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S.E.C. v. Merchant Capital, LLC
06-10353, 2007 WL 983082, 11th Cir.(Ga.), 04/06/2007
Holding
In reversing in part and in vacating in part the judgment of the US District Court for the Northern District of Georgia, the Court of Appeals, Eleventh Circuit, held that interests in registered limited liability partnerships (RLLPs) are classified as “investment contracts” that fall within the purview of federal securities laws, and that defendants made statements and omissions, construed as materially misleading, in marketing these RLLP interests.
Detailed Summary
An enforcement action was initiated by the SEC against defendants on the ground that the latter committed violations of the registration and antifraud provisions of the federal securities laws. According to the SEC, defendants sold interests in twenty-eight registered limited liability partnerships (“RLLPs”) to 485 persons. These RLLPs were engaged in the business of debt purchasing. In marketing these interests, defendants informed potential partners that, while they would be expected to participate in the operation and management of their partnership, their actual duties would be limited to checking a box on ballots that would be periodically sent to them. Defendants’ offering materials also represented that the RLLP interests were not securities and that the federal securities laws did not apply to the interests. In seeking injunctive relief against defendants before the district court, the SEC alleged that these interests were “investment contracts” as defined under federal securities laws, and that the defendants had committed securities fraud in marketing those interests. In dismissing the suit, the district court found that the interests were not investment contracts and that the defendants had not committed securities fraud.
The appellate judge, in remanding the case, declared that an RLLP interest may be considered an investment contract within the meaning of federal securities laws if one of the following factors exist: whether an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership, whether the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers, and whether the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers. An investment contract 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.” It was found by the court that the RLLP partners were led to expect their profits solely from the efforts of defendant Merchant.
In this case, the SEC presented uncontroverted evidence that the individual partners had no experience in the debt purchasing business. They were members of the general public, and included a railroad retiree, a housewife, and a nurse. Their possible general business experience is not significant in this case. They were relying solely on defendant Merchant which was the sole Managing General Partner (MGP) of all the twenty eight RLLPs to operate the business, as evidenced by the fact that one-hundred percent of the partners chose Merchant as their MGP. In practice, the partners exercised little control over the operations of their partnerships. Merchant, as MGP, had sole authority to bind the partnerships and made the key business decisions. Defendants did not disclose the existence of the other partnerships or the relationship with a company formed by the defendants as a whole sale debt purchaser to the RLLP partners. It was shown that the partners had the powers of limited partners since they had no ability to remove the MGP, and the purported authority to approve purchases did not exist in reality. They were completely inexperienced in the business of debt purchasing, and even assuming they could really remove the MGP, they had no realistic alternative to the MGP as manager since their shares were in fractional form with a company whose only contractual relationship was with the MGP.
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