Is My LLC Interest A Security?

Is My LLC Interest A Security?

Wendy CouturePresented to the

Idaho State Bar Business & Corporate SectionJanuary 12, 2011

Is My LLC Interest A Security…

under federal law?

Securities Act of 1933; Securities Exchange Act of 1934.

under Idaho law?

Idaho’s Uniform Securities Act (2004).

Why do we care?

• If it’s a “security,” it can’t be offered or sold unless it is either registered or exempt (or preempted) from registration.

Securities Act § 5(a); Idaho Code § 30-14-301.

• If it’s a “security,” it is subject to securities fraud provisions.

Securities Exchange Act § 10(b); Idaho Code § 30-14-501.


under federal law?


under Idaho law?


Federal Statutory Definitions of “Security”

’33 Act § 2(a)(1) ’34 Act § 3(a)(10)“When used in this Act, unless the context otherwise requires—[t]he term ‘security’ means any note, stock, . . . investment contract . . .”

“When used in this Act, unless the context otherwise requires—[t]he term ‘security’ means any note, stock, . . . investment contract . . .”

SEC v. Edwards, 540 U.S. 389 (2004) – these two definitions are “essentially identical in meaning”

=

Federal Statutory Definitions of “Security”

’33 Act § 2(a)(1) ’34 Act § 3(a)(10)“When used in this Act, unless the context otherwise requires—[t]he term ‘security’ means any note, stock, . . . investment contract . . .”

“When used in this Act, unless the context otherwise requires—[t]he term ‘security’ means any note, stock, . . . investment contract . . .” =investment investment contractcontract

?

Howey test for “investment contract”

• investment of money

• in a “common enterprise”

• with an “expectation of profits”

• “solely on the efforts of others”

S.E.C. v. Howey Co., 328 U.S. 293 (1946).


• investment of money - includes an investment of goods and services. Int’l Bhd. of

Teamsters v. Daniel, 439 U.S. 551, 560 n.12 (1979).

• in a “common enterprise”






• in a “common enterprise”- either horizontal commonality (where the investors’ fortunes are interwoven) or vertical commonality (where there is a direct

correlation between the success or failure of the promoter’s efforts and the success or failure of the investment). SEC v. Eurobond Exch., Ltd., 13 F.3d 1334, 1339 (9th Cir. 1993).






• in a “common enterprise”- either horizontal commonality (where the investors’ fortunes are interwoven) or vertical commonality (where there is a direct

correlation between the success or failure of the promoter’s efforts and the success or failure of the investment). SEC v. Eurobond Exch., Ltd., 13 F.3d 1334, 1339 (9th Cir. 1993).

• with an “expectation of profits”- “capital appreciation” and “participation in earnings” are examples, but a fixed rate of return also counts. SEC v. Edwards, 540 U.S. 389 (2004).


Howey test for “investment contract”• investment of money

- includes an investment of goods and services. Int’l Bhd. of Teamsters v. Daniel, 439 U.S. 551, 560 n.12 (1979).

• in a “common enterprise”- either horizontal commonality (where the investors’ fortunes are

interwoven) or vertical commonality (where there is a direct correlation between the success or failure of the promoter’s efforts and the success or failure of the investment). SEC v. Eurobond Exch., Ltd., 13 F.3d 1334, 1339 (9th Cir. 1993).


• “solely on the efforts of others”- satisfied if “the efforts made by those other than the investor are

undeniably the significant ones, those managerial efforts which affect the failure or success of the enterprise.” SEC v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973).

Howey test for “investment contract”• investment of money

- includes an investment of goods and services. Int’l Bhd. of Teamsters v. Daniel, 439 U.S. 551, 560 n.12 (1979).

• in a “common enterprise”- either horizontal commonality (where the investors’ fortunes are

interwoven) or vertical commonality (where there is a direct correlation between the success or failure of the promoter’s efforts and the success or failure of the investment). SEC v. Eurobond Exch., Ltd., 13 F.3d 1334, 1339 (9th Cir. 1993).


• “solely on the efforts of others”- satisfied if “the efforts made by those other than the investor are

undeniably the significant ones, those managerial efforts which affect the failure or success of the enterprise.” SEC v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973).*

• “solely on the efforts of others”- satisfied if “the efforts made by those other than the investor are undeniably the significant ones, those managerial efforts which affect the failure or success of the enterprise.” SEC v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973).

Limited Partnership InterestsGeneral Partnership Interests



Presumptively not securities. Generally are securities.

How to Overcome the Presumption that General Partnership Interests Are Not Securities

Three Non-Exclusive Ways (from 5th Circuit’s Williamson test):

• An agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership.

• The partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers.

• The partner or venture is so dependent on some unique entrepreneurial or management ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.



Presumptively not securities. Generally are securities.

Somewhat analogous to member-managed LLCs.

Somewhat analogous to manager-managed LLCs.

Factors Considered By Courts in Deciding Whether an LLC Interest is a Security

Weigh in favor of status as a security

Weigh against status as a security

• management agreement turned all principal management functions over to another (Nutek, 977 P.2d 826)• manager had sole power to authorize distributions (Shirley, 2010 WL 272185)•manager was a 2/3 owner and a membership meeting couldn’t be called without his consent (Nutek)• large # of geographically dispersed investors diluted power to such an extent that prevented members from exercising effective control (Nutek)•manager had veto power over change in manager (Shirley)• operating agreement had no provision for removal of manager for cause (Shirley)

• members had right to manage (Keith, 48 F. Supp. 2d 325)• members had right to vote in proportion to holdings (Keith)• members had right to participate in a detailed cash flow distribution structure (Keith)• members had right to call meetings of members (Keith)• member was sole owner and thus power wasn’t diluted (Great Lakes, 96 F. Supp. 2d 376)• members had power to remove manager with or without cause (Great Lakes)


under federal law?


under Idaho law?


“‘Security’ means a note; stock; . . . investment contract; . . .” Idaho Code § 30-14-102(28).

Idaho Statutory Definition of “Security”



investment contract



“‘Security’ includes as an ‘investment contract’ an investment in a common enterprise with the expectation of profits to be derived primarily from the efforts of a person other than the issuer. ‘Common enterprise’ means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment, a third party, or other investors.” Idaho Code § 30-14-102(28)(d).

investment contract



“‘Security’ includes as an ‘investment contract’ an investment in a common enterprise with the expectation of profits to be derived primaril from the efforts of a person other than the issuer. ‘Common enterprise’ means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment, a third party, or other investors.” Idaho Code § 30-14-102(28)(d).

investment contract

primarily

person offering the investment,



investment contract

“‘Security’ includes as an ‘investment contract,’ among other contracts, an interest in a limited partnership and a limited liability company and an investment in a viatical settlement, life settlement or senior settlement or similar agreement.” Idaho Code § 30-14-102(28)(e).



investment contract

“‘Security’ includes as an ‘investment contract,’ among other contracts, an interest I a limited partnership and a limited liability company and an investment in a viatical settlement, life settlement or senior settlement or similar agreement.” Idaho Code § 30-14-102(28)(e).

“‘Security includes as an ‘investment contract,’an interest in a limited liability

company



company

Interpretation One: An LLC Interest is Always An Investment Contract (and Thus A Security) Under Idaho Law.

Interpretation Two: An LLC Interest is An Investment Contract (and Thus A Security) Under Idaho Law If It Satisfies the Howey Test.


Investment Contracts

Interests Satisfying the 4-part Howey Test All LLC Interests


• Straightforward reading of statute



investment contract



company



• Oklahoma revised this provision when adopting the Uniform Securities Act.

“an interest in . . . a third party managed limited liability company”71 Okla. St. Ann. § 1-102(32)(e).





• Comparable caseIn re Trade Partners, Inc. Investors Litig., 2008 WL 3992168, at *4 (W.D. Mich. Aug. 22, 2008) (not reported) (applying Oklahoma law).






• Idaho Department of Finance Response to Request for No ActionLetter Dated March 26, 2006 (“Under § 30-14-102(28)(e) ‘security’ includes as an ‘investment contract,’ among other contracts, an interest in a limited partnership and a limited liability company. It appears that XXXXX meets the above criteria as well.”).






• Idaho Department of Finance Response to Request for No ActionLetter Dated March 26, 2006 (“Under § 30-14-102(28)(e) ‘security’ includes as an ‘investment contract,’ among other contracts, an interest in a limited partnership and a limited liability company. It appears that XXXXX meets the above criteria as well.”).

• Policy - clarity


Investment Contracts

Interests Satisfying the 4-part Howey Test All LLC Interests

•Nuanced reading of statute




investment contract



company

• Nuanced reading of statute

• Commentary to the Uniform Securities Act (source of this provision)“Section 102(28)(E) is consistent with state and federal laws which have recognized interests in limited liability companies and limited partnerships in some circumstances as securities, when consistent

with the court decisions interpreting the investment contract concept.” Uniform Law Comments cmt. 28 (2002) (emphasis added).


• Nuanced reading of statute

• Commentary to the Uniform Securities Act (source of this provision)“Section 102(28)(E) is consistent with state and federal laws which have recognized interests in limited liability companies and limited partnerships in some circumstances as securities, when consistent


• Uniformity Principle-one of the policies for the state administrator to consider when

acting under the Uniform Securities Act is “[m]aximizing uniformity in federal and state regulatory standards.” Idaho Code § 30-14-608.-“Uniformity of regulation among the states and coordination with

the Securities and Exchange Commission is a principal objective of this Act.” Uniform Law Comment 1 (2002).


• Nuanced reading of statute• Commentary to the Uniform Securities Act (source of this provision)

“Section 102(28)(E) is consistent with state and federal laws which have recognized interests in limited liability companies and limited partnerships in some circumstances as securities, when consistent


• Uniformity Principle-one of the policies for the state administrator to consider when

acting under the Uniform Securities Act is “[m]aximizing uniformity in federal and state regulatory standards.” Idaho Code § 30-14-608.-“Uniformity of regulation among the states and coordination with

the Securities and Exchange Commission is a principal objective of this Act.” Uniform Law Comment 1 (2002).

• Policy – prevent interference with dual regulatory balance, prevent over- regulation



under federal law?


under Idaho law?


Thank you!

I welcome your comments [email protected]

Is My LLC Interest A Security?

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