SEC v. International Loan Network ...968 F.2d 1304, 297 U.S.App.D.Ch@p://www.mlmlaw.com/library/cases/m/m/federal/dcsecintload92.htm

to such a point, the ability to create wealth expands to such a degree, that we could come
back and give somebody an award for up to $80,000." JA 165.

(5) Subsidiaries: ILN also operates several subsidiaries including a real estate acquisition
company, an educational scholarship service, a financial advisory service, a real estate
brokerage service and a printing and graphics company. Each of these is funded, at least in
part, by ILN and some of them provide services for ILN members as well as the general
public.

*1307 **25 On May 15, 1991, the SEC commenced this action against ILN, Ford and
Mundey, alleging that (1) they were selling unregistered securities in violation of section 5
of the Securities Act of 1933 (1933 Act), IS U.S.C. § 77e, and (2) they were doing so
fraudulently in violation of section 17(a) of the 1933 Act and section 10(b) of the Securities
Exchange Act of 1934 (1934 Act), 15 U.S.C. §§ 77q(a), 78j(b), and Securities and
Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. On May 15, 1991, the district
court issued a temporary restraining order which, inter alia, prohibited ILN, Ford, Mundey
or any other ILN agents from offering or selling securities without registration or by
fraudulent means and froze ILN's, Ford's and Mundey's assets. [FN4] On July 18, 1991,
following a three-day evidentiary hearing, the district court issued an opinion holding that
(1) the CFBS, the predecessors to the current PRA program and the Maximum
Consideration program all involved the offer or sale of unregistered securities in violation of
section 5 of the 1933 Act, 770 F.Supp. at 691-93, [FN5] and (2) the marketing of these
securities was accompanied by material misrepresentations in violation of sections 17(a) of
the 1933 Act, section 10(b) of the 1934 Act and Rule 10b-5. Id. at 693- 96. Based on these
holdings, the court concluded a preliminary injunction was required to continue the
prohibition on the marketing of these programs and the freeze of ILN's assets. Id. at 696-97.
Accordingly, on July 26, 1991, the court issued a preliminary injunction extending that
relief.

FN4. That order was amended on May 28, 1991, to free Ford's and Mundey's personal

assets.

FN5. The court concluded that the basic and club membership sales by themselves involve
no securities, 770 F.Supp. at 691, but noted that "club memberships do not currently have
an existence apart from the Capital Fund Bonus System," id. at 692 n. 14. The court further
found it unnecessary "at this preliminary stage" to decide whether the current PRA program
involves securities because that program is "inextricably intertwined" with the Maximum
Consideration program, which does. Id. at 693.

Ford and Mundey appeal the district court's opinion and injunction on the grounds that (1)
ILN's programs do not involve the offer or sale of securities and (2) they made no
misrepresentations in promoting those programs. [FN6] We find neither argument
persuasive.

FN6. Former appellant ILN has withdrawn its appeal. Stipulation of Dismissal of ILN as
Appellant (filed February 26, 1992).

First, the appellants assert the district court erroneously concluded that the CFBS and the
Maximum Consideration program involve the offer or sale of securities, namely investment
contracts, so as to come within the purview of the 1933 and 1934 acts. (FN7] We disagree.

FN7. They do not challenge the district court's holding that the three predecessors to the
current PRA program involved securities.

[1] The Supreme Court set out the now-familiar test for identifying investment contracts in

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SEC v. W.J. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244 (1946):
"The test is whether the scheme involves an investment of money in a common enterprise
with profits to come solely from the efforts of others." The district court properly applied
this tripartite test and we affirm both its conclusions and its analysis. See 770 F.Supp. at
688-93.

[2] Regarding the CFBS, we perceive no error in the district court's holding that all three
prongs of the Howey Test are satisfied. The appellants argue strenuously that the program
involves no investment of money because an individual need make no payment to ILN to
become an IR. The district court, however, found otherwise. Based on a President's Night
transcript and the testimony of witnesses "who ha[d] repeatedly heard [Ford] speak," the
court concluded that "the intent is for a person to become a member first and then recruit
new members." 770 F.Supp. at 691; see also id. at 682 ("[I]t is equally clear that the Capital
Fund is marketed so that a person will first join the organization himself and then recruit
others to join"). In particular, the court noted Ford's oft repeated *1308 **26 refrain: "you
come in, then you bring in your wife and your kids." Id. at 691. We find this evidence more
than sufficient to support the court's finding.

As for the common enterprise element, the fortunes of investors are clearly linked to each
other and to the success of ILN as an enterprise. The CFBS generates income for its
investors, and for the appellants, only through constant expansion of membership, which
depends on individual recruiting and the appeal of Ford's larger marketing campaign. Thus,
the court properly found the CFBS satisfies the second prong of the Howey test as well.
{FN8]

FN8. In fact the evidence suggests that the CFBS and Maximum Consideration program
may form a single, interlocking investment enterprise. See JA 163-65.

Finally, profits for CFBS investors are expected to accrue, if not solely, at least
predominantly from the efforts of others, namely of the downline members from whose fees
an IR expects to derive most of his wealth and of the appellants who created, promote and
operate ILN's programs. [FN9] Thus, the CFBS satisfies the third prong of the Howey test
as well. See SEC v. Glenn W. Tumer Enters., Inc., 474 F.2d 476, 482 (9th Cir.)
(interpreting third prong of Howey test broadly to require only that "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"), cert. denied, 414 U.S. 821, 94
S.Ct. 117, 38 L.Ed.2d 53 (1973); SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th
Cir.1974) (adopting Glenn W. Turner interpretation of Howey); Baurer v. Planning Group,
Inc., 669 F.2d 770 (D.C.Cir.1981) (applying Glenn W. Turner test).

FN9. The evidence suggests that at least in some cases Ford's President's Night promotions
are instrumental in consummating an IR's recruitment of new members. The district court
noted: "[T]o be credited with recruiting a new member may involve as little as inviting
someone to an ILN meeting or President's Night. If the ILN marketing representatives or
Melvin Ford himself are successful in persuading the potential recruit to join, the person
who extended the invitation, otherwise known as the 'sponsor,' will be credited as having
made the recruitment and will earn income from it." 770 F.2d at 692; see also JA 156-57.

[3] The Maximum Consideration program presents an even clearer picture of a classic
investment contract. A participant in that program typically invests money in a PRA [FN10]
and is led to expect a large annual "award" with only the modest additional effort of selling
$3,000 worth of PRAS. The appellants urge strenuously that this program does not involve
an investment contract because no return is ever "guaranteed." We find this argument
without merit. Very few investments "guarantee" a return--all that Howey requires is a
"reasonable expectation of profits." United Hous. Found., Inc. v. Forman, 421 U.S. 837,
852, 95 S.Ct. 2051, 2060, 44 L.Ed.2d 621 (1975). The evidence clearly supports such an
expectation here. See 770 F.Supp. at 686.

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FN10. Although the program literature permitted either purchase of a PRA or any earnest
money deposit on an agreement to purchase nonresidential real estate, see JA 108, Ford
marketed the program somewhat differently. At a President's Night meeting, he told his
audience:

[I]f you want to get that award that we call "Maximum Consideration," you have to have
one of those PRAs we just talked about. So you have to have a--actually, technically, you
could have a real estate contract or the PRA we just discussed.

But let me underline--after all, ILN sells PRAS, right. So we should be able to promote our
own business, so, if you have a PRA, you are eligible to participate in Maximum
Consideration.

JA 166-67.

П.

[4] Next, the appellants contend the district court erroneously held that they violated the
fraud provisions of the securities acts by making material misrepresentations in the offer or
sale of the investment contracts involved. The district court concluded:

With respect to whether misrepresentations have been made concerning ILN's programs, the
evidence is clear that ILN is nothing more than a glorified chain letter, destined to collapse
of its own weight. Despite the inevitability of this 1309 **27 outcome, potential investors
were, until the issuance of the temporary restraining order in this case, continuing to be
promised great wealth through their participation in the ILN. The pyramid nature of the
organization was never fully revealed to them.

770 F.Supp. at 694. The appellants assail this conclusion on two grounds, neither of which
is worth a Continental. [FÑ11]

FN11. The phrase "not worth a Continental" is a variant of "not worth a Continental dam.”
Respectfully Quoted: A Dictionary of Quotations Requested from the Congressional
Research Service 229 (Suzy Platt ed. 1989). As one source explains:

"Not worth a Continental dam' had its origin about this time [1780]. It is not a profane
expression. A 'dam' is an Indian coin of less value than one cent and a Continental one cent
was next to worthless when it took six pounds, or about thirty dollars to buy a 'warm
dinner.'"

Id. (quoting Oliver Taylor, Historic Sullivan 97 (1909)).

First, the appellants assert there is no evidence either that representations of profitability
were made or that the ventures do not in fact produce profits. We disagree. The record is
replete with Ford's descriptions of the profits available from ILN's programs, while the very
nature of those programs ensures that such profits will not extend to all investors. As the
Fifth Circuit has noted:

The essential vice of chain or pyramid distribution schemes has been well documented. For
example, if the founder recruited five distributors in the first month and if those five each
recruited five more distributors in month two, and if each of these subsequent recruits
enticed five people to join in the month following his own recruitment, over 244 million
new distributors would be recruited in the twelfth month. Obviously, this would be
impossible in a nation of only 220 million people. Equally as obvious is the fact that those
who have the greatest risk of loss are those who enter the pyramid when the market is
closest to saturation.... The disclosure which would be necessary to inform a new investor of

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his prospects for success or failure would have to change almost daily in order to reflect the
acquisition of new distributors. Needless to say, there would be substantial administrative
obstacles connected with any such regime of disclosure.

Piambino v. Bailey, 610 F 2d 1306, 1318 n. 9 (5th Cir.1980); see also Arthur Allen Leff,
Swindling and Selling 70 (1976). [FN12]

FN12. In fact, the district court noted in its opinion: "According to the SEC's
as-yet-undisputed allegations, the ILN has $500 million worth of obligations to investors,
but has only $4 million in liquid assets, $5 million in real property, and tax lien certificates
for property worth $75 million in assessed value." 770 F.Supp. at 697. ILN has since filed
for Chapter 11 bankruptcy. See Stipulation of Dismissal of ILN as Appellant (filed February
26, 1992).

Finally, Mundey asserts that he cannot personally be credited with any misrepresentations
because he did not personally make any. We disagree, finding ample evidence to hold
Mundey liable for ILN's misrepresentations. As the SEC points out, the evidence shows that
Mundey, ILN's vice president and 25% owner, was intimately involved with its daily
operations and controlled all disbursements of its funds. See JA 116, 118. These facts
support the inference that Mundey knew of Ford's representations and of the inevitability of
ILN's investors' losses. The district court therefore committed no error in finding him jointly
responsible for ILN's fraudulent sale of securities. Cf. Gross v. SEC, 418 F.2d 103, 107 (2d
Cir.1969) (concluding that vice president aided and abetted firm's violation of anti-fraud
provisions "[o]n the basis of [his] participation in the management of the firm and his
knowledge of the course of conduct in which his firm was engaging").

For the preceding reasons, the district court's opinion and its preliminary injunction are
Affirmed.

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73-779 D-01--4

INTERNATIONAL LOAN NETWORK, INC., Melvin J. Ford, and Odell Mundey,
Defendants.

Civ. No. 91-1102.

United States District Court,

District of Columbia.

July 18, 1991.

MEMORANDUM OPINION

THOMAS F. HOGAN, District Judge.

On May 15, 1991, the plaintiff Securities and Exchange Commission (SEC) applied to this
Court for an ex parte temporary restraining order enjoining defendants from committing
federal securities violations and freezing defendants' assets, among other things. The Court
granted the requested temporary relief upon the SEC's showing that there was a justifiable
basis for believing that defendants had sold securities in violation of the registration
provisions of the Securities Act of 1933, 15 U.S.C. 77a et seq., (the 1933 Act), and of the
antifraud provisions of the 1933 Act and the Securities Exchange Act of 1934, 15 U.S.C.
78a et seq., (the 1934 Act).

On May 30, 1991, defendants International Loan Network, Inc., and Melvin Ford sought
and received a modification of the temporary restraining order and asset freeze to permit
defendants to retain counsel on their behalf and to enable them to meet necessary business
and living expenses, among other things. Defendant Odell Mundey subsequently sought and
was granted minor modifications of this Order. After an expedited discovery period, the
SEC filed a Motion for a Preliminary Injunction, Order Freezing Assets, Appointment of a
Receiver and Other Ancillary Relief on June 21, 1991. After the Oppositions and Reply
were filed, this Court conducted a three-day evidentiary hearing from July 1, 1991 to July 3,
1991. Counsel for all parties delivered lengthy closing arguments on July 8, 1991.