[Editor’s Note: The following post is authored by Goodwin Procter LLP]
A California federal court recently declined to dismiss an SEC lawsuit over alleged fraud and securities registration violations in the sale of general partnership interests. In denying the Defendants’ motion to dismiss, the court held that the SEC had pled sufficient facts to establish that the general partnership interests at issue in the case were securities under federal securities laws.
In 2012, the SEC filed a complaint against Louis Schooler and First Financial Planning Corporation (the “Defendants”), alleging that the Defendants defrauded investors by offering and selling approximately $50 million worth of general partnership interests without disclosing material facts regarding the true value of the underlying land, the mortgages encumbering the properties, and the timing of the transfer of ownership of the underlying land from the Defendants to the general partnerships, and in so doing had violated Sections 5(a), 5(c), and 17(a)(1) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
The Defendants filed a motion to dismiss contending that the SEC failed to state a claim upon which relief can be granted because the interests offered and sold by the Defendants in the general partnerships were not securities. The court began its analysis with the Supreme Court’s holding in SEC v. W.J. Howey Co. that an interest is an investment contract, and thus a security, if it is “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. While noting the general presumption that general partnership interests are not securities, the court stated that the mere fact that an investment takes the form of a general partnership interest “does not inevitably insulate it from the reach of the federal securities laws. Articulating the test laid out by the Fifth Circuit decision in Williamson v. Tucker, the court noted that a general partnership is an investment contract if one of the following factors is present: (1) the general partnership agreement leaves so little in the hands of the partners that the arrangement in fact distributes power as would a limited partnership; (2) the partners are so inexperienced and unknowledgeable in the general partnership business affairs that they are incapable of intelligently exercising their partnership powers; or (3) the partners are so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that they cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.
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