of Securities: Some Cqmments, 14 Bus. LAW. 456 (1958-59); Cowett, Federal-State Relationships in Securities Regulation, 28 GEO. WASH. L. REV. 287 (1959-60); Warren, Reflections on Dual Regulation of Securities, 25 B.C.L. REV. 495 (1983-84); Wright, Correlation of State Blue Sky Laws and the Federal Securities Acts, 26 CORNELL L.Q. 258 (1941). For arguments critical of blue sky laws, see Arm strong, The Blue Sky Laws, 44 VA. L. REV. 713 (1958); Bloomenthal, Blue Sky Regu lation and the Theory of Overkill, 15 WAYNE L. REV. 1447 (1968-69); Hill, Some Comments on the Uniform Securities Act, 55 Nw. L. REV. 661 (l96\); Millonzi, Concurrent Regulation of Interstate Securities Issues: The Need for Congressional Reap praisal, 49 VA. L. REV. 1483 (1963); Mofsky, Blue Sky Restrictions on New Business Promotions, 1969 DUKE L.J. 273 (1969); Smith, State "Blue Sky" Laws and the Federal Securities Acts, 34 MICH. L. REV. 1135 (1936).
"The 'blue sky' laws had come to have a special meaning-a meaning full of complexities, surprises, unsuspected liabilities for transactions normal

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[Vol. 74
attorney involved with the sale of securities must examine the blue sky laws of each state in which the security will be offered to ascertain the state's pertinent registration requirements. If a security is to be offered in thirty-two states, for example, thirty three separate analyses must be completed, because compliance with federal laws is also required. 6 Of course, these registration requirements will not even be reviewed until the attorney con cludes that the particular investment to be sold constitutes a "security."7 This determination alone involves a separate anal ysis of all applicable state and federal laws. This Note examines the effects of state blue sky laws on the use of syndicates in the horse industry. Specifically, the defini tions of a security are explored to determine whether horse syndicates constitute securities under blue sky laws. Because few state courts have actually examined horse syndicates, this Note attempts to provide guidance concerning state securities defini tions by examining the federal interpretive influence on state decisions in the past. Federal securities law and the status of horse syndicates under that law are also analyzed. First, howand usual-in short, a crazy quilt of state regulations no longer significant or meaningful in purpose, and usually stultifying in effect, or just plain useless. " Armstrong, supra note 4, at 714-15. Obviously, some of this confusion is attributable to the emergence of federal securities laws and their expansion into fields previously occupied solely by blue sky laws. This conflict resulted in, and continues to fuel, arguments concerning preemption of state securities law by the federal laws. See generally Brainin & Davis, supra note 4, at 457; Millonzi, supra note 4, at 1494-99; Warren, supra note 4, at 498-538; Wright, supra note 4, at 260-83. A 32-state offering is not unrealistic for syndicates in the horse industry. Due to recent capital deficiencies, the use of public offerings and large partnerships in the industry has proliferated. It is no longer unusual to encounter as many as one thousand investors in a single financial scheme. See Heckmerman, Taking Stock of Shares, THE BLOOD HORSE, at 256 (Jan. 14, 1984). Although syndicates typically involve a much smaller group of investors, preparing such agreements may be quite burdensome. In 1958, Loss and Cowett wrote the following concerning this laborious process of preparing blue sky memoranda: To begin with, the process. contemplates at least four weeks' time from the date that [al preliminary blue sky memorandum has been prepared. Frequently that much time is not available to the blue sky attorney. And even if the overall time pressures are not great, there may be time pressures in a particular state. Loss & COWETT, BLUE SKY LAW 122 (1958). 7 See 15 U.S.C. 77b(l) for the federal definition of security.

" 497 F.2d 473 (5th Cir. 1974). {d. at 475-76. Koscot illustrates the operation of what is commonly referred to as a "pyramiding scheme." The Fifth Circuit Court of Appeals, using its expanded Howey test, concluded that the transaction constituted a security. As the discussion in this Note of state court decisions employing risk capital analysis explains, the same conclusion is reached almost universally. These state courts profess to use a test unlike the one used in Koscot, yet reach the same result, revealing the actual similarities of the two tests. 21 The district court had relied upon the "solely" language of Howey in concluding that the Koscot scheme did not constitute an investment contract. {d. at 477. " {d. at 483. The critical language quoted in Koscot was taken from a 1973 case decided by the Ninth Circuit Court of Appeals. In S.E.C. v. Glenn W. Turner Enter., 474 F.2d 476, 482 (9th Cir.), cert. denied, 414 U.S. 821 (973), investors contributed various sums of money in exchange for the right to attend classes aimed at improving self-motivation and sales ability. In addition, those investing in certain programs were allowed to sell the course, which included tapes, records and other materials, to others. {d. at 478. A sale of the course resulted in a commission for the investor. {d. at 479. In adopting the "undeniably significant" test set out in Koscot, the court stated: Our holding in this case represents no major attempt to redefine the essential nature of a security. Nor does our holding represent any real departure from the Supreme Court's definition of an investment contract as set out in Howey. We hold only that the requirements that profits come "solely" from the efforts of others would, in circumstances such as these, lead to unrealistic results if applied dogmatically, and that a more flexible approach is appropriate. {d. at 483. The Ninth Circuit, by analogy, made a persuasive argument that the "new" test was in accord with the Supreme Court's intention in Howey. See id. at 482. "Let us assume," the court hypothesized, "that in Howey. the sales and service agreement had provided that the buyer was to buy and plant the citrus trees." {d. at 482-83. In
The federal courts apparently have accepted this expanded interpretation of Howey.23 In fact, the United States Supreme Court may have implicitly approved the expanded test in United Housing Foundation v. Forman,z4 in which the Court stated that the "economic realities underlying a transaction" are the critical considerations in analyzing alleged securities. 25 It is within these parameters that syndicate organizers must operate. In structuring the duties of a syndicate manager/pro moter, the attorney must remember that an over-delegation of duties will result in a security. There is little case law interpreting horse syndicates under federal securities laws, although one recent district court case has addressed the issue. In Keja/as v. Bonnie Brae Farms, Inc. ,26 the court examined a syndicate agreement assigning the manager very few responsibilities. The agreement stated that the manager "would do no more than furnish a list of breeders who had inquired as to the availability of [breeding rights]. "27 While the court primarily based its decision on the fact that the syndicate

"Security" means any note; stock; treasury stock; bond; debenture; evi dence 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 certifi cate; certificate of deposit for a security; certificate of interest of partici pation in an oil, gas, or mining title or lease or in payments out of production under such a title or lease; 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 guar antee of, or warrant or right to subscribe to or purchase any of the foregoing. "Security" does not include any insurance or endowment policy or annuity contract under which an insurance company promises to pay [a fixed sum of) money either in a lump sum or periodically for life or for some other specified period. UNIF. SECURITIES ACT 401(1) (1985).

1985-861

which includes the term "investment contract" -the definition that the Howey Court relied upon 36 -in the definition of a security. Of those thirty-six jurisdictions adopting the Act, twenty three have retained this definition without any significant changes. 37 Furthermore, five states 38 not adopting the Act have enacted a substantially identical definition. Therefore, twenty eight states appear to be in the proper statutory position to rely upon federal case law when interpreting agreements, because those states' definition of a security is virtually identical to the pertinent federal provisions. 39 Otherwise, so far as horse syndications are concerned, Ohio,40 Pennsylvania41 and Texas42 contain perhaps the most dangerous provisions defining securities. In addition to the basic language contained in section 401(1) of the Uniform Securities Act, these states specifically address syndicates. For example, section 1707.01(B) of the Ohio Act includes "syndicate certificates" in the definition of a security.4J Groby v. State,44 an early case interpreting the term securities, determined that membership re ceipts in an oil syndicate were securities when profits and earn ings were anticipated from the property of the syndicate. 45
. S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298 (1946). n ARK. STAT. ANN. 67-1247(1); COLO. REV. STAT. 11-51-102(12); CONN. GEN. STAT. ANN. 36-471(m); D.C. CODE ANN. 2-2601(12); HAWAII REV. STAT. 485 1(12); IDAHO CODE 36-1402(12); IND. CODE ANN. 23-2-1-I(k); IOWA CODE ANN. 502.102(12); KAN. STAT. ANN. 17-1252(j); Ky. REV. STAT. ANN. 292.310(13); MD. CORPs. & ASS'NS. CODE ANN. 11-102; MASS. ANN. LAWS ch. 1I0A 401; MINN. STAT. ANN. 80A.14(18); MONT. CODE ANN. 30-10-103(12); NEB. REV. STAT. 8-1101(12); N.H. REV. STAT. ANN. 421-B:2(xx); N.J. STAT. ANN. 49:3-49(m); N.C. GEN. STAT. 78A-2(11); OR. REV. STAT. 59.015(14)(a), (b); S.C. CODE ANN. 35-1-20(12); UTAH CODE ANN. 61-1-13(12); VA. CODE 13.1-501(j); W. VA. CODE 32-4-401(1). " The five states are Arizona, Florida, Illinois, Maine and South Dakota. W See Securities Act of 1933, at 2(1), 15 U.S.c. 77b(l) (1981); Securities Exchange Act of 1934, at 3(a), 15 U.S.c. 78c(a)(l0) (1981). '" OHIO REV. CODE ANN. 1707.01(B) (1985). " PA. STAT. ANN. til. 70 102(5) (1972). " TEX. REV. CIV. STAT. ANN. art. 581-4 (Vernon 1964). " OHIO REV. CODE ANN. 1707.01(B). 143 N.E. 126 (Ohio 1924). " Jd. at 127-28. Although this is a broad interpretation, a later case implies that at least some analysis of the investor's efforts in a syndicate agreement is required. See State v. George, 362 N.E.2d 1223, 1228 (Ohio Ct. App. 1975).

Other statutes that cause the greatest confusion are those based upon the risk capital test, discussed in section four of this Note. 46 Statutes in Alaska,47 Georgia,48 Michigan,49 North Da kota,50 Oklahoma51 and Washington52 specifically include risk capital language. Although the Hawaii and California courts 53 use the risk capital test in defining a security, neither state statutorily embraces the language of the test. 54 Of the twenty-eight jurisdictions adopting the Act's defini tion of security, courts in twenty-four jurisdictions have used the general federal guidelines when interpreting the definition of investment contract or security under blue sky laws. 55 This should
"" See notes 81-128 infra and accompanying text. "ALASKA STAT. 45.55130(12). " GA. CODE ANN. 10-5-2(16) (1982). 4. MICH. COMPo LAWS ANN. 451.801(1).
'" N. D. CENT. CODE 10-04-02(12) (1985).
" OKLA. STAT. tit. 71 2(20).
" WASH. REV. CODE 21.20.005(12).
" See notes 94-128 infra and accompanying text.
" CAL. CORP. CODE 25019 (West 1977); HAWAII REV. STAT. 485-1(12) (1968).
" The states closely following federal law include:
Alabama: See Burke v. State, 385 So. 2d 648 (Ala. 1980) (citing S.E.C. V. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974) and S.E.C. v. Glenn W. Turner Enter., 474 F.2d 476 (9th Cir.), cert. denied. 414 U.S. 821 (1973). See also Buffo v. State, 415 So. 2d 1158, 1162 (Ala. 1982) (" [F]ederal cases should be reviewed to aid in the proper interpretation of the corresponding sections of Alabama statutory law inasmuch as the sections are virtually identical."); Gallion v. Alabama Mkt. Centers, Inc., 213 So. 2d 841 (Ala. 1968) (adopting strict Howey standard), modified, Burke v. State, 385 So.2d 648 (Ala. 1980) (stating that investment contract shall be more broadly construed than in Gallion). Alaska: See American Gold and Diamond Corp. v. Kirkpatrick, 678 P.2d 1343 (Alaska 1984) (In determining whether "investment contracts" exist, substance and economic reality prevail over form). See also Wheeler v. State, 659 P.2d 1241 (Alaska 1983) (reliance by investors on corporation's efforts was critical to finding of investment contract); Hentzner v. State, 613 P.2d 821 (Alaska 1980) (gold mining scheme constitutes investment contract under Howey). Arizona: See Rose v. Dobras, 624 P.2d 887 (Ariz. Ct. App. 1981) (lease of land and sale of orchard trees accompanied by management contract constitutes a security under Glenn W. Turner even though buyers had right to cancel management agreement). Colorado: See People v. Milne, 690 P.2d 829 (Colo. 1984) (investment notes sold by consumer finance corporation constitute "investment contracts" under Howey); Lowery v. Ford Hill Inv. Co., 556 P.2d 1201 (Colo. 1976) (condominium investment agreement containing mandatory exclusive management and rental agreement constitutes investment contract under Howey). See also Sauer v. Hays, 539 P.2d 1343 (Colo. Ct. App. 1975) (sale of corporation's "distributorships" constitutes "investment contract"

comfort promoters of, and investors in, horse syndicates, at
to lease of apartment did not constitute a security). New Mexico: State v. Sheets, 610 P.2d 760 (N.M. Ct. App. 1980) (recognizing Howey as appropriate test for an investment contract). New York: See Gardner v. Lefkowitz, 412 N.Y.S.2d 74Q (Sup. Ct. 1978) (sale of diamonds for investment purposes is an investment contract under Howey). North Dakota: See State v. Gates, 325 N.W.2d 166 (N.D. 1982) (loan commitments are securities under guidance of federal cases); State v. Goetz, 312 N.W.2d I (N.D. 1981), cert. denied. 455 U.S. 924 (1982) (using federal cases in determining that no evil intent is required to show willful violation of state securities law). Pennsylvania: A.B.A. Auto Lease Corp. v. Adam Indus., 387 F. Supp. 531, 534 n.6 (E.D. Pa. 1975) (Section 1.2.201 of the Pennsylvania Securities Commission Rules adopts a "significant managerial efforts" test.). South Carolina: O'Quinn v. Beach Assoc., 249 S.E.2d 734 (S.C. 1978) (no invest ment contract exists where condominium manager merely offers rental services to pur chaser whose efforts were therefore greater than "nominal or insignificant"). Texas: See Searsy v. Commercial Trading Corp. 560 S.W.2d 637 (Tex. 1977) (commodity options are securities under "undeniably significant" test of Glenn W. Turner); Mayfield v. Troutman, 613 S.W.2d 339 (Tex. Civ. App. 1981) (limited part nership with general partner performing managerial duties is an investment contract under Howey and its progeny); Wilson v. Lee, 601 S.W.2d 483 (Tex. Civ. App. 1980) Goint venture interests in raw land held solely for appreciation profit are not securities under Howey and progeny); McConathy v. Dal Mac Commercial Real Estate, Inc., 545 S.W.2d 871 (Tex. Civ. App. 1976) Goint venture interests in raw land held solely for appreciation profit are not securities under Howey and progeny); Star Supply Co. v. Jones, 665 S.W.2d 194 (Tex. Ct. App. 1984) (transfer of company stock merely indicating ownership of entire business is not a sale of securities under Howey-Forman); Cross v. DFW South Entry Partnership, 629 S.W.2d 860 (Tex. Ct. App. 1982) (sale of interest in unimproved land is not a security where promoter merely managed daily activities and purchaser retained ultimate control of investment and profits). Utah: Payable Accounting Corp. v. McKinley, 667 P.2d 15 (Utah 1983) (investor contracts through which company generated capital to fund business of managing payrolls for other businesses are investment contracts under Glenn W. Turner). Vermont: Northern Terminals, Inc. v. Leno, 392 A.2d 419 (Vt. 1978) (security cannot exist when plaintiffs' expectation of profits depended upon acquisition of new facilities rather than entrepreneurial or managerial efforts of others). Washington: See McClellan v. Sundholm, 574 P.2d 371 (Wash. 1978) (investment contract exists under Howey when investor in silver bars expects to derive profit from seller's ability to wisely manage selection, purchase and resale activities). See also Sauve v. K.C., Inc., 591 P.2d 1207 (Wash. 1979) (transaction involving loan of capital in return for promise of fixed interest payments and return of principal within three years is a security under federal standards). reversing Sauve v. ICC., Inc., 577 P.2d 599 (1978) (in which court of appeals incorrectly applied risk capital test and found no security); State v. Markham, 697 P.2d 263, 269 n.6 (Wash. Ct. App. 1985) (affirming use of Howey while also noting addition of risk capital language to Washington securities law); Christgard, Inc. v. Christensen, 627 P.2d 136 (Wash. Ct. App. 1981) (sale of interest in sawmill is a security when investor depended on seller's knowledge, skills, managerial expertise and marketing experience). Wyoming: Gaudina v. Haberman, 644 P.2d 159 (Wyo. 1982) (inter vivos trust managed for investors is a security under Howey).

least in breeding syndicates. s6 Although it is difficult to deter mine the amount of effort that the syndicate manager is allowed to exert before the syndicate is ruled a security, at least concrete guidelines are in place. Marshall v. Harris,S? decided in 1976 by the Oregon Supreme Court, illustrates a state court's use of federal guidelines. In Marshall, the defendants purchased from the plaintiffs a one third interest in the track earnings of two thoroughbreds. In addition to the initial purchase price, the investor agreed to pay for training, feeding and other maintenance expenses. The pro moter expressly retained the right of control over the care and activities of the horses. Within a matter of months, the investor terminated all payments, thus compelling the promoter to file a law suit. s8 The court had little trouble holding that the agreement constituted an investment contract under Howey.s9 Because the two horses had been shipped to California for training, it was impossible for the investor to have any control whatsoever. 60 In addition, the promoter contractually retained complete control of the horses. A Florida court reached a similar result in Brown v. Rai righ. 6 \ In Brown the investor purchased a ten percent interest in five horses for $11 ,675.00. 62 The investor was to receive ten percent of the horses' winnings, while the seller "was to retain custody and control of the horses and undertake all the work of training, caring for and racing them. "63 Although the court
" See notes 26-32 supra and accompanying text. " 555 P.2d 756 (Or. 1976). " Id. at 758. W Although the Oregon court applied federal standards in this case, Oregon is not categorized as having "adopted" those guidelines because of several other Oregon cases either considering or adopting risk capital analysis. See Pratt v. Kross, 555 P.2d 765 (Or. 1976) (risk capital test was noted as a viable option, but modified Howey test was applied in holding that a limited partnership interest is an investment contract); Black v. Corp. Div., 634 P.2d 1383 (Or. Ct. App. 1981) (tax shelter investment scheme is a security under both Howey and risk capital tests); State v. Consumer Business System. Inc., 482 P.2d 549 (Or. Ct. App. 1971) (franchise agreements are securities under risk capital test). ~, 555 P.2d at 758.
" 363 So. 2d 590 (Fla. Dist. Ct. App. 1978).

" Id. at 591.

" Id.
concluded that no security existed because there was no common enterprise,64 it noted that the efforts requirement of the Howey test had been satisfied because the investor was relying solely upon the efforts of the promoter. 65 This decision is not surpris ing, even though the contract gave the investor the privilege of selling his interest back to the promoter until the end of the year. 66 A recent Illinois case provides a similar illustration of the effects of federal standards in the analysis of breeding syndi cates. Although Ronnett v. American Breeding Herds, Inc. 67 involved what is commonly known as a "cattle-care contract," the principles, and the facts, greatly resembled a stallion syndi cate. 68 In that case, the investor, Ronnett, was advised by defend ant Shannon to invest in a cattle breeding operation offered by defendant American Breeding Herds (ABH). In 1972, Ronnett purchased thirty-six Charolais cows and a one-quarter interest in a Charolais bull for a total of $113,000.00. Ronnett also agreed to pay $80.00 per animal in quarterly maintenance fees. 69 The contract provided Ronnett with one breeding privilege for each cow but the selection of the sire was reserved exclusively to ABH. Although the contract entitled Ronnett to cancel the maintenance program upon ninety days notice and to sell the cattle publicly or privately, ABH retained "complete jurisdiction and control of the animals. "70 That authority included exclusive control over maintenance and feed for the animals and the choice of the animals' location. Ronnett received status reports on the animals' condition and personally inspected the herd and the facilities. 7 1

. The court held that, under Howey, there could be no common enterprise with only one investor. ld. at 593. MId. The court also noted that the term "solely" had been modified in federal cases. ld. at 592 n.3. '" ld. at 591. " 464 N.E.2d 1201 (Ill. App. Ct. 1984). , See notes 8-12 supra and accompanying text. " 464 N.E.2d at 1202. As in many of these cases, the investor in Ronnetl was totally unfamiliar with cattle breeding. In fact, he was a physician advised to invest for tax purposes. ", ld.

" ld.

In June, 1977, after investing approximately $204,000.00 into the venture, Ronnett ordered the cattle sold and received in return a check for $7,016.27. Subsequently, he sought recision of the contract and a refund of invested funds. 72 As the court noted, the principal issue was whether the transaction amounted to an investment contract subject to the federal and state securities laws. 73 After finding that a common enterprise existed due to a "vertical commonality, "74 the court addressed the difficult efforts issue. Although the court acknowl edged Ronnett's authority in first delegating maintenance duties to ABH and then in ordering the sale of the cattle, it determined that an investment contract did exist.75 The control retained by Ronnett was insufficient to vitiate the true nature of the contract:
Ronnett was permitted to observe his herd, and he commented upon his satisfaction with the way things were going. Yet, he could not have participated in the. vital aspects of the operation in terms of its potential for success since they were within the sole control of ABH.76
It may be significant that the court reached this conclusion even though Ronnett had the right to order his cattle sold. 77 The court also emphasized that Ronnett had no expertise in breeding or selling cattle, even though he was an experienced investor.78 As indicated, state courts clearly adopting federal interpre tations for security analysis have provided critical groundwork for parties interested in syndicate agreements. There are, how ever, three other categories of states in which the courts' posi tions are not as clear. One category contains states indicating in some manner-either by dictum or by implication-that they at least acknowledge federal interpretations;79 another contains states

Id. at 1203.

Id. at 1204.

Id. at 1206.

n The investment agreement provided, however, that ABH would decide "when, how, where and for what price" the cattle would be sold. [d. '" Id. " The following jurisdictions have accepted, at least directly or indirectly, general federal guidelines. District of Columbia: See Price v. Griffin, 359 A.2d 582 (D.C. 1976)
" " " " "

That language juxtaposed beside section 1O-5-2(15)(C) clearly belies the legislative impetus for adopting the risk capital test in 1974. The test employed by the court appears overly restrictive when compared with modern federal standards. Nevertheless, the legislature's hyperactive attitude was unnecessary in light of federal decisions between the time Georgia Market Centers was decided in 1969 and section 10-5-2(16) was enacted in 1974. For example, S.E.C. v. Glenn W. Turner:~o decided in 1973, inter preted such pyramiding schemes as constituting securities. Fur thermore, the new legislation compelled the Georgia courts to consider risk capital in subsequent decisions. 91 Most courts have found their own way to the expanded federal standards without such legislative tampering. The difficult aspect of analyzing risk capital states is deter mining exactly what risk capital analysis entails. Many authors have tried to explain the distinction between this test and the prominent federal standard,92 although none of the arguments is particularly persuasive. This may be because the two tests are, in fact, identical. To state it indelicately, these courts generally find that capital is at risk when the promoter or third party retains control over the use of the capital-when he is responsible for the entrepreneurial or managerial efforts93 and the investor exerts no effort.

" Id. at 622.

,. Id. at 623-24.
~, 474 F.2d 476 (9th CiL), cert. denied, 414 U.S. 821 (1973).
, See Dunwoody Country Club of Atlanta v. Fortson, 253 S.E.2d 700 (Ga. 1979). , See, e.g., Coffey, The Economic Realities of a "Security:" Is There a More Meaningful Formula?, 18 W. RES. L. REV. 367 (1967). , See notes 19-25 supra and accompanying text.
This efforts analysis, if accepted in all fifty states, would provide the analytical framework presently found in the federal courts. Some criteria must be universally accepted so that syn dicators and investors, without trepidation, can structure syndi cate agreements. Such an agreement, if the syndicator wishes to avoid security classification, should carefully follow federal guidelines in limiting the syndicate manager's duties. The case most often cited as the genesis of the risk capital test is Silver Hills Country Club v. Sobeiski. 94 It may be argued, however, that State v. Gopher Tire & Rubber Co., 95 decided in 1920 by the Minnesota Supreme Court, actually provides the neck around which this albatross may be hung. In Gopher Tire, a case involving the sale of certificates entitling purchasers to a commission on the sale of tires, the court stated:
No case has been called to our attention defining the term "investment contract." The placing of capital or laying out of money in a way intended to secure income or profits from its employment is an investment as the word is commonly used oand understood. If the defendant issued and sold its certifi cates to purchasers who paid their money, justly expecting to receive an income or profits from the investment, it would seem that the statute should apply.96

The court's analysis focused primarily upon the rights granted to members under the membership application and the corporate by-laws. The court noted:
The purchaser of a membership in the present case has a contractual right to use the club facilities that cannot be re voked except for his own misbehavior or failure to pay dues. Such an irrevocable right qualifies as a beneficial interest in title to property within the literal language of subsection (a) of Section 25008. 106
This emphasis on a beneficial interest in title to property al lowed-or caused-the court to avoid the efforts issue. Further more, it facilitated the court's holding that such memberships were securities even though there was no expectation of any material benefits. 107 "[I]t seems. clear that [the Act's] objec tive is to afford those who risk their capital at least a fair chance of realizing their objectives in legitimate ventures whether or not they expect a return on their capital in one form or another." 108 The court's analysis exposes the infirmities created by the Silver Hills decision and its subsequent application. Because the court focused upon a beneficial interest in title to property, the efforts and profits analyses required in investment contract anal ysis are absent. The beneficial interest in property was created by mere investment of funds and required the investor to exert no efforts. Perhaps the court believed that the efforts issue was trivial. Although obscure at first, the distinction between an investment contract analysis and a beneficial interest in property
,,~ [d. at 188. When Silver Hills was decided. CAL. CORP. CODE 25008 (West 1960) read as follows: 'Security' includes all of the following: (a) Any stock, including treasury stock; any certificate of interest or participation; any certificate of interest in a profit sharing agreement, any certificate of interest in an oil, gas, or mining title or lease; any transferable share, investment contract, or beneficial interest in title to property, profits, or earnings. (b) Any bond; any debenture; any collateral trust certificate; any note; any evidence of indebtedness, whether interest bearing or not. (c) Any guarantee of a security. (d) Any certificate of deposit for a security.
"" 13 Cal. Rptr. at 187.
"" [d. at 188-89.
analysis becomes critical when the effects of Silver Hills are recognized. The decision has been misapplied in the past, and the potential for future error remains because some courts con tinue to rely upon Silver Hills in analyzing investment contracts. The use of "effort" analysis, although neglected by Silver Hills, was well-founded in California law. For example, in Hol lywood State Bank v. Wilde, 109 decided in 1945, a district court of appeal held that securities-laws apply to the sale of chinchillas when the purchasers are led to believe that the sellers will "by their own efforts make the investments safe without the appli cation of effort by the investors. " 110 California courts since Silver Hills have conducted an efforts analysis even though they purport to adopt the risk capital approach. In Sarmento v. Arbax Packing Co., III decided four years after Silver Hills, Arbax was engaged in the business of packing and shipping cherry and grape cropS.1I2 In 1961, Arbax sold eighty acres of Tokay grapes to the plaintiff for $25,000.00. The sales contract contained an agreement under which Arbax promised to care for the crop at its own expense until harvest. At harvest time, the plaintiffs/purchasers would harvest the crop at their expense. A second contract provided that Arbax would market the crop at its normal rate of commission. Before har vest, however, heavy rains damaged the crop, resulting in a loss to the purchasers of $7,069.84. The purchasers filed suit against Arbax alleging that the transaction constituted an unregistered security.113 The court, citing Silver Hills, stated that the broad definition of a security in the California statutes "is designed to embrace speculative schemes to attract risk capital. "114 In a departure from Silver Hills, however, the court focused immediately upon the elements of control and effort exerted by the parties. The court concluded that this transaction did not constitute a secu rity, because, the court emphasized, the purchasers had exercised

The Hawaii Supreme Court recognized the conceptual prob lem in the Silver Hills risk capital test and expressly added an efforts analysis. That court's risk capital test provides that an investment contract exists whenever:
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 offer or'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 enter prise. 120
purchaser working undercover for the district attorney. The transaction involved, basi cally, the sale of an interest in a limited partnership formed to promote a fluke invention. Id. at 322. The defendant urged the court to adopt the Howey test and to apply a strict interpretation of the "solely" requirement. Such an analysis might have benefitted the defendant because the partnership agreement anticipated that the investor would heavily promote the invention. Id. at 321. Such an analysis may also have shocked the state's attorney given the high degree of acceptance of the risk capital test in California. The defendant was not advancing a spurious defense, however, and cited a 1979 California case adopting federal standards. Id. at 327 (citing People v. Park, 151 Cal. Rptr. 146 (Cal. Ct. App. 1978. Rather than arguing for a risk capital analysis, the state in response argued that the "solely" language of Howey should be rejected in favor of an "essential managerial efforts test." 210 Cal. Rptr. at 323. The opinion states: "Both parties ignore the fact that the Howey test, whether modified or not, may well not be the means by which a 'security' is defined in California." Id. at 323. Although the opinion is somewhat confusing, it is clear that the court interpreted the interest to be a security because the efforts exerted by the investor were not "those essential managerial efforts which affect the failure or success of the enterprise." Id. at 325. By way of a footnote to this conclusion that the risk capital and Howey analyses merged, the court declared that it need not decide "whether the Silver Hills risk capital analysis is the exclusive definition of a security in California or whether the. tests are complementary and alternative." Id. at 325 'n.12. The effects of Silver Hills are clear. Although the court reached the proper conclusion by applying the expanded Howey test, it was compelled to credit Silver Hills with an element it simply did not address-the efforts of the investor. This decision clearly illustrates the confusion still generated by Silver Hills. 120 State v. Hawaii Market Center, 485 P.2d 105, 109 (Hawaii 1971).

The court stated in its development of the "new" test that the Howey test's narrow concept of investor participation had led courts to engage "in polemics over the meaning of the word 'solely.' "121 Such entrapment results in a failure to consider whether investors who participate to a limited degree in the operation of the business should be protected. 122 As emphasized throughout this Note, however, that element of the Howey test has been modified and corresponds closely to the language in subsection four of the Hawaii test. 123 Furthermore, the modified risk capital test parallels the Howey-type analysis in that it avoids the myopic view taken by Silver Hills. By including the provision regarding efforts, the test illustrates that the Silver Hills court was engaged in polemics regarding risk capital, thereby ignoring the efforts issue. It should now be clear that the two tests are the same. This conclusion is illustrated by the case that spawned the Hawaii risk capital test, State v. Hawaii Market Centers, Inc. 124 In that case, Hawaii Market Center (HMC) intended to open a retail store that would sell merchandise only to persons possess ing purchase authorization cards. HMC raised initial capital and distributed the first memberships by recruiting "founder-mem bers." For $320.00, these founder-members were given a sewing machine or cookware set and an agreement with the corporation called a "Founder-Member Purchasing Contract Agreement." That agreement specified five ways the founder-members could earn commissions from the corporation; each related in some way to the distribution of membership cards or the induction of a new member into the corporation. 125 Eventually, the state commissioner of securities filed suit against HMC, alleging that the memberships constituted securi ties. The trial court supported the commissioner, holding that the agreements were investment contracts. The Hawaii Supreme Court affirmed, using its new risk capital test. 126 The circum

'" Id. at 108.

'" Id.
'" See notes 16-25 supra and accompanying text.

'" 485 P.2d at 105.

'21 Id. at 107. '" Id.
stances recited above should create a sense of deja vu because the facts are virtually identical to those in S.E.C. v. Koscotl 27 and S. C. v. Glenn W. Turner,128 two of the principal cases in the development of the "new" federal standard. Applying the expanded Howey test, both of those courts held that such agree ments were investment contracts. Those holdings support the theory that the federal standard and the "Hawaiian" risk capital test are identical.

CONCLUSION

This Note, while indicating which states interpret blue sky laws under federal guidelines, has also implicitly revealed at least one area of confusion created by a dual system of securities regulation. Though one set of states argues that it applies an analysis differing from the federal test, this Note argues that the tests are identical. Whether or not the reader accepts that argument or appre ciates the ramifications, it should at least be clear that the ambiguities fueling the argument are an unnecessary impediment to business transactions. Without a doubt, the threat of civil and/or criminal sanctions deters prospective investors from en gaging in business transactions. It should be realized that cooperation-either judicial or legislative-is needed in order to supply the uniformity between state and federal securities laws. Until this uniformity is ob tained, inconsistent judicial decisions and unnecessary investor trepidation will continue. John Coleman Ayers

'" 497 F.2d 473 (5th CiL 1974). See notes 18-25 supra and accompanying text. '" 474 F.2d 476 (9th CiL), cert. denied. 414 U.S. 821 (1973). See notes 18-25 supra and accompanying text.