In Shirley v. Jed Capital, LLC[1], the district court decided that an ownership interest in an LLC can qualify as an investment contract. This decision may signify that an increasing number of transactions will become reviewable under the Securities and Exchange Act of 1933.
In Jed Capital, Christopher Shirley filed a suit against Jed Capital, LLC and its manager, John Harada, alleging a violation of the Securities and Exchange Act of 1933. The plaintiff owned 20% of Jed Capital, LLC. The initial ten-percent interest in Jed Capital that the plaintiff received was a conversion of money Jed Capital owed him for work performed related to implementing automated securities trading at Jed Capital. The defendant convinced the plaintiff to invest an additional $250,000 sum in Jed in order to expand their automated trading capabilities to the London Exchange. In total, the plaintiff was a 20% owner and a member of Jed Capital, LLC, a manager-managed LLC. The plaintiff alleged that the defendant used the funds he invested to pay off debts including personal debts and those of other companies the defendant was involved in.
In moving to dismiss with respect to the federal securities fraud claim, the defendants argued that the plaintiff’s ownership interest was not an investment contract and therefore could not be afforded protection under the Securities and Exchange Act.[2] The defendants asserted that, due to the plaintiff’s involvement in the implementation and control of automated trading capabilities at Jed Capital, the plaintiff’s ownership interest did not constitute an investment contract in that the plaintiff’s profits did not come solely from the entrepreneurial or managerial efforts of others.[3]
The court found that the plaintiff’s ownership of Jed Capital was an investment contract, despite the plaintiff’s involvement in Jed Capital as both a member and employee. Because the plaintiff was a member of a manager-managed LLC and as such, could not bind the company nor exercise ultimate control over the company, the court decided that the plaintiff did not exercise the entrepreneurial or managerial efforts that would have excluded the plaintiff from protection under the Securities and Exchange Act. This liberal interpretation was warranted, the court found, because the Act was intended to protect investors and promote full disclosure of the risks involved in investment. Given the broad goals of the Act, the court found that generally, where an investor has no voting rights in the company they have invested in and they otherwise satisfy the conditions laid out in Howey[4], their investment will be found to constitute an Investment Contract under the Securities and Exchange Act of 1933.
Given this inclusive understanding of investment contracts, it is possible that investment arrangements not traditionally governed by the Securities and Exchange Act might now fall under its scope. We at Rock Fusco and Connelly structure investments, securities and the like every day and both litigate and act as advisors to help our clients navigate through these and other issues.
[1] Shirley v. Jed Capital, LLC, 724 F. Supp. 2d 904 (N.D. Ill. 2010)
[2] See 15 U.S.C.A § 77b(a)(1).
[3] An “Investment Contract” is (1) an investment of money (2) in a common enterprise (3) with profits to come solely from the entrepreneurial or managerial efforts of others. S.E.C. v. W.J. Howey Co., 66 S. Ct. 1100, 1104 (1946).
[4] Id.