Yurow on U.S. v. Leonard

Yurow on U.S. v. Leonard

 
In U.S. v. Leonard, 529 F.3d 83 (2d Cir. 2008), the Second Circuit considered whether an interest in a limited liability company was a security for purposes of the federal securities laws. The court's answer -- yes -- was based not on the corporate form or the terms of the parties' agreement, but rather on the reality of the parties' positions. In her commentary, Lois Yurow analyzes the court's opinion and offers guidance for practitioners.
 
Excerpt:
 
LLC "Investment Units"
 
Appellants were independent marketing agents retained to sell "investment units" in two limited liability companies "formed to finance the production and distribution of motion pictures." The appellants identified prospects and made cold calls to generate interest. If a potential investor wanted more information, the film promoter would send offering materials, including an operating agreement, a subscription agreement, and a risk disclosure statement. Interested investors returned their subscription agreements and their money directly to the promoter.
 
Compensation to Appellants for finding investors came in the form of commissions equal to either 42 percent or 45 percent of the price of each investment unit sold. These commissions were the basis for the charges against them. Specifically, each was convicted of securities fraud under the Securities Exchange Act of 1934, and conspiracy to commit securities fraud, because the offering documents did not adequately disclose their commission amounts. On appeal, the marketing agents argued that their conduct was not subject to the securities laws because the investment units were not "securities" under the Exchange Act.
 
The Definition of "Security"

The definition of the term "security" in Section 3 of the Exchange Act lists a few dozen instruments. The parties in Leonard agreed that, of all the enumerated possibilities, the only term that could possibly capture the investment units marketed by the appellants was "investment contract."