General Partnership Interests May Be Subject to Securities Regulations

In United States Securities & Exchange Commission v. Schooler, 2018 S.O.S. 16-55167 (filed Sept. 26, 2018), the U.S. Court of Appeals for the Ninth Circuit concluded that general partnership interests a defendant sold were “investment contracts” and, thus, securities under federal securities laws.

For more than 30 years, Schooler bought land and then sold investors interests in general partnerships that owned the land. The U.S. Securities and Exchange Commission (“SEC”) sued Schooler and his company for a number of securities law violations and won on summary judgment. Schooler appealed.

The Ninth Circuit Court defined an “investment contract,” as “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” and noted that investment contracts can be present even where a scheme purports to give investors power or responsibility to advance the common enterprise. The Court focused on “whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.”

Consequently, the Appellate Court concluded that if the relevant facts fit within any one of the following three factors there is an investment contract:

1. 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; or
2. the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or
3. the partnership or venture 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.

Securities violations can carry huge penalties and consequences for your business. If you are involved in a general partnership where one partner essentially makes all the decisions, you might want to contact your legal counsel to discuss changing to a different type of business entity.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.