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Although ordinary real estate investments usually are not securities under either Federal or state law, the facts of each case determine whether or not particular instruments are securities. That which we call a rose, by any other name would smell as sweet. The same principle applies when determining whether a real-estate transaction is a security: substance governs, not name or label or form. What matters is the economic reality of the transaction. So long as money is invested in a common enterprise with profits anticipated by virtue of others' work, there may be an investment contract.
Plaintiffs-Appellants, purchasers of condominiums in the Hard Rock Hotel San Diego, brought a putative class action against the Hotel's developer, operator, broker, and related entities. Plaintiffs alleged that the Purchase Contract they executed with 5th Rock, LLC not only sold them their condominiums but also obligated them to enter into the Rental Management Agreement with Tarsadia Hotels. Even though these contracts were executed with distinct entities eight to fifteen months apart, Plaintiffs allege that these contracts together form an investment contract because Plaintiffs have no control over their units and expect a profit only through the efforts of the Hotel developer and operator. Plaintiffs contended that the alleged investment contract did not comply with federal and state securities laws. The district court dismissed the second amended complaint, holding that the Plaintiffs had not alleged that the condominium units constituted a security. Alternatively, the district court held that the securities claims were time-barred and that the fraud claims were not pleaded with the particularity required by Federal Rule of Civil Procedure 9(b). Plaintiffs appealed.
Did the sale of the hotel condominiums and the subsequent Rental Management Agreement constitute the sale of a security?
The court held that the sale of condominiums, along with a subsequent rental management agreement, did not constitute the sale of a security for purposes of the condominium purchasers' securities fraud claims, as the purchasers did not allege facts showing that the purchase contracts and the rental management agreements were offered as a package. The "economic reality" of the transactions did not show that the sale and the rental management agreement were part and parcel of one scheme, and the purchasers did not claim that they were induced to buy the condominiums by the rental management agreement. Absent a sale of a security, the purchaser's common-law fraud claims failed, and in any event the fraud claims did not satisfy Fed. R. Civ. P. 9(b)'s particularity requirement.