The story we're going to go through today goes to the heart
of whether what you're working on right now is a security and
something that needs to be registered with the SEC, or come
under an exemption or be part of a blue sky law. Or if it's
something else just to contract. Today, we're going to talk about
the case of SEC versus how.
As a syndication attorney and attorney that works on private
equity funds, my favorite case of all time has to be SEC vs.
Howey. This is the fundamental case that talks about whether
something is a security or is not. So I thought it would be
helpful for you to go through that case, what happened and
what that decision is. And then out of that, you can extract
what you're working on and apply it and see, does this make
sense? And does what I'm working on right now? Is that a security
or not? So let's go through it. So, a long, long time ago, in
the 1930s and early 1940s, there was a company named Howie, and
how he corporation did one thing and it did it very well. They
would buy 500 acres of land. And out of that 500 acres of land,
they would cut it up into strips but not all the way. So they
would cut about half of it into strips, and then the other half
they would they would leave for themselves. Now these strips had
on them 48 orange trees. So there'll be these 48 or an
orange trees. And what they would do is they would or they
also owned a resort. Now I wish I could draw a resort, but my
drawing skills are not that good. So let's just pretend this
looks exactly like a nice, beautiful resort with a big bay
window. In this resort, guests would come from around the
country, not only from Florida, but most of their guests would
come from other states. So the guests would come and they would
see pamphlets as part of the thing saying come visit the
beautiful orange trees. These orange trees are just happened
to be the ones located on these strips. So they'd come and visit
and then they would begin the sales pitch. The sales pitch
when something like this Dear Mr. investor, you see how
beautiful this place is we've got orange trees, and you know
how much money we make from those orange trees, we make a
lot of money. That's how we can afford to have a beautiful
resort like the one you're staying in. Do you like your
steak? Sure you do. Now as part of your stay, you also get to
see this. But you know, we have a special right now that we
would like you to be part of our business. You see, we've got
these, these orange trees that we've divided up into special
slit special things. And as part of that we're offering to sell
you have a beautiful piece of that tract of land that 48 trees
you can buy. Now most of our people buy about five, five of
these strips, but you could buy more, you can buy as many as you
like. But right now we're selling these wonderful. And
what you'll get is full title. We're not going to own anything
to do with this land. This is your land where you can make
just as much money as we make selling oranges. Now I
understand you're from out of state. But as the deal goes, we
just so happened to be experts at farming oranges. As you can
see, the orange trees are all in bloom, everything's going very
nicely. So what we're willing to do is this is we will take a
lease on your property. This is supposed to be a lease. We'll
take a lease on that property for 10 years. And as part of
that lease, we're going to pay you money in because you own the
land, right? And so we're going to pay you for the ticket to use
your land but we're also going to pay you part of the profits.
Does that sound like a good deal now what kind of returns you
Talking about I'm sure you've seen many other hotels, on
Facebook and things like that offering similar packages. Well,
right now we're not offering a preferred return, but we are
offering an IRR of 20%. Sounds pretty good and slick how safe
it is you own title to the land, all you need to do is buy the
land. And we're going to enter into this contract in order to
do the servicing of that land. So that's the sales pitch that
these investors would hear. And they would get people to invest
in this. And people would come from around state. And so as
this became more and more successful for how they also
decided that the resort was only doing so well, that maybe they
should also just send regular mail out. And so they'd send
regular mail and they'd either invite them to the resort, or
they'd invite them to this and they tell people about this
great investment opportunity. Now that all sounds well and
good, right? Sounds like a simple transaction. Well, the
SEC didn't agree the SEC said, Hey, hold on a minute, you guys,
Howie, you're this is a security what you're doing here. And that
as a security, it's just not going to work. You need to
either registered, stir it or you need to come under some
exemption. Now Rule five Reg D did not exist at this point. But
there were other exemptions that were occasionally used. So how
you need to get your act together? How we said no, this
isn't a security at all. We don't need to do that. And so it
went to court. And ultimately it found its way up to the Court of
Appeals the Circuit Court of Appeals. So that's the second
level. So when federal court first and then I went up to the
to the Court of Appeals, and the Court of Appeals looked at this
closely, and they said you know what? We think how he's right.
We don't think that this is a securities contract, that this
is an investment contract. See the law is this. Let me drag
this over. This is what a investment contract is. I may
delete these an investment contract is a security are I
mean, it's a security is something that is an investment
contract. But we don't think this is an investment contract.
Why? Well, for two reasons. We don't think this is an
investment contract, first of all, is that it's not
speculative. The investors are buying the land. Right. So
that's not speculative. They're getting that land. It's there's
nothing speculative about it. And the second problem with it
being a security is this, oops, can't see this under the
picture. There we go. And the second problem being a security
is this is that the sale itself had value. So it was the sale of
the land that how he was selling. And certainly the sales
of land isn't a security. Right? Well, so this case went all the
way up to the Supreme Court. And the Supreme Court took a look at
it, and they saw where it said investment contract. And that's
what that was really the question, what exactly is an
investment contract. Now also, as a side note, I put some other
of the of what is a security here, just because I think it's
interesting of promissory notes, stock, treasury stock bonds,
certificates of interest, participation and the profit
sharing agreement. And we'll talk about those in just a
minute. But let's go back to what the Supreme Court was
saying. And the Supreme Court looked at this and said, You
know what, let's put that aside, I think there should be a four
part test. And that four part test should look like this, that
any time that there is an investment of money in a common
enterprise, with the expectation of profit, which is based on the
third on the on the effort of others, that's an investment
contract, and that is a security by the Securities Act of 1933.
So was there an investment of money? Yes, there was an
investment of money in the land, because they didn't people who
bought this land didn't have a choice on how it would actually
be practical to service that land. Right. So they bought the
land. And they actually they bought it from Howie number two.
Was there a common enterprise? Absolutely. This was orange
farming.I mean, you know, these people were all coming together
in order to farm oranges to make money, which is number three,
the expectation of profit. Now if nobody goes and just buys a
strip of land in the middle of Florida without there being some
expectation of profit, because why would you buy a strip of
Orange Grove in the middle of nowhere, just say you own one,
right? You're expecting to make money. And number four, it's
based on the effort of others hear how he was doing all the
work, they were leasing it, and then they would do all the work
on the actual farming, and then they share in the profits. So
this was the core element of why it became why the way the
Supreme Court said Hunter, Howie, this is an investment
contract, how he you did wrong, the you this is a security. Now
let's go back to what to this note one more time. So when we
take a look at what you are working on, you have to ask
yourself, does it fit into those categories? So does it meet? Is
it an investment contract? Was there a contribution of money
and investment of money in a common enterprise for the with
the expectation of profit based on the work of another meaning
you the syndicator, probably is that person or the fund manager
is that are those elements there? Because there's other
things too, that also constitute a security such as notes, a
promissory note, as long as there's an investment going in
with the expectation, it may be a security. Now, not all notes
are securities, but the ones that I hear about all the time,
are securities, and that's where they get a bunch of people
together, they say, Hey, we're gonna borrow $5,000 or $5
million, in order to get our business off the ground, and
we're gonna raise it from friends and family. So that
doesn't qualify does it? We're just gonna pay them simple
interest, we just are taking loans from everybody. Well, the
only loans that are exempt from this are really loans from banks
alone from from other people is a security as long as it meets
those tests, as long as it's an investment of money. So I'm
giving you this money in order to for your business, within a
common enterprise, your business with the expectation, with the
expectation of profit, I'm expecting to get that money back
plus interest, and relying on the work of another meaning you
I'm expecting you to do your business so that you can afford
to pay me back. Right, that is a security. Likewise, this
participation in any profit sharing agreement, as long as
that profit sharing agreement is relying on the investor taking a
passive role. That is a security which must either be registered
with the SEC, or fall under an exemption like Regulation D. And
it doesn't matter whether it's written down or not. As I've
said in other videos, what matters is what's in the
investors head. Does the investor believe that they have
a passive role? Or do they actually have a passive role,
either one of those is fine to make it automatically US
security. So I hope that helps. This is the big test in all of
securities, the Howey Test, super famous, because it
outlines those four elements that are present in any
security. It's the it's the very clear rule, which helps us to
find it. Now, of course, there's been new case law, but the new
case law has just helped help let us know what the boundaries
are. Those are the still the main four pillars in any test to
see whether or not it is a security. My name is Tilden
Moschetti. I am a syndication securities attorney with the
Moschetti Syndication Law Group. Now if we can help you in your
offering and your security offering, please don't hesitate
to give us a call. We can go through whatever you're working
on and determine with you whether or not it's a security,
we can talk about whether it makes sense that it is or in
some cases it doesn't. Because sometimes I've had people call
me and at the end of the day, I don't think it's a security and
neither should they. So if we can be of help to you and in
doing that exploration, we'd be happy to do it.