In the Matter of Octopus Network, Inc.

[PED * CASE NO. 98-2220. May 22, 1998.] IN THE MATTER OF OCTOPUS NETWORK, INC. OMNIBUS ORDER On February 25, 1998, this Commission issued a Show Cause Order against 12 entities including a certain Octopus Network, Inc. the pertinent portion of which reads: LibLex "The Commission upon proper investigation has determined that the documents/papers in the form of . . . . coupons . . . . being issued, sold disposed, offered or distributed to the public for value by . . . . xxx xxx xxx 8. OCTOPUS NETWORK, INC. xxx xxx xxx are not registered and permitted to be sold in accordance with the registration requirements mandated by Section 4 of the Revised Securities Act. WHEREFORE, the above indicated corporations, firms, entities and its operators, promoters, proprietors, directors and officers are hereby ordered to SHOW CAUSE in writing why no sanctions should be imposed against them for said violation . . . xxx xxx xxx . . . . the aforecited . . . entities and any and all persons acting for and on behalf or participating thereat are hereby ordered to CEASE AND DESIST from further offering, distributing, disposing and or selling . . . . coupons . . . which the Commission considers "securities" under Section 2 of the Revised Securities Act including any and all activities in pursuance thereof. FURTHER, the operators . . . are hereby ordered to appear at the hearing of these cases with the Commission En Banc on March 20, 1998 . . ." Records of the Commission show that Octopus Network, Inc. (Octopus, for brevity), is a corporation duly registered with the Commission on January 8, 1998, with the primary purpose of engaging in the business of trading of goods, such as novelty items, and handicrafts on wholesale/retail basis. Records further show that the following persons appeared as incorporators/directors thereof: Renato F. Sugay II; Renato L. Sugay; Aileen C. Sugay; Ma. Luisa F. Sugay and Rene Anne F. Sugay. On March 18, 1998, Octopus, by counsel, submitted a pleading captioned "Compliance with Show-Cause Order and Position Paper". The officers of subject corporation likewise appeared along with legal counsel Atty. Andres Hagad at the hearings conducted by the Commission. On March 25, 1998, an Order was issued by this Commission, the pertinent portion of which provides: "WHEREFORE, OCTOPUS NETWORK, INC. and its responsible officers are hereby ordered to appear with the Commission En Banc for a hearing on March 30, 1998, . . . . to show cause and explain why they should not be CITED IN CONTEMPT pursuant to Section 45 (c) of the Revised Securities Act for possible violation of the Revised Securities Act for possible violation of the Cease and Desist Order issued by the Commission." During the hearings, Octopus posited the argument that the "product coupons", do not fall within the definition of "securities" as defined in Section 2 of Batas Pambansa Blg. 178, otherwise known as the Revised Securities Act (RSA). The issue to be resolved by the Commission in the exercise of its regulatory functions as mandated by the RSA is whether or not OCTOPUS NETWORK, INC. in engaging in the line of business of selling, or offering for sale or distribution to the public the product coupons pursuant to a marketing scheme has violated the provisions of the Revised Securities Act, more particularly Section 4 in relation to Section 2, thereof. Section 4(a) of RSA mandates that, to wit: "(a) No securities . . . . shall be sold or offered for sale or distribution to the public within the Philippines unless such securities shall have been registered and permitted to be sold as hereinafter provided." This Commission rules in the affirmative, Section 2 of the Revised Securities Act provides: (a) " Securities " shall include bonds, debentures, notes, evidences of indebtedness, shares in a company, pre-organization certificates or subscriptions, investment contracts , certificates of interest or participation in a profit sharing agreement, collateral trust certificates, equipment trust certificates (including conditional sale contracts or similar interests or instruments serving the same purpose), voting trust certificates, certificates of deposit for a security or fractional undivided interest in oil, gas or other mineral rights, or in general, interests or instruments commonly considered to be "securities", or certificates of interest or participation in, temporary or interim certificates for, receipts for, guarantees of, or warrants or rights to subscribe to or buy or sell any of the foregoing; or commercial papers evidencing indebtedness of any person, financial, or non financial entity; irrespective of maturity, issued, endorsed, sold, transferred or in any manner conveyed to another, with or without recourse, such as promissory notes, repurchase agreements, certificates of assignment, certificates of participation, trust certificates or similar instruments; or proprietary or non-proprietary membership certificates, commodity futures contracts, transferable stock options, pre-need plans, pension plans, life plans, joint venture contracts, and similar contracts and investments where there is no tangible return on investment plus profits but an appreciation of capital as well as enjoyment of particular privileges and services."(emphasis ours). The RSA under Section 2 thereof defines the word securities by enumerating what are included in the word securities. The Commission, being the agency exclusively tasked to implement the RSA under Section 3 thereof has, after careful and exhaustive evaluation of the evidence available in this case, determined that the marketing scheme adopted or used by subject corporation in its business operation including the distribution and/or sale of coupons to the public is an " investment contract " which is one of those classified as "securities" within the meaning of Section 2 of the RSA. In construing a provision of law, it is important to consider the legislative intent. The basic philosophy for the enactment of the RSA is to protect the investing public (sponsorship speech 12-12-81; Comm. Laws of the Phil., Agbayani, p. 708). Accordingly, the interpretation of the meaning of the provisions of the RSA shall be pursuant to the said general legislative intent which is to protect the investing public. Parenthetically, considering that the RSA has been patterned after the American Uniform Sale of Securities and the Federal Securities Act of 1933, the Commission in order to fully address and resolve the issues involved has found persuasive the comments of the American authorities in the field of securities including the interpretation of aforesaid laws by the U.S. courts. Admittedly, the definition of securities is extraordinarily broad. Included within the scope of "security" are such standard documents as stocks and bonds. Also included are instruments of a more variable character designated by such descriptive terms as " investment contract " and "in general any interest or instrument commonly known as "security". In particular, the term " investment contract " has been viewed by the courts as a " catch all " phrase designed to encompass novel devices which serve the same purpose as a " security " (Cary & Eisenberg Corp. 6th Ed. Concise UCB-22 p. 948) In SEC vs. W.J. Howey Co., 328 U.S. 293 (1946), the U.S. Supreme Court established a definition of an investment contract as follows: "An investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . ." This definition was modified in SEC vs. Glenn Turner Enterprises, Inc. 474 F. 2d 476, 414 U.S. 821, 94. In the modified test, the touchstone is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others (69 Am Jur 2d p. 108) I. There is a contract, transaction or scheme The phrase " investment contract " as enumerated under Sec. 2 of the RSA is taken from the Federal Securities Act. Said phrase or term as appearing in the Federal and Hawaii Securities Act is designed to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits. (infra) It is clear that the term " investment contract " as interpreted in the Howey case was not limited to the existence of a mere agreement by and between the promoter and the investor. It was given such a broad meaning as to include schemes for as long as it involves the use of the money of others on the promise of profits. Moreover, a writing is not essential for an investment contract. (1 Loss, Securities Regulation 2d Ed 489.) In the case at bar, Octopus is undisputedly engaged in a multi-level marketing scheme which indispensably makes use of the distribution and/or sale of coupons with promise of financial yield or cash windfall. Looking deeper into its so called marketing scheme as clearly shown in the coupon and the brochures being distributed to participants, the same has seven (7) levels. The levels represent the ranking or position of the participants and tell how far a participant has gone into the scheme with the newest participant starting from the lowest position (7th position) until he reaches the top or number one position. The levels likewise represent the processes one has to undergo if one has to derive the full benefits from the scheme , to wit; LEVEL 7 YOU as newest participant as appearing in seventh (7th) position in the coupon will invite/recruit three (3) prospective participants. LEVEL 6 These 3 new participants will invite/recruit three (3) each prospective participants (3x3 = 9) and YOU as appearing in the coupons will be promoted to sixth (6th) position. LEVEL 5 These 9 new participants will invite/recruit three (3) each prospective participants (9x3 = 27) and YOU as appearing in the coupons will go to fifth (5th) position. LEVEL 4 These 27 new participants will invite/recruit (3) each prospective participants (27 x 3 = 81) and YOU as appearing in the coupons will be in fourth (4th) position. LEVEL 3 These 81 new participants will invite/recruit three (3) each prospective participants (81 x 3 = 243}and YOU as appearing in the coupons will be promoted to third (3rd) position. LEVEL 2 These 243 new participants will invite/recruit three (3) each prospective participants (243 x 3 = 729) and YOU as appearing in the coupons will be placed in the second (2nd) position. LEVEL 1 YOU as appearing in the coupons will be on top position. These 729 new participants will invite/recruit three (3) each prospective participants (729 x 3 = 2,187). 2,187 These 2,187 new participants should pay or remit to YOU (as participant on top position) P100.00 each to your bank account (2,187 x P 100.00 = P218,700.00). These 2,187 new participants will invite three each prospective participants and the participants will be promoted to their respective level or rank as recruitment of participants continue and the process repeated as designed and conceptualized in the scheme. The levels in the scheme having been presented as shown above, it is necessary to look into the "procedures" in order for one to qualify as a participant. As clearly shown and indicated in the coupon and the brochure, the prospective participant shall purchase a coupon (from one already a participant) in the amount of P100.00; deposit the amount of P100.00 to the bank account of the person on the top or in the number one position as appearing in the coupon; submit the purchased coupon together with the machine validated deposit slip to the office of Octopus; pay Octopus P100.00 and receive the three (3) product coupons with the name of the new participant appearing in the bottom position (7th position), distribute or sell the three (3) coupons to three (3) prospective participants at P100.00 each. Simply put, as participants come into the picture, one reaches a certain level or position and when he reaches top level or number one position, the 2,187 participants will remit to his bank account P100.00 each or a total sum of P218,700.00. dctai II. There is an investment of money . As it is, one joining Octopus' multi-level marketing scheme stands to part with the amount of P300.00 with the intention of participating in the scheme including all the seven (7) positions as hereinabove described with the expectation of receiving P218,700 in accordance with the scheme, hence, there is an investment. To further bolster the existence of an investment, Ms. Maria Luisa F. Sugay, an officer of the subject corporation testified in the hearing as follows: COMM. CONCEPCION You are the promoter. What product are you selling in the coupon? What would be the motivation for this people to pay P300.00? MS. SUGAY Well actually, we're telling them its their investment in themselves. (t.s.n. page 36) From the foregoing, it is quite clear that the money being shelled out, though it is paid to three different persons namely the immediate recruiter, Octopus Network, Inc. and the person appearing in the top level or in number one position, is an investment, intended to derive therefrom the amount of P218,700.00 by way of profit. III. The investment is made in a common enterprise . Several tests have evolved to determine what constitutes "common enterprise". One of these tests is the horizontal commonality approach. Under this test, the determination of whether a transaction satisfies the commonality element of the modified Howey test involves an inquiry into whether said transaction involved the joint participation of more than one investor in the investment of funds or the sharing of profits . (69 Am Jur 2d citing Stenger v. R.H. Love Galleries, Inc. 741 F2d 144). Furthermore, joint participation by investors in the same investment enterprise, achieved by pooling the invested funds for a common purpose, is required in order to satisfy the common enterprise element (Wasnowic v. Chicago Bd. of Trade 352 F Supp 1066). In the case at bar, there are 21,201 participants in the scheme based upon the "List of Participants" submitted by Octopus to this Commission. Clearly, the horizontal approach has been satisfied with the number of participants that have joined the scheme since its inception. Likewise, there is a pooling as participants deposit P100.00 each to the account of the participant on the top position. IV. There is expectation of profits . As previously discussed, a participant in order to get into the scheme must shell out a total of P300.00, P100.00 of which will be paid to Octopus for "activation" of his participation and for the issuance in his favor of three (3) coupons which said participant can dispose of to prospective participants for P100.00 each. If the said participant moves on in accordance with the scheme and thus reaches the top level or number one position, the investment of P300.00 will earn P218,700.00. This fact has been admitted and confirmed by Ms. Sugay, thus "COMM. CONCEPCION: And if it is investment . . . the profit that will be derived from the . . . investment . . . you have P218,700.00? MS. SUGAY: Hopefully Yes, if they able to work their downline in such a way that everybody works and cooperate with each other, then they stand to make a windfall . (t.s.n. page 39) The receipt of maximum of P218,700.00 is but the last stage in the scheme and is evidently the inducement for one to join the scheme. Elsewise stated, a participant who joins the scheme expects to derive profits therefrom. V. Profits arise from the entrepreneurial and managerial efforts of others The question under the modified Howey test is whether efforts made by those other than the investor are undeniably the significant ones, those essential managerial efforts that affect failure or success of the enterprise (SEC v. Glenn Tumer, Supra). In the instant case, profits in the maximum amount of P218,700.00 out of an investment in the amount of P300.00 arise without a doubt from the entrepreneurial and managerial efforts of Octopus. Firstly, the scheme subject of this case as a multi level marketing network was conceptualized and promoted by Octopus. Secondly, the manner by which one can avail of the benefits of the scheme is dictated undoubtedly by Octopus. If one will not obtain a coupon or fail to follow the instructions/steps as appearing in the coupons being issued, his participation will not be processed and activated and thus be unable to get into the scheme and receive the P218,700.00. Once activated, it is Octopus and not the participants who determines one's position in the scheme. prLL As may be clearly observed, the efforts exerted by Octopus are undeniably the significant ones, since the participants are substantially dependent upon the activation and monitoring and management of Octopus in order to obtain the promised windfall. Upon the other hand, the participant, while he is not totally inactive, merely participates to a limited degree in the operation of the scheme. The U.S. courts have held that a pyramid selling scheme constituted investment contracts notwithstanding the fact that the investors themselves participated in the operation of the enterprise. (SEC v. Glen Tumer, Supra) Moreover, in SEC v. International Network, Inc. et al. 968 F 1304 (D.C. Cir. 1992) where a corporation promoting a "financial redistribution system, sold memberships to approximately 40,000 investors without any product and with a promise of $100,000.00 return, it was held, using the Howey test, that the scheme was a "security" considering that the company's income were derived from the recruitment of members whose membership fees were paid to earlier investors. The totality of the elements of the Howey test being present in the instant case, taking into consideration every step of the way the general legislative intent of protection to public investors, the Commission is convinced that the multi level marketing scheme of Octopus including the distribution of coupons to the public is an investment contract and therefore a security within the purview of the RSA . Being a security, it cannot be offered publicly without first being registered with this Commission. Section 46 of the RSA provides for an administrative sanction, to wit: "If after proper notice and hearing, the Commission finds that there is a violation of this Act . . . it shall, in its discretion, impose any or all of the following sanctions. xxx xxx xxx (b) A fine of no less than two hundred (P200.00) pesos nor, more than fifty thousand (P50,000.00) pesos plus not more than five hundred (P500.00) pesos each day of continuing violation." xxx xxx xxx d) Other penalties within the power of the Commission under existing laws. Anent the issue of indirect contempt as set forth in the Show Cause Order dated March 25, 1998, the records of the Commission show that Octopus indeed committed a violation of the CDO when it processed the coupons purchased by operatives of this Commission on March 19, 1998 notwithstanding receipt of the CDO on March 4, 1998. The List of Participants as certified by Ms. Nenita Pedrajas and submitted by Octopus to this Commission show the names of the SEC operatives namely, Jerome R. Locre, Allan F. Imbo and Antonio Romero as participants of their scheme. Moreover, the "Manifestation of Compliance' submitted by Octopus on March 30, 1998 admitted to the foregoing facts and pleaded good faith by way of defense. Section 45 (c) of the RSA provides that: "(c) Any person who, without cause, fails or, refuses to comply with any order, decision or subpoena issued by the Commission in the proper exercise of its authority and jurisdiction under . . . Section 47 of this Act, if in the power of such person to do so, shall after due notice and hearing, be guilty of contempt to the Commission and shall be subject to discipline by the Commission as in the case of contempt of court, either by a fine in such reasonable amount as the Commission may determine . . ." WHEREFORE, foregoing considered, for having violated Section 4 (a) in relation to Section 46 of the Revised Securities Act, Octopus Network, Inc., the issuer of coupons and promoter of the subject multi level marketing scheme is hereby FINED in the amount of FIFTY THOUSAND (P50,000.00) PESOS. Octopus is likewise ordered to return the investment in the guise of service fees paid by the participants in the amount of ONE HUNDRED (P100.00) PESOS each. For having violated Section 47 in relation to Section 45 (c) of the Revised Securities Act, Octopus Network, Inc. is hereby cited for INDIRECT CONTEMPT by this Commission and FINED an additional amount of TWENTY FIVE THOUSAND (P25,000.00) PESOS. The Cease and Desist directive contained in the Show Cause Order of this Commission on February 25, 1998 in so far as Octopus, any and all persons/individual or participants are concerned is hereby made PERMANENT. Moreover, Octopus Network, Inc. is hereby directed to submit a compliance report to the Commission on the return of investments within thirty (30) days from receipt hereof. This Order imposing administrative sanctions shall be without prejudice to the filing of criminal charges against the individuals responsible for the violation. SO ORDERED. (SGD.) FE ELOISA C. GLORIA (SGD.) EDIJER A. MARTINEZ Associate Commissioner Associate Commissioner (SGD.) ROSALINDA U. CASIGURAN (SGD.) DANILO L. CONCEPCION Associate Commissioner Associate Commissioner (SGD.) PERFECTO R. YASAY, JR. Chairman