The story we're going to go through today goes to the heart of whether what you're working on right now is a security and something that needs to be registered with the SEC, or come under an exemption or be part of a blue sky law. Or if it's something else just to contract. Today, we're going to talk about the case of SEC versus how. As a syndication attorney and attorney that works on private equity funds, my favorite case of all time has to be SEC vs.
Howey. This is the fundamental case that talks about whether something is a security or is not. So I thought it would be helpful for you to go through that case, what happened and what that decision is. And then out of that, you can extract what you're working on and apply it and see, does this make sense? And does what I'm working on right now? Is that a security or not? So let's go through it. So, a long, long time ago, in the 1930s and early 1940s, there was a company named Howie, and
how he corporation did one thing and it did it very well. They would buy 500 acres of land. And out of that 500 acres of land, they would cut it up into strips but not all the way. So they would cut about half of it into strips, and then the other half they would they would leave for themselves. Now these strips had on them 48 orange trees. So there'll be these 48 or an orange trees. And what they would do is they would or they also owned a resort. Now I wish I could draw a resort, but my
drawing skills are not that good. So let's just pretend this looks exactly like a nice, beautiful resort with a big bay window. In this resort, guests would come from around the country, not only from Florida, but most of their guests would come from other states. So the guests would come and they would see pamphlets as part of the thing saying come visit the beautiful orange trees. These orange trees are just happened to be the ones located on these strips. So they'd come and visit
and then they would begin the sales pitch. The sales pitch when something like this Dear Mr. investor, you see how beautiful this place is we've got orange trees, and you know how much money we make from those orange trees, we make a lot of money. That's how we can afford to have a beautiful resort like the one you're staying in. Do you like your steak? Sure you do. Now as part of your stay, you also get to see this. But you know, we have a special right now that we
would like you to be part of our business. You see, we've got these, these orange trees that we've divided up into special slit special things. And as part of that we're offering to sell you have a beautiful piece of that tract of land that 48 trees you can buy. Now most of our people buy about five, five of these strips, but you could buy more, you can buy as many as you like. But right now we're selling these wonderful. And what you'll get is full title. We're not going to own anything
to do with this land. This is your land where you can make just as much money as we make selling oranges. Now I understand you're from out of state. But as the deal goes, we just so happened to be experts at farming oranges. As you can see, the orange trees are all in bloom, everything's going very nicely. So what we're willing to do is this is we will take a lease on your property. This is supposed to be a lease. We'll
take a lease on that property for 10 years. And as part of that lease, we're going to pay you money in because you own the land, right? And so we're going to pay you for the ticket to use your land but we're also going to pay you part of the profits. Does that sound like a good deal now what kind of returns you Talking about I'm sure you've seen many other hotels, on Facebook and things like that offering similar packages. Well, right now we're not offering a preferred return, but we are
offering an IRR of 20%. Sounds pretty good and slick how safe it is you own title to the land, all you need to do is buy the land. And we're going to enter into this contract in order to do the servicing of that land. So that's the sales pitch that these investors would hear. And they would get people to invest in this. And people would come from around state. And so as this became more and more successful for how they also decided that the resort was only doing so well, that maybe they
should also just send regular mail out. And so they'd send regular mail and they'd either invite them to the resort, or they'd invite them to this and they tell people about this great investment opportunity. Now that all sounds well and good, right? Sounds like a simple transaction. Well, the SEC didn't agree the SEC said, Hey, hold on a minute, you guys, Howie, you're this is a security what you're doing here. And that
as a security, it's just not going to work. You need to either registered, stir it or you need to come under some exemption. Now Rule five Reg D did not exist at this point. But there were other exemptions that were occasionally used. So how you need to get your act together? How we said no, this isn't a security at all. We don't need to do that. And so it went to court. And ultimately it found its way up to the Court of Appeals the Circuit Court of Appeals. So that's the second
level. So when federal court first and then I went up to the to the Court of Appeals, and the Court of Appeals looked at this closely, and they said you know what? We think how he's right. We don't think that this is a securities contract, that this is an investment contract. See the law is this. Let me drag this over. This is what a investment contract is. I may delete these an investment contract is a security are I mean, it's a security is something that is an investment
contract. But we don't think this is an investment contract. Why? Well, for two reasons. We don't think this is an investment contract, first of all, is that it's not speculative. The investors are buying the land. Right. So that's not speculative. They're getting that land. It's there's nothing speculative about it. And the second problem with it being a security is this, oops, can't see this under the picture. There we go. And the second problem being a security
is this is that the sale itself had value. So it was the sale of the land that how he was selling. And certainly the sales of land isn't a security. Right? Well, so this case went all the way up to the Supreme Court. And the Supreme Court took a look at it, and they saw where it said investment contract. And that's what that was really the question, what exactly is an
investment contract. Now also, as a side note, I put some other of the of what is a security here, just because I think it's interesting of promissory notes, stock, treasury stock bonds, certificates of interest, participation and the profit sharing agreement. And we'll talk about those in just a minute. But let's go back to what the Supreme Court was saying. And the Supreme Court looked at this and said, You know what, let's put that aside, I think there should be a four
part test. And that four part test should look like this, that any time that there is an investment of money in a common enterprise, with the expectation of profit, which is based on the third on the on the effort of others, that's an investment contract, and that is a security by the Securities Act of 1933. So was there an investment of money? Yes, there was an investment of money in the land, because they didn't people who bought this land didn't have a choice on how it would actually
be practical to service that land. Right. So they bought the land. And they actually they bought it from Howie number two. Was there a common enterprise? Absolutely. This was orange farming.I mean, you know, these people were all coming together in order to farm oranges to make money, which is number three,
the expectation of profit. Now if nobody goes and just buys a strip of land in the middle of Florida without there being some expectation of profit, because why would you buy a strip of Orange Grove in the middle of nowhere, just say you own one, right? You're expecting to make money. And number four, it's based on the effort of others hear how he was doing all the work, they were leasing it, and then they would do all the work
on the actual farming, and then they share in the profits. So this was the core element of why it became why the way the Supreme Court said Hunter, Howie, this is an investment contract, how he you did wrong, the you this is a security. Now let's go back to what to this note one more time. So when we take a look at what you are working on, you have to ask yourself, does it fit into those categories? So does it meet? Is
it an investment contract? Was there a contribution of money and investment of money in a common enterprise for the with the expectation of profit based on the work of another meaning you the syndicator, probably is that person or the fund manager is that are those elements there? Because there's other things too, that also constitute a security such as notes, a promissory note, as long as there's an investment going in
with the expectation, it may be a security. Now, not all notes are securities, but the ones that I hear about all the time, are securities, and that's where they get a bunch of people together, they say, Hey, we're gonna borrow $5,000 or $5 million, in order to get our business off the ground, and we're gonna raise it from friends and family. So that doesn't qualify does it? We're just gonna pay them simple
interest, we just are taking loans from everybody. Well, the only loans that are exempt from this are really loans from banks alone from from other people is a security as long as it meets
those tests, as long as it's an investment of money. So I'm giving you this money in order to for your business, within a common enterprise, your business with the expectation, with the expectation of profit, I'm expecting to get that money back plus interest, and relying on the work of another meaning you I'm expecting you to do your business so that you can afford
to pay me back. Right, that is a security. Likewise, this participation in any profit sharing agreement, as long as that profit sharing agreement is relying on the investor taking a passive role. That is a security which must either be registered with the SEC, or fall under an exemption like Regulation D. And it doesn't matter whether it's written down or not. As I've said in other videos, what matters is what's in the investors head. Does the investor believe that they have
a passive role? Or do they actually have a passive role, either one of those is fine to make it automatically US security. So I hope that helps. This is the big test in all of securities, the Howey Test, super famous, because it outlines those four elements that are present in any security. It's the it's the very clear rule, which helps us to find it. Now, of course, there's been new case law, but the new case law has just helped help let us know what the boundaries
are. Those are the still the main four pillars in any test to see whether or not it is a security. My name is Tilden Moschetti. I am a syndication securities attorney with the Moschetti Syndication Law Group. Now if we can help you in your offering and your security offering, please don't hesitate to give us a call. We can go through whatever you're working on and determine with you whether or not it's a security, we can talk about whether it makes sense that it is or in
some cases it doesn't. Because sometimes I've had people call me and at the end of the day, I don't think it's a security and neither should they. So if we can be of help to you and in doing that exploration, we'd be happy to do it.