West Case Update

Internet Stock Market Game Is Securities Fraud

Description Appeals court held that an Internet game offering shares of stock in virtual companies earning high rates of return was the sale of unregistered securities, since the terms of the deal meet the Howey test of an investment contract. The operation was a Ponzi scheme to be halted immediately with all assets frozen.

Topic Securities Law

Key Words Investment; Howey Test; Ponzi Schemes

C A S E S U M M A R Y

Facts SG ran a "StockGeneration" website offering the chance to buy shares in "virtual companies" listed on SG's "virtual stock exchange." SG arbitrarily set the buy and sell prices of each stock in the imaginary companies biweekly and allowed investors to buy and sell any quantity at posted prices. Millions of dollars had been collected by SG, and participants had trouble redeeming their shares until SG suspended operations. The SEC sued, contending that the sale of shares in a company that was a "game without any risk" that had an average increase in value of 10% per month, was a sale of an unregistered security in violation of the Securities Exchange Act. The district court dismissed the complaint, holding that the shares were clearly marked and defined as a game lacking a business context. The SEC appealed.

Decision
Reversed. Under the Howey test, these are investment contracts, given how they were marketed to the public. It does not matter if the promoter presents the enterprise as a serious commercial venture or calls it a game. The game was a Ponzi or pyramid scheme in which there was a pooling of assets from multiple investors in a manner that all share in profits and risks of the enterprise operated by third parties. An injunction against the operation is issued and assets of SG are to be frozen.

Citation SEC v. SG Ltd., 265 F.3d 42 (1st Cir., 2001)

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Internet Stock Market Game Is Securities Fraud
Description	Appeals court held that an Internet game offering shares of stock in virtual companies earning high rates of return was the sale of unregistered securities, since the terms of the deal meet the Howey test of an investment contract. The operation was a Ponzi scheme to be halted immediately with all assets frozen.
Topic	Securities Law
Key Words	Investment; Howey Test; Ponzi Schemes
C A S E S U M M A R Y
Facts	SG ran a "StockGeneration" website offering the chance to buy shares in "virtual companies" listed on SG's "virtual stock exchange." SG arbitrarily set the buy and sell prices of each stock in the imaginary companies biweekly and allowed investors to buy and sell any quantity at posted prices. Millions of dollars had been collected by SG, and participants had trouble redeeming their shares until SG suspended operations. The SEC sued, contending that the sale of shares in a company that was a "game without any risk" that had an average increase in value of 10% per month, was a sale of an unregistered security in violation of the Securities Exchange Act. The district court dismissed the complaint, holding that the shares were clearly marked and defined as a game lacking a business context. The SEC appealed.
Decision	Reversed. Under the Howey test, these are investment contracts, given how they were marketed to the public. It does not matter if the promoter presents the enterprise as a serious commercial venture or calls it a game. The game was a Ponzi or pyramid scheme in which there was a pooling of assets from multiple investors in a manner that all share in profits and risks of the enterprise operated by third parties. An injunction against the operation is issued and assets of SG are to be frozen.
Citation	SEC v. SG Ltd., 265 F.3d 42 (1st Cir., 2001)