Securities And Exchange Commission v. Koscot Interplanetary, Inc.

497 F.2d 473 (5th Cir. 1974)

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Nature of the Case

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Facts

D operates a multi-level network of independent distributors, purportedly engaged in the business of selling a line of cosmetics. A 'beauty advisor' is the lowest level whose income is derived solely from retail sales of D products made available at a discount, customarily of 45%. The next level is a supervisor or retail manager. For an investment of $1,000, a supervisor receives cosmetics at a greater discount from retail price, typically 55%, to be sold either directly to the public or to be held for wholesale distribution to the beauty advisors. A supervisor who introduces a prospect to the D program with whom a sale is ultimately consummated receives $600 of the $1,000 paid to D. A distributor makes an investment of $5,000 and entitles a distributor to purchase cosmetics at an even greater discount, typically 65%, for distribution to supervisors and retailers. Moreover, fruitful sponsorship of either a supervisor or distributor brings $600 or $3,000 respectively to the sponsor. P maintains that the marketing of cosmetics and the recruitment aspects are separable and that only the latter is within the definition of a security. That the district court acknowledged that many if not all of the persons, seeking to become D distributors are attracted by the lure of money to be earned by high-pressure recruiting of other persons into the program, rather than the sale of the cosmetics themselves. In the initial stage, an investor's sole task is to attract individuals to an Opportunity meeting. D employees, frequently in conjunction with investors, undertake to apprise prospects of the 'virtues' of enlisting in the D plan. The virtues are presented by a script that is to be used verbatim. Investors and D employees are instructed to drive to meetings in expensive cars, preferably Cadillacs, to dress expensively, and to flaunt large amounts of money. P argued that the scheme qualified as a profit-sharing arrangement, an interest commonly known as a security, and an investment contract. This was rejected because a successful recruiting distributor receives not a share of D's profit but rather a fixed fee. The court reasoned that the third prong of the Howey test was not satisfied because the investors were involved in the recruitment of employees. The court denied an injunction and P appealed.