Is My LLC Interest A Security?

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Presentation to the Idaho State Bar Business & Corporate Section, January 12, 2011

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Is My LLC Interest A Security?

  1. 1. Is My LLC Interest A Security? Wendy Couture Presented to theIdaho State Bar Business & Corporate Section January 12, 2011
  2. 2. Is My LLC Interest A Security… under under Idahofederal law? law?Securities Act of 1933;Securities Exchange Idaho’s UniformAct of 1934. Securities Act (2004).
  3. 3. Why do we care?• If it‘s a ―security,‖ it can‘t be offered or sold unless it iseither registered or exempt (or preempted) fromregistration. Securities Act 5(a); Idaho Code 30-14-301.• If it‘s a ―security,‖ it is subject to securities fraudprovisions. Securities Exchange Act 10(b); Idaho Code 30-14-501.
  4. 4. Is My LLC Interest A Security… under under Idahofederal law? law?Securities Act of 1933;Securities Exchange Idaho’s UniformAct of 1934. Securities Act (2004).
  5. 5. Federal Statutory Definitions of “Security” ’33 Act 2(a)(1) ’34 Act 3(a)(10)―When used in this ―When used in this Act,Act, unless the context unless the context otherwiseotherwise requires—[t]he requires—[t]he termterm ‗security‘ means any ‗security‘ means any note,note, stock, . . . investmentcontract . . .‖ = stock, . . . investment contract . . .‖ SEC v. Edwards, 540 U.S. 389 (2004) – these two definitions are ―essentially identical in meaning‖
  6. 6. Federal Statutory Definitions of “Security” ’33 Act 2(a)(1) ’34 Act 3(a)(10)―When used in this Act, ―When used in this Act,unless the context unless the context otherwiseotherwise requires—[t]he requires—[t]he termterm ‗security‘ means any ‗security‘ means any note,contract . . .‖contract investmentnote, stock, . . . investment = stock, . . . investment contract . . .‖ investment contract ?
  7. 7. Howey test for “investment contract‖ S.E.C. v. Howey Co., 328 U.S. 293 (1946).• investment of money• in a “common enterprise”• with an “expectation of profits”• “solely on the efforts of others”
  8. 8. 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”• with an “expectation of profits”• “solely on the efforts of others”
  9. 9. 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).• with an “expectation of profits”• “solely on the efforts of others”
  10. 10. 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).• 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).• “solely on the efforts of others”
  11. 11. 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).• 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).• “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).
  12. 12. 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).• 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).• “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).
  13. 13. • “solely on the efforts of others”- satisfied if ―the efforts made bythose other than the investor are undeniably the significant ones, those managerialefforts which affect the failure or success of the enterprise.‖ SEC v. Glenn W.Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973). General Partnership Interests Limited Partnership Interests
  14. 14. • “solely on the efforts of others”- satisfied if ―the efforts made bythose other than the investor are undeniably the significant ones, those managerialefforts which affect the failure or success of the enterprise.‖ SEC v. Glenn W.Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973). General Partnership Interests Limited Partnership Interests Presumptively not securities. Generally are securities.
  15. 15. How to Overcome the Presumption that General Partnership Interests Are Not SecuritiesThree Non-Exclusive Ways (from 5th Circuit‘s Williamson test):• An agreement among the parties leaves so little power in the hands of thepartner or venturer that the arrangement in fact distributes power as would alimited partnership.• The partner or venturer is so inexperienced and unknowledgeable in businessaffairs that he is incapable of intelligently exercising his partnership or venturepowers.• The partner or venture is so dependent on some unique entrepreneurial ormanagement ability of the promoter or manager that he cannot replace themanager of the enterprise or otherwise exercise meaningful partnership orventure powers.
  16. 16. • “solely on the efforts of others”- satisfied if ―the efforts made bythose other than the investor are undeniably the significant ones, those managerialefforts which affect the failure or success of the enterprise.‖ SEC v. Glenn W.Turner Enter., Inc., 474 F.2d 476, 482 (9th Cir. 1973). General Partnership Interests Limited Partnership Interests Presumptively not securities. Generally are securities. Somewhat analogous to Somewhat analogous to member-managed LLCs. manager-managed LLCs.
  17. 17. Factors Considered By Courts in Deciding Whether an LLC Interest is a Security Weigh in favor of Weigh against status status as a security as a security• management agreement turned all • members had right to manageprincipal management functions over to (Keith, 48 F. Supp. 2d 325)another (Nutek, 977 P.2d 826) • members had right to vote in• manager had sole power to authorize proportion to holdings (Keith)distributions (Shirley, 2010 WL 272185) • members had right to participate in•manager was a 2/3 owner and a a detailed cash flow distributionmembership meeting couldn’t be called structure (Keith)without his consent (Nutek) • members had right to call meetings• large # of geographically dispersed of members (Keith)investors diluted power to such an extent • member was sole owner and thusthat prevented members from exercising power wasn’t diluted (Great Lakes, 96 F.effective control (Nutek) Supp. 2d 376)•manager had veto power over change in • members had power to removemanager (Shirley) manager with or without cause (Great• operating agreement had no provision for Lakes)removal of manager for cause (Shirley)
  18. 18. Is My LLC Interest A Security… under under Idahofederal law? law?Securities Act of 1933;Securities Exchange Idaho’s UniformAct of 1934. Securities Act (2004).
  19. 19. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . . investment contract; . . .‖ IdahoCode § 30-14-102(28).
  20. 20. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28).
  21. 21. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28). ―‗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).
  22. 22. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28). ―‗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 primaril 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 person offering the investment, investors.‖ Idaho Code § 30-14-102(28)(d).
  23. 23. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28). ―‗Security‘ includes as an ‗investment contract,‘ among othercontracts, an interest in a limited partnership and a limited liabilitycompany and an investment in a viatical settlement, life settlementor senior settlement or similar agreement.‖ Idaho Code § 30-14-102(28)(e).
  24. 24. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28).―‗Security includes as an ‗investment contract,‘ among other ―‗Security‘ includes as an ‗investment contract,‘contracts, an interest in a limited partnership and a limited liability an interest Icompany and an investment in a viatical settlement, life settlementor senior settlement or similar agreement.‖ Idaho Code § 30-14-102(28)(e).
  25. 25. ―‗Security includes as an ‗investment contract,‘ among other ―‗Security‘ includes as an ‗investment contract,‘contracts, an interest in a limited partnership and a limited liability an interest Icompany and an investment in a viatical settlement, life settlementor senior settlement or similar agreement.‖ Idaho Code § 30-14-102(28)(e).Interpretation One: An LLC Interest is Always An InvestmentContract (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 HoweyTest.
  26. 26. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. Investment ContractsInterests Satisfying the 4-part Howey Test All LLC Interests
  27. 27. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. • Straightforward reading of statute
  28. 28. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28).―‗Security includes as an ‗investment contract,‘ among other ―‗Security‘ includes as an ‗investment contract,‘contracts, an interest in a limited partnership and a limited liability an interest Icompany and an investment in a viatical settlement, life settlementor senior settlement or similar agreement.‖ Idaho Code § 30-14-102(28)(e).
  29. 29. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. • Straightforward reading of statute • 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).
  30. 30. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. • Straightforward reading of statute • 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 case In re Trade Partners, Inc. Investors Litig., 2008 WL 3992168, at *4 (W.D. Mich. Aug. 22, 2008) (not reported) (applying Oklahoma law).
  31. 31. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. • Straightforward reading of statute • 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 case In 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 Action Letter 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.‖).
  32. 32. Interpretation One: An LLC Interest is Always An InvestmentContract (and Thus A Security) Under Idaho Law. • Straightforward reading of statute • 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 case In 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 Action Letter 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
  33. 33. Interpretation Two: An LLC Interest is An Investment Contract(and Thus A Security) Under Idaho Law If It Satisfies the HoweyTest. Investment ContractsInterests Satisfying the 4-part Howey Test All LLC Interests
  34. 34. Interpretation Two: An LLC Interest is An Investment Contract(and Thus A Security) Under Idaho Law If It Satisfies the HoweyTest.•Nuanced reading of statute
  35. 35. Idaho Statutory Definition of “Security”―‗Security‘ means a note; stock; . . .investment contract . . .‖ Idaho investment contract;Code § 30-14-102(28).―‗Security includes as an ‗investment contract,‘ among other ―‗Security‘ includes as an ‗investment contract,‘contracts, an interest in a limited partnership and a limited liability an interest Icompany and an investment in a viatical settlement, life settlementor senior settlement or similar agreement.‖ Idaho Code § 30-14-102(28)(e).
  36. 36. Interpretation Two: An LLC Interest is An Investment Contract(and Thus A Security) Under Idaho Law If It Satisfies the HoweyTest.• 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).
  37. 37. Interpretation Two: An LLC Interest is An Investment Contract(and Thus A Security) Under Idaho Law If It Satisfies the HoweyTest.• 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).• 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).
  38. 38. Interpretation Two: An LLC Interest is An Investment Contract(and Thus A Security) Under Idaho Law If It Satisfies the HoweyTest.• 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).• 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
  39. 39. Is My LLC Interest A Security… under under Idahofederal law? law?Securities Act of 1933;Securities Exchange Idaho’s UniformAct of 1934. Securities Act (2004).
  40. 40. Thank you!I welcome your comments at wgcouture@uidaho.edu

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