August 24, 2019

Tenth Circuit: Issue of Fact Existed Concerning Whether Investments Were “Investment Contracts” Under Securities Law

The Tenth Circuit Court of Appeals published its opinion in SEC v. Shields on Monday, February 24, 2014.

The Securities and Exchange Commission (“SEC”) brought this civil enforcement action against Defendant-Appellees Jeffory D. Shields, GeoDynamics, Inc. (“GeoDynamics”), and several other business entities affiliated with Mr. Shields, alleging securities fraud in connection with four oil and gas exploration and drilling ventures Mr. Shields, as managing partner of GeoDynamics, marketed to thousands of investors nationwide as Joint Venture Agreements (“JVAs”). The district court granted defendants’ Fed. R. Civ. P. 12(b)(6) motion to dismiss. The SEC appealed, contending that despite their labels as JVAs, the investment agreements were actually “investment contracts” and thus “securities” subject to federal securities regulations as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934 (collectively, the “Securities Acts”).

The central issue raised on appeal was whether the investments sold by Mr. Shields as managing partner of GeoDynamics were “investment contracts” and thus “securities” subject to federal securities regulations.

Congress painted with a broad brush in defining a “security.” Coverage of the antifraud provisions of the securities laws is not limited to instruments traded at securities exchanges and over-the-counter markets, but extends to uncommon and irregular instruments. Although the Securities Acts broadly define a security, neither act specifically defines an “investment contract.” The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

The parties confined their argument to whether the investment was premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The joint venture agreements here were denominated general partnerships, and the Tenth Circuit applies a strong presumption that an interest in a general partnership is not a security, mainly because the partners – the investors – are ordinarily granted significant control over the enterprise. But presumptions are not per se rules, and the court recognized that the presumption can be rebutted by evidence that the general partners were rendered passive investors because they were somehow precluded from exercising their powers of control and supervision. Access to information about the investment, and not managerial control, is the most significant factor in determining whether investors are in need of the protections of the securities acts.

The Tenth Circuit agreed with the SEC that the allegations in the complaint were clearly sufficient to rebut the presumption that the purported general partnerships were not securities, and raised a fact issue concerning whether investors were relying on the efforts of Mr. Shields and GeoDynamics to significantly affect the success or failure of the ventures. The allegations also raised a fact issue as to whether the investors actually had the type of control reserved under the agreements to obtain access to information necessary to protect, manage, and control their investments at the time they purchased their interests. The allegations were sufficient to defeat a motion to dismiss on the issue of whether the investors lacked meaningful control over their interests. They raised a plausible claim that the joint venture agreements, in substance as opposed to form, actually distributed powers similar to a limited partnership, which is usually held to be a security.

Because it could not be said as a matter of law that the investments at issue were not “investment contracts,” the Tenth Circuit REVERSED and REMANDED for further proceedings consistent with this opinion.

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