The test for materiality of an omission is whether a reasonable man would attach importance to the fact omitted in determining a course of action. It is well established that a materially misleading omission of past performance information occurs when a promoter makes optimistic statements about the prospects of the business but fails to include past performance information that would be useful to a reasonable investor in assessing those statements. Additionally, general cautionary language does not render omission of specific adverse historical facts immaterial.
The SEC brought this enforcement action against defendants Steven Wyer, Kurt Beasley, and Merchant Capital, LLC ("Merchant"), alleging violations of the registration and antifraud provisions of the federal securities laws. Wyer and Beasley, through Merchant, sold interests in twenty-eight registered limited liability partnerships ("RLLPs") to 485 persons. The SEC asserted that these interests were "investment contracts" within the meaning of the federal securities laws, and that the defendants had committed securities fraud in marketing the interests. The district court concluded that the interests were not investment contracts and, regardless, that the defendants had not committed securities fraud.
Are the RLLP interests "investment contracts" regulated by the federal securities laws?
The firm was the managing general partner for each RLLP, and invested partnership funds in fractional interests of debt pools purchased and owned by another company. The interests were investment contracts because the partners had no real ability to remove the firm and were completely inexperienced in the industry. The purported authority to approve purchases was illusory. Defendants violated the registration provisions of the securities laws. While the early circulars advised that there were no assurances that any amount of debt could actually be recovered, after June 2002, the unrebutted testimony showed that defendants knew their business model was not succeeding, the materials continued to paint a rosy picture, and defendants continued to sell interests without disclosing the lack of success or the specific reasons why the business was failing. And, failing to disclose one of the principal's bankruptcy was a material omission because they had touted his business experience. Failing to disclose a state cease and desist order against identical instruments was clearly relevant to a reasonable investor.