Securities and Exchange Commission vs. Prosperity.com, Inc.

For a transaction to qualify as an "investment contract" (and thus as a "security" requiring SEC registration under R.A. 8799), all five elements of the Howey test must concur: (1) a contract, transaction, or scheme; (2) an investment of money; (3) in a common enterprise; (4) with an expectation of profits; and (5) where profits arise primarily from the efforts of others. A scheme involving the sale of a tangible product with referral commissions does not constitute an investment contract where the consideration paid is for the product itself and any returns are derived from the buyer's own efforts in referring customers rather than from the promoter's management efforts.

Prosperity.Com, Inc. (PCI) was engaged in selling computer software and hosting websites. It devised a marketing scheme patterned after Golconda Ventures, Inc. (GVI), which had previously been issued a cease and desist order by the SEC. Under the scheme, PCI offered internet websites for sale with the opportunity for buyers to earn commissions and other incentives by recruiting down-line buyers, creating a multi-level marketing structure. Following complaints from former GVI members, the SEC investigated PCI's operations to determine if it was offering unregistered securities in the form of investment contracts.

• PCI sold computer software and hosted websites without providing internet service.
• PCI offered buyers an internet website with 15-MB capacity for US$234.00 (later increased to US$294.00).
• Buyers could earn commissions, interests in real estate in the Philippines and the United States, and insurance coverage worth P50,000.00 by referring down-line buyers.
• To benefit, a buyer must enlist and sponsor at least two other buyers as down-lines, who could in turn build their own down-lines.
• For each pair of down-lines, the buyer-sponsor received a US$92.00 commission.
• Referrals were capped at 16 per day; excess commissions inured to PCI.
• PCI patterned its scheme from Golconda Ventures, Inc. (GVI), which ceased operations after the SEC issued a cease and desist order against it.
• The same persons who ran GVI directed PCI's actual operations.
• In 2001, former GVI members filed a complaint with the SEC against PCI, alleging it had taken over GVI's operations.
• After hearing, the SEC issued a cease and desist order (CDO) against PCI, ruling that its scheme constituted an investment contract requiring registration under R.A. 8799.
• PCI filed a petition for certiorari with the Court of Appeals with an application for temporary restraining order (TRO) instead of requesting the SEC to lift the CDO.
• PCI also filed a request to lift the CDO with the SEC before the lapse of the five-day period, and subsequently moved to withdraw its CA petition to avoid forum shopping.
• The CA issued a TRO enjoining enforcement of the CDO.
• The SEC filed a motion to dismiss in the CA on ground of forum shopping.
• The CA initially dismissed the petition but later reinstated it upon PCI's motion.
• The CA consolidated PCI's case with another case raising the same issues.
• On July 31, 2003, the CA rendered a decision granting PCI's petition and setting aside the SEC's CDO, ruling that PCI's scheme did not constitute an investment contract.

• PCI's scheme constitutes an investment contract as defined under the Securities Regulation Code (R.A. 8799).
• Investment contracts are "securities" that must be registered with the SEC before distribution and sale.
• The scheme satisfies the definition of an investment contract where a person invests money in a common enterprise and is led to expect profits primarily from the efforts of others.
• PCI should have registered the contract or securities with the SEC before offering them to the public.

• PCI's scheme does not constitute an investment contract under the Howey test.
• The US$234.00 paid by buyers is consideration for the purchase of a tangible asset (the 15-MB website), not an investment in PCI's business.
• The buyers do not invest money in PCI for use in running a business that would generate profits for investors.
• The commissions, real estate interests, and insurance coverage are merely incentives to down-line sellers to bring in customers, not profits from investment.
• It is PCI, not the buyers, who expects profit from the network marketing of its products.
• The last requisite of the Howey test—profits arising primarily from the efforts of others—is lacking because any returns depend on the buyers' own efforts in referring customers.

• Procedural Issues: Whether PCI committed forum shopping by simultaneously filing a petition with the Court of Appeals and a request to lift the cease and desist order with the SEC; whether the Court of Appeals properly consolidated the cases.
• Substantive Issues: Whether PCI's marketing scheme constitutes an "investment contract" as defined under R.A. 8799 (Securities Regulation Code) and its Implementing Rules and Regulations, requiring registration with the SEC.

• Procedural: The Court noted that while procedural issues such as forum shopping were raised and resolved by the Court of Appeals (which initially dismissed the petition but subsequently reinstated it), the resolution of these issues was not the primary basis of the SEC's petition for review before the Supreme Court. The Court focused on the substantive issue of whether the scheme constituted an investment contract. The consolidation of cases by the Court of Appeals was also noted as a procedural step properly taken.
• Substantive: The Supreme Court denied the SEC's petition and affirmed the Court of Appeals' decision. The Court held that PCI's scheme did not constitute an investment contract requiring registration under R.A. 8799. Applying the Howey test, the Court found that while the first four elements might appear present, the fifth element—expectation of profits arising primarily from the efforts of others—was absent. The Court ruled that the buyers paid US$234.00 as consideration for a tangible product (the website), not as an investment in PCI's business. The commissions and other benefits were incentives for network marketing rather than investment profits. Unlike typical investment contracts where investors expect profits from the promoter's efforts (citing San Miguel Corporation's commercial papers as an example), here the buyers' returns depended on their own efforts in referring customers. The Court characterized PCI's scheme as network marketing, where the company expects profits from product sales, not the buyers from passive investment.

• Howey Test for Investment Contracts — Established in SEC v. W.J. Howey Co., this test requires five concurrent elements for a transaction to be considered an investment contract: (1) a contract, transaction, or scheme; (2) an investment of money; (3) investment in a common enterprise; (4) expectation of profits; and (5) profits arising primarily from the efforts of others. The Court applied this test to determine that PCI's scheme lacked the fifth element because the buyers received a tangible product for their payment and any returns were derived from their own efforts, not from PCI's management efforts.
• Network Marketing vs. Investment Contracts — Distinguishes between legitimate network or multi-level marketing (where participants earn commissions from product sales and referrals) and investment contracts (where participants invest money expecting profits from the promoter's efforts). The Court applied this distinction to characterize PCI's scheme as the former, noting that PCI expected profits from network marketing while buyers received a product for their payment.

• "An investment contract is a contract, transaction, or scheme where a person invests his money in a common enterprise and is led to expect profits primarily from the efforts of others."
• "The United States Supreme Court held in Securities and Exchange Commission v. W.J. Howey Co. that, for an investment contract to exist, the following elements, referred to as the Howey test must concur: (1) a contract, transaction, or scheme; (2) an investment of money; (3) investment is made in a common enterprise; (4) expectation of profits; and (5) profits arising primarily from the efforts of others."
• "The buyers of the website do not invest money in PCI that it could use for running some business that would generate profits for the investors. The price of US$234.00 is what the buyer pays for the use of the website, a tangible asset that PCI creates, using its computer facilities and technical skills."
• "The commissions, interest in real estate, and insurance coverage worth P50,000.00 are incentives to down-line sellers to bring in other customers. These can hardly be regarded as profits from investment of money under the Howey test."
• "Evidently, it is PCI that expects profit from the network marketing of its products."

• Securities and Exchange Commission v. W.J. Howey Co. (328 US 293) — Established the definitive test for determining what constitutes an investment contract; adopted by the Philippine Supreme Court to analyze whether PCI's scheme was a security requiring registration.
• United Housing Foundation, Inc. v. Forman (421 US 837) — Cited as additional American jurisprudence discussing the nature of investment contracts.
• Securities and Exchange Commission v. Glen W. Turner Enterprises, Inc. (474 F.2d 476) — Cited as additional American jurisprudence on the definition of investment contracts.
• Philippine Health Care Providers, Inc. v. Commissioner of Internal Revenue (G.R. No. 167330, September 18, 2009) — Cited for the principle that while United States Supreme Court rulings are not binding in the Philippines, they enjoy persuasive weight when logical and consistent with the country's best interests, justifying the adoption of the Howey test.
• Prudential Guarantee and Assurance, Inc. v. Trans-Asia Shipping Lines, Inc. (524 Phil. 716) — Cited in Philippine Health Care Providers regarding the persuasive effect of foreign jurisprudence.

• Republic Act No. 8799 (Securities Regulation Code) — Defines "securities" to include investment contracts and requires registration before sale or distribution; governs the regulatory authority of the SEC over investment schemes.
• Section 64.3 of Republic Act No. 8799 — Provides the procedure for lifting cease and desist orders issued by the SEC.
• Implementing Rules and Regulations of R.A. 8799, Rule 3.1-1 — Defines investment contract as a contract, transaction, or scheme where a person invests money in a common enterprise and is led to expect profits primarily from the efforts of others.