US Coins

Court ruling on what is a security is worrisome

I have written frequently over the years about my view that coins, when sold in the normal retail manner, are not securities regulated by federal and state securities laws. A recent decision in New York, however, seems out of line on this issue and worries me.

To be regulated as a security, or “investment contract” to use the technical legal term, a transaction must satisfy the three-part test the U.S. Supreme Court established in 1946 in SEC v. W.J. Howey Co., namely “[1] an investment of money [2] in a common enterprise [3] with profits to come solely from the efforts of others.”

One appeals court ruling

Since Howey, only one federal appeals court has considered whether a retail coin sale meets that test, and it determined that the sale of bullion coins was not a security because investors’ profits came entirely from fluctuations in the world market that are out of the dealer’s control.

One district judge in the 1970s found that dealers who select the coins for the client and purport to “manage” clients’ investment accounts may be selling securities, but that decision predated recent evolutions in the definition of securities.

The current thinking among courts is that an investment is a security only when “narrow vertical commonality” exists between the investor and the seller, such that the investor’s fortunes are interdependent with the seller’s.

In Llewellyn v. North American Trading et al., a case I litigated, a New York federal judge found that rare coins retailed to investors by a telemarketer were not securities. The court emphasized that “Although defendants’ fortunes rose when plaintiff purchased the rare coins, the defendants would maintain their financial position even if plaintiff’s investment decreased in value.”

In other words, the dealer made a profit on the initial sale, but didn’t lose money if the customer’s coins later declined in value.

Typical sales transaction

So it seems pretty clear that the typical retail sales transaction would not be a security. Out of an abundance of caution I’ve advised clients not to offer buy-back guarantees, because doing so results in the customer “investing” in the dealer’s ability to fund the buy-back in the future.

But a recent decision in the case of Marini v. Adamo confuses things. The court ruled that dealers who liquidate coins for their clients, charging a fee based on the coins’ value, are selling securities because if the coins lose value, the dealer’s liquidation fee also decreases. To me this logic seems inconsistent with the purpose of the Howey test, which is to identify situations where the investor was aligning his or her interests with the dealer — in other words, “investing” in the dealer’s success.

Finding that a dealer had a small investment in the customer’s success via the liquidation fee doesn’t strike me as the same thing at all. 

The rise or fall of the investor’s portfolio value still was the result of outside market forces over which the dealer has no control.

The upshot of all this is that I will probably advise clients to either stop offering liquidation services, or if they do so, not to peg their fees to portfolio value.

This way they can avoid an unhappy client (or the SEC) later accusing them of having sold unregistered securities. 

But I don’t agree with the Marini decision.

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