Watch What You Promise Buyers. In October 2022, the U.S. Securities and Exchange Commission (“SEC”) filed a multi-count Federal lawsuit against a Florida real estate agent and his real estate companies. The SEC sought a permanent injunction against the Realtor from practicing real estate, disgorgement of all funds as ill-gotten gains, interest, and civil penalties, due to the real estate agent’s alleged violation of Sections §5(a) [Selling a Security without an approved prospectus], §5(c) [Selling unregistered securities], §17(a)(1) [Offering a security as an artifice/scheme to defraud], §17(a)(2) [Offering a security with untrue statements or omissions], §17(a)(3) [engage in fraud or deceit] of the Federal Securities Act, and §10(b) [use manipulative or deceptive devices], §10b-5(a) [employ device/scheme/defraud], §10b-5(c) [engage in fraud/deceit], §15(a)(1) [Failing to registered as a national securities broker] of the Federal Exchange Act.
What did the Realtor do? The SEC accused the realtor of giving investors: (1) Assurances their investments would be successful; (2) An “Attestation of Rent” guaranteeing investors a specified monthly rental income; (3) False promises how their funds would be used, to wit: to repair, renovate, and then lease properties, but the funds were not used for that purpose; (4) Marketing brochures with pictures, descriptions and addresses of the properties, amount of rent and taxes, the property management fee, and the amount of expected monthly profits; and(5)An opportunity to invest in an enterprise which would generate investment returns.
“Securities” include more than you think. So what’s wrong with promising a buyer a return on their investment? Well, you may be surprised to learn that although the term “Securities” is generally thought of as traditional investments like stocks and bonds; “securities” also includes the much broader and more encompassing term “Investment Contracts.” Both the SEC and the federal courts frequently use the “investment contract” analysis to determine whether business offerings or arrangements qualify as a “security,” which therefore would be under their jurisdiction and subject to federal securities laws. In fact, for well over half a century, “investment contracts” have been the critical vehicle used by the SEC to bring a host of investments into the traditional definition of a security.
Howey analysis of “Investment Contracts.” The U.S. Supreme Court’s Howey case and subsequent cases have found that an investment contract exists when: (1) a person invests money; (2) in a common enterprise; (3) with a reasonable expectation of profits; (4) to be derived from the efforts of others. The so-called “Howey test” applies to any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities. The focus of the Howey analysis is not only on the form and terms of the instrument itself but also on the circumstances surrounding the investment and the manner in which it is offered, sold, or resold. Therefore, persons and entities engaged in the marketing, offering, selling, reselling, or distribution of any investment will need to analyze the offering to determine whether the federal securities laws apply.
So what if what I am offering is a security? The SEC’s goal is to provide investors with enough information to allow investors to make informed investment decisions. Therefore, the federal securities laws require all offers and sales of securities, to either be registered under the SEC’s provisions or to qualify for an exemption from registration. The registration provisions are stringent, require persons to disclose certain information to investors, and which must be both complete and not materially misleading. Therefore, in hindsight, it probably would have been advisable for the Realtor to not have made such bold promises that the buyers/investors were guaranteed any type of investment return and should conduct their own due diligence.
DISCLAIMER: Topics discussed are general concepts, not intended to constitute legal advice, accuracy, nor completeness, and may not be relied upon as such; consult an attorney or accountant. The author Randy Gilbert, J.D. is neither an attorney nor an accountant. FTIC is a national award winning title insurance company known for its white glove customer service and “No Junk Fee Guarantee.”
Section 10(b) and of the Securities Exchange Act of 1934 (“Exchange Act”) [15 U.S.C. §78j(b)];
Rule 10b-5 thereunder [17 C.F.R. §240.10b-5];
Sections 5(a) and (c) of the Securities Act [15 U.S.C. §§77e(a) and 77e(c)]; and
Section 15(a)(1) of the Exchange Act [15 U.S.C. §78o(a)(1)].
 Whether a contract, scheme, or transaction is an investment contract is a matter of federal, not state, law and does not turn on whether there is a formal contract between parties. Rather, under the Howey test, “form [is] disregarded for substance and the emphasis [is] on economic reality.” Howey, 328 U.S. at 298. The Supreme Court has further explained that that the term security “embodies a flexible rather than a static principle” in order to meet the “variable schemes devised by those who seek the use of the money of others on the promise of profits.” Id. at 299.