F ILED U.S. COURT O F APP EALS EL EV EN TH C IRC UIT A pril 4 , 2 007 T HOMA S K. KA HN CLERK

Honora ble Richard W. Goldber g , J udg e, United States Court of International Trade , * sitti ngby desig nation. [PUBLIS H] IN THE UN ITED STATES COURT OF APPEALS FO R T HE EL EV EN TH CIRC UI T

____ ____ ____ ____ ____ ____ N o. 06- 1035 3

____ ____ ____ ____ ____ ____ D. C. Docket N o. 02-02984 -CV -MH S-1 SECURITIES AND EXCHANGE COMMIS SION, Pl ai nti ff -Appe llant, ve rs us MER CHA

NT CA PIT AL , L LC , ST E V E N C. WY E R, a nd KURT V. BEASLEY , D ef en dants -Appe lle es .

____ ____ ____ ____ ____ ____ Appeal f rom the United State s District Court fo r the N orthe rnD istri ct

of G eo rg ia

____ ____ ____ ____ ____ ____ _ (A pr il 4, 200 7) Before AN DE RSO N and BARKET T, Circuit Judges, and GO LD BE RG, Judge. * AN DE RSO N, Circuit Judge:In stating the fac ts, we re ly on the district court’s f

indings of f

acts, e x cept to the e x tent 1 we f ind those fac ts, viewing the re cord a s a whole, to be clea rly err oneous. See infr a. 2 The S EC brought this enforcem ent action against defendants Steven W y er, K urt B ea sle y , a nd M er ch an t C ap ita l, L L C ( “ Me rc hant” ), a lle gin g vi olatio ns o f the re gis tr at iona nd anti fr au d pr ovi sio ns o f the f ed er al se curi tie s law s. Wy er a nd Beasley , through Merchant, sold in terests in twenty -eight registered lim ited lia bil ity partne rs hip s ( “ RL L Ps ”) to 485 pe rs ons. T he S E C a sse rt ed that the se interests wer e “ investm ent contracts” w ithin the m eaning of the federa l securities law s, a nd tha t the de fe ndants ha d c om m itt ed se curi tie s f

ra ud i n m ar ke tin g th e int er es ts. T he dis tr ic t c ourt c onc lud ed that the int er es ts w er e not inv es tm en t co nt ract s an d, re ga rd le ss , th atth e d efen da nt s h adno t co m m it te d s ecu rit ie s fr au d. W e re ve rs e in p ar

t, va cate in part , a nd r em an d f or f urthe r pr oc ee din gs. I. F ac ts 1

Wy er a nd B ea sle y

f orm ed Me rc hant i n or de r to p ar tic ipate in the bus ine ss o f buy ing, collecting, and reselling charged-off consum er debt fr om

financial ins tit uti ons suc h a s banks an d c re dit c ar d c om panie s. B ec au se thi s c as e de pe nds to a significant extent on th e nature of this indust ry , w e w ill set out it s charac teristics3

in s om e de ta il. When a consum er is delinquent on a cr edit account, the com pany that pr ovi de d th e ac co unt

be gin s by

tr y ing to co lle ct

the de bt i tse lf

. A ft er 180 day s, however, the com

pany norm ally sells the debt to a wholesale purchaser. Most sales of debt occur in large pools. Som e of these pools are sold at auction. O thers are sol d purs uant t o lo ng t er

m c ontra ct s w ithlarg e pur ch as er s, so- ca lle d “ fo rw ar d- fl ow co ntr ac ts. ” F or

w ar d- fl owc ontra ct s are a ttr ac tiv e to the se lle r be ca use the y pr ovi de a co nsi ste nt and r el ia

ble w ay to ge t r id o f de bt. T he y

a re a ttr ac tiv e to the wholesaler bec ause they

provide a reliable supply and also ty

pically guarantee that the a cc ount s are ar ep re se ntativ e sa m ple of the c om pany ’ s de bt p ool a nd tha t no ne of the de bto rs a re de ce as ed or bankr upt . A ft er auc tio n and f

or w ar d- fl owc ontra ct s di spos e of the larg e pool s, ac re dit card c om pany or bank m ay

ha ve sm al l am ount s of

de bt l ef t ov er . I t w ill ge ne ra lly se ll the r em ai nin g de bt i n sm al l po ols in w ha t are kno w n a s “ one -o ff ” sa le s. T he se sales m ay occur in parce ls as sm all as $25,000, and have none of the guarantees that are pr es en t i n th e lon g te rm f or w ar d- fl owc ontra ct s. Whil e som e w hol es al er s a tte m pt t o c oll ec t the de bt the m se lve s, m ost pur ch as e de bt and the n ou tso ur ce the c oll ec tio n of that de bt t o a tto rn ey s and co lle ct iona ge nc ie s. F or

the se w hol es al er s, the ke y bus ine ss d ec isi on i sA pool of debt sells at a steep discount to its face value, ty pically cents on the dollar , 2 beca use the a ccounts ther ein ar e still delinquent after 180 day s, and many

will never be collecte d. Th e on e s th at are c oll e c te d u su a lly re qu ir e so me e xpe nd iture of c os ts. Th e wh ole sa le r m us t asce rtain whe ther the pr ice of the pool will allow it to m ake a profit, g iven the fa ctors enumer ated a

bove. I f n o p ay me nt w a s e ve r m a de , th e a c c ount m ay be the re su lt o f f

ra ud or ide nti ty the ft . 3 4 de te rm ini ng the pr ic e at

w hic h th ey

a re w ill ing to buy

part ic ular pool s of

de bt f ro m the issuer. 2 A s e sta bli she d a t tri al , the appr opr ia te pr ic e fo r a pool of de bt d ep en ds o n th e m an y f ac tor s th at

de te rm ine howli ke ly

it is that the de bt i n th e pool w ill be collected. These f

actors include (1) w ho the iss uer is, (2) how har d the issu er trie s to c oll ec t the de bt b ef

or e se lli ng i t, ( 3) howthe iss ue r se le ct s th e ac co unt s it se lls fr om the ge ne ra l po ol o f de bto r ac co unt s, ( 4) w he the r the se le ct ionpr oduc es af ai r re pr es en ta tio n of

the iss ue r’ s ge ne ra l de bt p ro fi le , ( 5) the ge ogr ap hic dis tr ibu tio n of t h e a c c o u n t s , ( 6 ) t h e l aw s o f t h e s t a t e s w h e r e t h e a c c o u n t s a r e l o c a t e d , ( 7 ) t h e t e rms an d c ondi tio ns o f the part ic ular de bto r ac co unt s, ( 8) howold the a cc ount s are , ( 9) how rec ently

a pay m ent was m ade on an account, ( 10) how m any paym ents wer e m ade on an account, and (11) whether a paym ent was e ver m ade on an account at al l. Whol es al er s of

te n have pr opr ie tary

c om put er pr ogr am s th at

a ssi gn a w ei ght to 3 the vari ous fa ct or s, a sse ss the c hara ct er ist ic s of the part ic ular de bt p ool , a nd the re by e sti m at e howva lua

ble the poo l i s. T he w hol es al er m ak es it s pr of

it by5

buy ing poo ls tha t se em

pr of ita ble ; ou tso ur ci ng the c oll ec tio n f or ac er ta in p er iod

of tim e; and then reselling the debt o n the secondary m arket for

an even lower

price than it pa id f or the de bt. Wy er an d B eas le y

ha d n o p rio r ex pe rie nc e in th e d eb t p ur ch as in g i nd us try. Wy er w as form erly

a principal in a securities fir m . His m ost recent business wa s conductin g direct m arketing for financial institutio ns. Wy er had declar ed personal bankrupt cy

because that business d efaulted on certa in obl igation s that he had pe rs ona lly

guarante ed . B ea sle y

w as alaw y er

a nd C PAw hose pr ac tic e fo cu se d on banki ng, a sse t pr ote ct ion , a nd c or por at e re pr es en ta tio n. H e ha d pr ev iou sly don e legal work f

or Wy er. Wy er be cam e int er es te d inthe de bt p ur ch as ing bus ine ss thr ough conversations with a par

ticipant in th e industry , F red H owar d. H owar d was pr inc ipa l owne r of

N ewV isi on F inanc ia l ( “N ewV isi on” ), aw hol es al e de bt pur ch as er . Wy er

sou ght to en te r a busi ne ss whe re his pe rs ona l r el at ion shi ps w ith fi nanc ia l i nst itu tio ns w oul d be va lua ble , a nd thr oughdis cu ssi ons w ithH ow ar d, he be lie ve d de bt p ur ch as ing w as suc h abus ine ss. H ow ar d ha d pr ev iou sly r ai se d f unds by se lli ng RL L P int er es ts, but ha d a bandon ed that m ode l be ca

use anum

be r of state s w er e inv es tig at ing w he the r the RL L P int er es ts w er e se curi tie s un de r state law . H ow ar d pr ovi de d Wy er w ithbus ine ss m ode ls and l eg al opi nio ns o n th e status6

of the RL L P int er es ts unde r the se curi tie s law s. H e al so i nf orm ed Wy er a nd Be as le y of the e xis te nc e of

the state se curi tie s in ve sti ga tio ns. Wy er a nd B ea sle y

f orm ed Me rc hant, w ithWy er

ow nin g se ve nty -f

ive pe rc en t, a nd B ea sle y

tw en ty -f ive pe rc en t. Wy er

a nd B ea sle y

planne d to r ai se f

unds through Merc hant and then b uy fra ctional shares in debt po ols ult im ately purchased by Ne w V ision . Ne w V ision would aggregate m oney from Merc hant and oth er sources, purchase debt pools throu gh auction and forw ard-f low contracts, and then ou ts ou rce t he co ll ect io n o f th e d eb t t o En ha nc edAss etMan ag em en t (“ EAM”), a co lle ct ionc om

pany . T o f

orm al iz e thi s r el at ion shi p, Me rc hant e nte re d in to a se rv ic es c ontra ct

w ithN ewV isi on. Me rc hant b eg anr ai sin g m one y in N ove m

be r 2001 by

sol ic iti ng m em

be rs of the ge ne ra l pu

bli c to b ec om e partne rs in Co lor ad o R eg ist er ed L im ite d L ia

bil ity Partne rs hip s ( “ RL L Ps ”) . Me rc hant e m plo y ed ane tw ork of

r ec ru ite rs to se ll the RL LP interests, and provi ded the recr uiters with scripts. T hese rec ruiters inform ed pot en tia l partne rs that, w hil e the y w oul d be e xpe ct ed

to part ic ipate in the ope ratio n of the ir partne rs hip , the ir

a ct ua l du tie s w oul d be li m ite d to c he ck ing abox on ba llo ts tha t w oul d be pe ri odi ca lly se nt t o th em . Me rc hant’ s of fe ri ng m at er ia ls a lso represe nted that the RLL P interests w ere not securities and th at the feder al se curi tie s law s di d no t a

ppl y to the int er es ts.Merc hant had r epre sented to the I RA administrator that the intere sts were limit ed 4 pa rt ne rs hip int e re sts . I RAfu nd s ma y no t be se lf

-d ir e c te d into g e ne ra l pa

rt ne rs hip int e re sts . 7 E ac h R L L P w as to ha ve no m or e than 20 partne rs . Me rc hant e ve ntu al ly or ganiz ed tw en ty -e igh t R L L Ps , c ont ai nin g 48 5 partne rs , w ithatot al c ap ita liz at ion of over $26 m illion . The e ventual RLL P partners w ere all m em bers of the genera l publ ic w ithno d em onstrate d e xpe rt ise in the de bt p ur ch as ing bus ine ss, a nd inc lud ed anur se , ahou se w if

e, a nd a r ai lr oa d r et ir ee . E ac h partne r ha d ane t w orth of a t l ea st $ 250, 000, a nd m or e than se ve nty -f ive pe rc en t ha d a

ne t w orth e xc ee din g $500 ,000. F urther, ninety perce nt of the partners self-r eported busin ess experience be tw ee n “ av er ag e” a nd “ ex ce lle nt. ” T w o- thi rd s of the inv es tor s in ve ste d th ro ugh the ir I RAa cc ount s. 4 T he partne rs hip s w er e m ar ke te d and s old

a s f re es tandi ng e nti tie s. Me rc hant did no t disclos e the existence of the other partnerships o r the re lationsh ip with Ne w Vision to the RLL P partners. D espite the partnerships’ f orm al independence, Wy er testified at trial that Mer chant planned from the beginni ng to p ool th e m oney co lle ct ed f ro m the RL L Ps in or de r to p ur ch as e fr ac tio na l i nte re sts in de bt p ool s ow ne d by N ewV isi on. U nde r the partne rs hip a gr ee m en t pr ovi de d by Me rc hant, e ac h partne rs hip w as sc he dul ed

to part ic ipate in the de bt p ur ch as ing , c oll ec tio n, a nd r es al e busi ne ss8

for three y ears, at w hich poi nt it would be dis solved. The m anaging general partner (M G P) w oul d be the ope ratio na l he ad of the partne rs hip , w ithsol e au tho ri ty to bin d the partne rs hip . A t the e nd o f the thr ee y ears , the partne rs hip a sse ts w oul d be distribu ted to the partners and the MGP . The par tnership agreem ent also provid ed that partne rs c oul d e le ct

to re ce ive r et

ur ns o n c ap ita l e qua l t o 3. 6 pe rc en t of the ir co ntr ibu tio n pe r quart er

f or thr ee y ears , or

e lse a16. 5 pe rc en t annua l r et ur n on capital pay able at the end of the three y ears. T he MGP would collect fee s on each tr an sa ct ionin de bt. I n a ddi tio n, the MG P w oul d part ic ipate in an y pr of its ove r an d ab ove the 14. 4 or

16. 5 pe rc en t annua l r et

ur n. P ar tne rs w oul d r ec ei ve f

if ty pe rc en t of such profits, and the MGP would rece ive the other half. T he partne rs hip m at er ia ls t old the partne rs that the y

w er e ex pe ct ed

to ha ve ana ct ive r ole in m an ag ing the bus ine ss o f the ir partne rs hip . T he a gr ee m en t res erv edcert ai n p owe rs forth e p art ne rs . They ha d t he ab il it y to sel ectth e MGP. They had the exclusive right to approve any act obligating the partnership in an am ount exceeding $500 0. T hey could rem ove the MGP upon a unanim ous vo te, fo r ca use . F ina lly , the y

c oul d in spe ct

boo ks and r ec or ds and p ar tic ipate in vari ous co m m itt ee m ee tin gs. Me rc hant p re pare d a ll the partne rs hip m at er ia ls and w as the sol e busi ne ss contact for all of the partners. It w as the only candidate for MG P and w as nam edMe rc ha nt a lso su bmi tte d mo nth ly

state me nts to t

he pa rt ne rs ind ic atin gthe de bt p oo ls i n 5 wh ic h th e ir

pa rt ne rs hip s o wn e d s ha

re s. 9 on o ne -hundr ed

pe rc en t of

the ba llo ts. Me rc hant thus be cam e MG P fo r ea chof the tw en ty -e igh t R L L Ps . Inpr ac tic e, the partne rs e xe rc ise d li ttl e co ntr ol o ve r the ope ratio ns o f the ir partne rs hip s. Me rc hant, a s M G P, ha d so le auth or ity to bin d th e partne rs hip s and m ade the key

busin ess decisions , such as whether and when to purchase the shares in N ewV isi on d eb t po ols . Me rc hant s ubm itt ed ba llo ts t o th e partne rs , but tho se ba llo ts c ont ai ne d on ly

the na m e of

the iss ue r, the f

ac e va lue of

the poo l, a nd the pr ic e pe r dol lar of

de bt. Mo re ove r, unt il the S E C b eg anit s in ve sti ga tio n, the ba llo ts h ad

onl y asig na tur e lin e. I f a ba llo t w as not c as t, the partne rs hip a gr ee m en t pr ovi de d th at

it w as vot ed

in favor of m an ag em en t’ s pr opos al . I n a ddi tio n, Merchant f

requently disregarded the balloting process. The S EC ’ s expert survey ed the votin g records of five par tnerships, and his u nrebutted testim ony showed that Merchant purchased m ore debt than the partners authorized thirty tim es; purchased de bt b ef or e the ba llo ts h ad

be ense nt s ix t im es , a nd p ur ch as ed de bt b ef or e the 10- day r et ur n pe ri od h ad

e xpi re d se ve nty -thr ee ti m es . 5 Me rc hant a lso f

ai le d to ope rate the bus ine ss s uc ce ssf ull y . A s e ar ly

a s June 2002 , Me rchant and its principals kn ewthat the existing partnerships wer e10

perform ing po orly . The benchm ark for perform ance goals wa s the capital co nt rib ut io n o f eac h p art ne rs hi p p lu s t he 14 .4% o r 16 .5% el ect edreturn o n c ap it al . By Jun e 2002 , the partne rs hip s w er e pe rf orm ing a t 89 % of

be nc hm ar

k. B y nin e m onths, the partne rs hip s w er e at 77% ; a t f if te enm onths, 62% . S om e partne rs hip s we re doing far w orse. An e m ail revea led that the principals kn ewin June 20 02 that RL L P- 5 w as c oll ec tin g a t 55 % of be nc hm ar

k. Me rc hant n ev er

the le ss c ont inu ed

to se ll the partne rs hip s, w iththe sam e partne rs hip m at er ia ls, thr oughN ove m be r 2002 . D es pit e the poo r pe rf

orm an ce , no p ar

tne rs hip r ep la ce d M er ch an t duri ng the pe ri od b ef

or e the S E C b eg anit s in ve sti ga tio n. O ne barr ie r to re pla ce m en t w as the fact that the partnerships d id not own their ow n debt po ols. Rather , Me rchant had inv es te d partne rs hip f

unds in fr ac tio na l i nte re sts of de bt p ool s purc ha se d and ow ne d by N ewV isi on. A ft er the S E C’ s in ve sti ga tio n be gan, Me rc hant d ev ise d am ethod to m ak e it easier f or partnerships to repossess their debt pools . Together w ith EA M and Ne w V isi on, Me rc hant d ev el ope d apr oc es s, c al le d “ n- se le ct , ” by w hic h ashare in a fr ac tio na liz ed

de bt p ool c oul d be c onve rt ed int o w hol e de bto r ac co unt s. T he nselect process selecte d a random assortm ent of acc ount s that cam e as close as poss ible to the partnership’s share in the debt po ol. T he differ ence w as then re co nc ile d w ithc as h. N -s el ec t m ad e it the or et ic al ly pos sib le f

or apartne rs hip to11

rece ive an identifiable set of debtor accounts to app roxim ate its capital co ntr ibu tio n, a nd thus ope rate a s an in de pe nde nt b usi ne ss. RL LP -19 tookadvantage of the n-select proce ss to rem ove Merchant as MG P in Augus t 20 04, ne ar the e nd o f its thr ee -y ear lif e, a nd r ec ei ve d po sse ssi on o f its de bto r ac co unt s f

ro m Me rc hant. B y

that po int , the r el at ion shi p w ithN ewV isi on ha d e nde d. Me rc hant h ad r ep la ce d N ewV isi on w ithac om pany c al le d T ri log y Cap it al Man ag em en t i n J an ua ry 20 03 , and th en wit h M erch an t M an ag em en t, a co m pany ow ne d by

Me rc hant, in N ove m

be r 2003 . I n June 200 4, tw o m onths be fo re RL L P- 19 w ith dr ew , Me rc hant i nf orm ed the partne rs hip s th at

li qui da tio n was pre ferabl e to co nt in ui ng as a go in g c on cern . At th e ti m e RLLP-1 9 wi th dr ew, Me rc hant M an ag em en t w as in poss es sio n of the poo ls o f de bt.

II. Proce edings in the district court and scope of review

T he S E C b ro ught

thi s a ct ionon N ove m

be r 4, 200 2. Me rc hant c onse nte d to a te m po rary rest rai ni ng ord er t ha t p recl ud editfro m sel li ng fur th er RLLP i nt eres ts . Me rc hant h ad

a lr ea dy r ec ei ve d ac ea se a nd d es ist or de r fr om

the S ta te of

Ca lif or nia in O ct obe r 2002 , e nj oin ing the sa le of unr eg ist er ed

se curi tie s and p re cl udi ng i t from selling th e interests in that state.12

T he S E C a lle ge d vi olatio ns o f the r eg istratio n and anti fr au d pr ovi sio ns o f the fed eral sec ur it ie s l aws , and so ug ht in jun ct iv e rel ie f, di sg or ge m en t, an d p en al ti es . The district court conducted an evidentiary hearing on the SEC ’ s application for a prelim inary

injunction, and denied the application o n May 1, 2003. A fter m ore discovery , a

bench trial took pl ace in January 2005 . In Novem

ber 2005, the district co urt de nie d th e SE C’ s a

ppl ic at ionf

or inj unc tiv e re lie f, dis gor ge m en t, a nd c ivi l pe na lti es , a nd e nte re d j udgm en t i n f av or of the de fe ndants . I t c onc lud ed that the RLLP in te res ts were n ot in ve st m en t co nt ract s an d t he refo re n ot sec ur it ie s. Alter natively , the district court concluded that the defendants had no t com m itted se curi tie s f

ra ud. O n a ppe al , the S E C c ha lle nge s bo th o f the se de te rm inatio ns. T he m eanin g of “ inv es tm en t c ontra ct ” is a que sti on o f lawr ev ie w ed de nov o. S E C v . U nique Fin. C oncepts, Inc. , 196 F. 3d 11 95, 1198 (11t h Cir. 1999 ). W e re view f or clear er ro r the f ac tua l f ind ing s un de rl y ing the dis tr ic t c ourt’ s de te rm inatio n th at the RL L P int er es ts w er e not

inv es tm en t c ontra ct s. S ee Mi tc he ll v. H ill sbor ough Co u n t y, 46 8 F. 3 d1 2 7 6 , 1 2 8 2 (1 1 t h Ci r. 2 0 0 6 ). We al s o re v i ew t h e d i s t ri ct co u rt ’s fi ndi ngs on m at er ia lity

a nd s ci en te r (whic h un de rl ie the se curi tie s f ra ud de te rm inatio n) f

or c le ar e rr or . L uc as v. F la . P ow er & L igh t C o. , 765 F . 2d 1 039, 1040 -4 1 ( 11th C ir . 198 5) . Af ind ing w ill be he ld c le ar ly e rr one ous onl y

w he n “ the“Inv es tm en tco n tra ct ” h as th e s am e m ea n i n g un d er th e S ec uri t i es Ac tan d

th e E x ch an ge 6 Act. United HousingFound., Inc. v. F orman, 421 U.S. 837, 847 n.12, 95 S. Ct. 2051, 2058 n.12 (1975). 13 re vie w ing c ourt onthe e nti re e vid en ce is le ft w iththe de fi nit e an d f

irm c onvi ct ion that a m istake has been com m itted.” United States v. U .S . G y psum Co., 333 U.S . 364, 395, 68 S. C t. 525, 542 (1948).

III. St atus of R LLP in te res ts un de r th e fed eral sec ur it ie s l aws

T he ke y iss ue in thi s c as e is whe the r the RL L P int er es ts m ar ke te d by Me rc hant w er e “ inv es tm en t c ontra ct s” c ove re d by the f ed er al se curi tie s law s. B oth the S ec ur iti es A ct

a nd the E xc hange A ct

de fi ne “ se curi tie s” to inc lud e “ inv es tm en t c o n tr a c t s . ” 1 5 U . S . C . § § 7 7 b ( a ) ( 1 ) , 7 8 c ( a ) ( 1 0 ) . A n i n v e s t me n tc o n t r a c ti s “a co ntr ac t, tr an sa ct ion , or

sc he m e w he re by

ape rs on i nve sts his m one y in a co m m on enterprise and is led to expect profits solely from the eff orts of the prom oter or a thi rd party . ” S E C v . W . J. H ow ey Co . , 328 U . S. 293 , 298 -9 9, 66 S . Ct . 110 0, 110 3 (1946). T he issue in th is case is w hether the RL LP partners w ere led to expect

6 the ir pr of its sol el y f ro m the e ff orts o f Me rc hant. U nde r thi s pr ong of

H ow ey , “ sol el y ” is n ot i nte rp re te d r es tr ic tiv el y . “ T he Suprem e Court has repeatedly em phasized that econom ic rea lity is to gov ern overIn Bonne r v. City of Prichar d, 661 F.2d 1206, 1207 ( 11th Cir. 1981) (en ba nc), w e 7 adopted a s binding pre cede nt all decisions from the f ormer F ifth Circuit decided on or befor e September 30, 1981. 14 fo rm a nd tha t the de fi nit ion s of the vari ous ty

pe s of se curi tie s sh oul d no t hi nge on ex ac t and l ite ra l t es ts. ” W ill ia m son v. T uc ke r, 645 F . 2d 4 04, 418 ( 5thCi r. May 20, 1981 ). A n interest thus d oes not fall outs ide the definition of investm ent contract

7 m er el y be ca use the pur ch as er

ha s so m e nom ina l i nvol ve m en t w iththe ope ratio n of the bus ine ss. R athe r, “ the f oc us i s onthe de pe nde nc y of the inv es tor

on the e n t r e p r e n e u r i a l o r

man a g e r i a l s k i l l s o f

ap r o mo t e r

o r o t h e r p a rt y.” Go r d o n v . Te rry, 684 F.2d 736 , 741 (11th Cir. 1982). A gener al partnership interest is presum ed not to b e an investm ent contract be ca use age ne ra l partne r ty

pic al ly take s an a ct ive part

in m an ag ing the bus ine ss and therefore does notrely solely on the efforts of others. W illiam son, 645 F.2d at 4 2 2 . B u tc o n s i s t e n tw i t h t h e s ub s t a n c e o v e r f o rm p r i n c i p l e o f

H o w e y, “[ a ] s c h e me w hic h se lls inv es tm en ts t o in ex pe ri en ce d and unkno w le dge ab le m em be rs of the ge ne ra l pu

bli c cannot

e sc ap e the r ea chof

the se curi tie s law s m er el y by la be lin g it se lf a ge ne ral pa rtn ers hi p o r joi nt ve nt ur e.” Will ia m so n, 6 45 F.2d at 4 23 . A general partner ship in terest m ay qualify as an investm ent contract if the gener al pa rtn er i n fa ctret ai ns li tt le ab il it y to co nt ro l t he pro fit ab il it y of t he in ve st m en t. W illiam son recognized three situation s where this would be the case:15

(1 ) “ [A ] n a gr ee m en t am ong the part ie s le av es so l itt le pow er in the hands of

the partner or venturer

that the arrangem ent in fact distributes po we r as w oulda lim ited partne rs hip , ” id. a t 42 4; (2 ) “ [T ] he partne r or

ve nture r is s o in ex pe ri en ce d and unkno w le dge ab le in busi ne ss affa irs that he is incapable of intelligentl y exerc ising his partnership or ventu re pow er s, ” id. ; or (3 ) “ [T ] he partne r or

ve nture r is s o de pe nde nt o n so m e uni que e ntr ep re ne ur ia l or m anagerial ability

of the prom oter or m anager that he cannot replace the m anager of th e en te rp ris e o r ot he rwis e ex erci se m ean in gf ul pa rtn ers hi p o r ve nt ur e p owe rs ,” id. Under W illiam son, the presence of any one of these fac tors renders a gener al partne rs hip int er es t an in ve stm en t c ontra ct . I d. T he thr ee f ac tor s a lso a re not ex haust ive . I d. a t 42 4 n. 15. W ill ia m son is u lti m at el y sim ply agui de to de te rm ini ng whe the r the partne rs e xpe ct ed to de pe nd s ole ly

on the e ff

orts o f oth er s, thu s satis fy ing the H ow ey te st. T he S E C arg ue s th at

the de fe ndants sho uld

not r ec ei ve the be ne fi t of

the W il li am so n p res um

pt io n a ga in st in ve st m en t co nt ract st atus be cau se th e RLLP interests are m ore akin to lim ited partnership int erests, which ar e routinely treate d as in ve st m en t co nt ract s. See W il li am so n, 6 45 F.2d at 4 23 . It i s t ru e th atan RLLP16

be ar s so m e sim ilari ty

to a lim ite d partne rs hip . A n R L L P partne r is l ia ble onl y f or the a m ount

of his or he r ca pit al c ontri but ion , plu s th e partne r’ s pe rs ona l a ct s, a nd i s not e xpos ed to vic ar iou s li ab ili ty

f or the a ct s of

oth er partne rs or

the a ct s of

the partne rs hip a s aw hol e. S ee Co lo. Re v. S ta t. 7- 60- 115( 2) (a ), ( b) . T his li m itatio n on lia bil ity m eans tha t R L L P partne rs ha ve le ss o f aninc en tiv e to p re se rv e co ntr ol than ge ne ra l partne rs do. Whil e ge ne ra l partne rs nor m al ly w ishto pr es er

ve c ontro l be ca use the ir pe rs ona l a sse ts are a t r isk , RL L P partne rs ha ve onl y the ir inv es tm en t at risk if they

rem ain passive, and risk personal liabilit y only if they becom e active. On the other hand, it is not invariably true that partners in an RL LP , lim ited lia bil ity c om pany ( L L C) , or

li m ite d li ab ili ty

partne rs hip ( L L P) la ck

the abil ity

to co ntr ol the pr of

ita bil ity of the ir inv es tm en ts. T he pow er s of partne rs or

m em be rs in the se f orm s of bus ine ss c anbe a lte re d by a gr ee m en t, a nd m ay

a ssu m e virtua lly

a ny sha pe , de spi te the li m itatio n onli ab ili ty . A s th es e busi ne ss f orm s r ep re se nt a hy brid between gener al and lim ited partnerships, it is uns urprising th at courts, e ven in jurisdictions th at apply W illiam son to general partnership in terests, have reac hed m ixe d r es ult s c onc er

nin g w he the r the W ill ia m son pr es um pti on a ga ins t i nve stm en t co ntr ac t st at

us a ppl ie s to RL L P, L L P, a nd L L C i nte re sts . S ee , e . g. , Ro bin son v. G ly nn, 349 F . 3d 1 66, 174 ( 4thCi r. 200 3) ; S E C v . S hin er , 268 F . S upp. 2d 1 333, 1340 ( S. D . F la . 200 3) ; K ei th v . Bl ac k D ia m ond A dvi sor s, I nc . , 48 F . S upp. 2d 3 26,17

333 (S.D .N .Y . 1999). It is cl ear in this c ir cu it, how ev er , that an R L L P int er es t i s an in ve stm en t contract if one of the W illiam son factors is present. T hat is because the powers av ai labl e in an RLLP can no t ex ceed th e p owe rs av ai labl e in a ge ne ral pa rtn ers hi p. If a nythi ng, a n R L L P is s om ewha t m or e lik el y to be a n in ve stm en t c ontra ct be ca use of the inc en tiv e ag ai nst

e xe rc isi ng c ontro l tha t i s pr oduc ed by the li m ite d li ab ili ty shield. T herefor e, because the presence of one of the three W illiam son factors re nde rs e ve n age ne ra l partne rs hip int er es t an in ve stm en t c ontra ct , af ortio ri the pr es en ce o f on e su ch fact orwou ldren de r an RLLP in te res t an in ve st m en t co nt ract . Be ca use w e ne ed

not de ci de the ge ne ra l a

ppl ic ab ili ty

of the W ill ia m son pr es um pti on t o li m ite d li ab ili ty

int er es ts i f one of

the W ill ia m son fa ct or s is pr es en t, we begin byanaly zing tho se. Ina ddi tio n to de fi nin g th e co ndi tio ns unde r w hic h age ne ra l partne rs hip int er es t m ay

qua lif y a s an in ve stm en t c ontra ct , W ill ia m son al so d ef ine s th e sc ope of the inv es tm en t c ontra ct

a na ly sis . W e an al y ze the e xpe ct at ion s of c ontro l a t the tim e the int er es t i s so ld, r athe r than a t so m e la te r tim e af te r the e xpe ct at ion s of co ntr ol h av e de ve lop ed

or e vol ve d. W ill ia m son, 645 F . 2d at 42 4 n. 14. Apos t- sa le de le ga tio n c an not , f

or e xa m ple , c onve rt

age ne ra l partne rs hip int o an in ve stm en t contract, if the partner s had control at the begin ning . Id. As an e videnti ary m atter,18

how ev er , w e m ay

loo k a t ho wthe RL L Ps a ct ua lly ope rate d to a nsw er

the que sti on of howc ontro l w as a llo cate d a t the out se t. S ee A lbane se v. F la . N at ’ l B an k, 823 F. 2d 40 8, 412 (11th Cir. 1987) (lookin g to “ reality ” of partner s’ control over placem ent of ice m achines as evidence of am ount of control present at inception); Rivanna Tr aw lers U nltd. v. T hom pson Tr aw lers, Inc. , 840 F. 2d 23 6, 242 (4th Cir. 1988 ) (noting, as evidence of c ontrol at inceptio n, that the m anagers w ere in fact replace d on two later occa sions ). W ill ia m son al so d ef

ine s th e kin d of

e vid en ce that i s to be c onsi de re d in de te rm ini ng the e xpe ct at ion s of c ontro l. C onsi ste nt w ithH ow ey ’ s f oc us o n subs tanc e ove r fo rm , w e loo k a t a ll the r ep re se ntatio ns m ad e by the pr om ote r in m ar ke tin g th e int er es ts, not

j ust a t the le ga l a gr ee m en ts unde rl y ing the sa le of the int er es t. S E C v . C. M. Joi ne r L ea sin g C or p. , 320 U . S. 344 , 353 , 64 S . Ct . 120 , 124 (1943) (“ In the enforce m ent of an act such as this it is not inappropriate that prom oters’ offer ings b e j udged as bein g what they we re r epresented to be”); G or don, 684 F . 2d at 74 2 ( “ W ill ia m son re qui re s an e xa m inatio n of the re pr es en ta tio ns and p ro m ise s m ad e by pr om ote rs . . . to ind

uc e re lianc e uponthe ir en tre pr en eu ria l ab il it ie s” ); Ko ch v. Han ki ns , 92 8 F .2d14 71 , 14 78 (9t h C ir. 1 99 1) . T he ult im at e iss ue und er

H ow ey is w he the r the partne rs e xpe ct ed to re ly sol el y on the efforts of others, and w e m ay rely on the totalit y

of the circ um stances19

sur ro undi ng the of

fe ri ng i n m ak ing thi s de te rm inatio n. A . D id the a rr an ge m en t i n f ac t di str ibu te pow er

a s w oul d ali m ite d partne rs hip ? T he f ir st W ill ia m son fa ct or

r equir es us t o ana ly ze w he the r “ ana gr ee m en t am ong th e parties leaves so litt le power in the hands o f the partner or venturer that the arrangem ent in fact distributes po we r as w oulda lim ited partnership.” W illiam son, 645 F.2d at 424. In ar guin g that the partners did no t function as lim ited partners, Merchant r elies prim arily on the allegedly

subst antial powers re se rv ed to the partne rs thr oughthe partne rs hip a gr ee m en t. T he partne rs hip m at er ia ls i nf

orm ed partne rs that the y

w er e ex pe ct ed

to ta ke an a ct ive r ole in the busin ess, and the agreem ent gave partners ce rtain rights and po we rs. Partners had the abil ity

to ca ll m ee tin gs and h old r eg ular quart er ly

m ee tin gs; the abil ity

to part ic ipate in co m

m itt ee s; the abil ity

to el ec t the MG P; the abil ity to re m ove the MG P fo r ca

use upo n ac er

ta in v ote ; the abil ity

to ins pe ct

boo ks and r ec or ds; the ab ili ty to ap pr ove a ddi tio na l f

undi ng; the abil ity

to am en d th e ag re em en t or to dis sol ve the partne rs hip upo n atw o- thi rd s vo te ; and the e xc lus ive auth or ity to ap pr ove obl igatio ns e xc ee din g $5 000. Inthe f ir st p la ce , the pow er

to na m e the MG P w as not asig nif ic an t on e in this case. Partner s wer e re quired to turn in their ballots with their capital20

contributi on, before their partnerships had even been form ed. The pow er there fore reveals nothing about the partners’ ability to control the bu siness after their initial investm ent. Mor eover, Merc hant was the only optio n for MG P. T he investors h ad no i nde pe nde nt e xpe ri en ce in the de bt p ur ch as ing ind ustry a nd n o w ay

of kno w ing ab out a lte rn at ive MG Ps . A nd, a s ar es ult , Me rc hant w as na m ed on a ll ba llo ts. T his pow er w as not sig nif ic an t. The par tners also did no t have the practical a bilityto rem ove Merchant once it was i ns ta ll edas M GP. Firs t, t he ag reem en t p ro vi de d fo r rem ov al on ly for cau se . T his m eant tha t M er ch an t c oul d no t be r em ove d r ea dil y , a nd e ve n inthe c as e of gross incom

petence, the partners w ouldhave had to litig ate any unconsen ted re m ova l. W e ha ve pr ev iou sly f ound that w he re r em ova l i s on ly f or c au se , a nd the inv es tor s have no o the r ab ili ty to im pa ct m an ag em en t, the int er es t i s an in ve stm en t co ntr ac t a s am atte r of

law . A lbane se , 823 F . 2d at 41 1. H er e the re w er e furthe r barr ie rs to re m ovi ng M er ch an t. T he partne rs hip agreem ent required a unanim ous vo te of the partners. T he district court found th at Merchant could be rem oved som ew hat m ore ea sily , w ith a 2/3 vo te of the partners in an in div idu al partne rs hip . E ve n if atw o- thi rd s vo te w er e en ough , w e w oul d lik el y c onc lud e that r em ova l w as pr ac tic al ly im poss ibl e, w he n c om

bin ed w iththe other factors. But we find that the dist rict court clearly err ed. The written21

m at er ia ls are som ewha t am big uous : the partne rs hip a gr ee m en t se em s to say that a 2/3 vot e is e noug h, w hil e the partne rs hip a ppl ic at ionsay s th at

aunanim ous vot e is re qui re d. Wy er

a dm itt ed a t tri al , how ev er , that he tol d partne rs aunanim ous vot e is re qui re d. W ill ia m son m ak es c le ar that i ts t es t a

ppl ie s to the r ep re se ntatio ns m ad e by prom oters, not to the strict legal term s of the partnership agreem ent. S ee W ill ia m son, 645 F . 2d at 42 4 n. 14. T ha t a ppr oa chis ne ce ssary

be ca use the ult im at e te st unde r H ow ey

is w he the r a pe rs on “ is l ed to ex pe ct pr of its sol el y f ro m the ef fo rt s of the pr om ote r or

athi rd party . ” H ow ey , 328 U . S. a t 29 9, 66 S . Ct . a t 11 03 (e m p h as i s ad d ed ). Fo r t h e p u rp o s es o f Wi l l i amso n , t h en , we h o l dWy er ’s re pr es en ta tio n a ga ins t hi m and c onc lud e that a

unanim ous vot e w as r equir ed . A nd it is clear that such a vote, com bined with rem oval onl y

for ca use and the factors dis cu sse d be low , r en de re d M er ch an t e ff ec tiv el y unr em ova

ble . C f. G or don, 684 F. 2d at 74 1 ( in the a

bse nc e of oth er W ill ia m son fa ct or s, partne rs in standard j oin t ve nture w ho c ontro l by

m aj or ity vot e do n ot h old

inv es tm en t c ontra ct s) ; H old env. Ha gopi an, 978 F. 2d 11 15, 1120 (9th Cir. 1989 ) (no investm ent contract w here m anager could be rem oved with sim ple m aj ority

vote). Com poun ding the legal difficulty in rem ovin g Merchant, the investors in an ind ivi dua l partne rs hip w er e ge ogr ap hic al ly dis pe rs ed , w ithno p re ex ist ing relationship s. H owey

found it si gnificant that the interests in th at case we re off eredFor these same rea sons, the power to amend or dissolve the pa rtnership a g ree ment was 8 a lso ill us or

y . Su c h a mov e wo uld

have re qu ir e d a

tw o- thi rd s v ote of

g e og ra ph ic a lly dis tant, unacqua inted partne rs. This power there fore did not cure the lack of other powe rs. No amendments we re e ver ma de, and no pa rtnerships we re e ver dissolved. 22 “ to persons who reside in dis tant localities.” H owey , 328 U. S. at 299, 66 S. Ct. at 1103 . Sim ilarly , in this case, the lack of fa ce-to-f ace c ontact am ong th e partners ex ac er ba te d th e oth er

dif fi cu lti es a nd r en de re d th e supp ose d po w er to re m ove M e r c h a n ti l l u s o ry. 8 T he dis tr ic t c ourt, in fi ndi ng tha t the partne rs in anind ivi dua l partne rs hip co uld r em ove Me rc hant, r el ie d inpart on the f ac t tha t R L L P- 19 d id s uc ce ed in re m ovi ng M er ch an t a s M G P. T ha t e ve nt d oe s no t sh ak e our c onf ide nc e that, a t the tim e of the or igi na l i nve stm en t, the partne rs did not ha ve the pr ac tic al abil ity to re m ove Me rc hant. B y

the ti m e RL L P- 19 r ep la ce d M er ch an t, Me rc hant h ad no int er es t i n op posi ng r em ova l. I t ha d a lr ea dy r ec om m en de d li qui da tio n of

the RL L Ps , w hic h m eant tha t the re w oul d be no m or e de bt transa ct ion s and thus no furthe r fe es f

or Me rc hant. Me rc hant a lso a t tha t t im e ha d an a ct ive int er es t i n en co u ra g i n g re m o v al ; t h e S EC i n v es t i g at i o n wa s i n p ro g re s s , a n dMe rc h an t ’s de fe nse hin ge d up on s how ing that the partne rs w er e in c ontro l. T he r em ova l of Me rc hant at tha t st ag e the re fo re sho w s no thi ng a bout w he the r partne rs c oul d have overcom e the cause, unanim ity , and dis persion barriers and re m oved Merchant asTo the extent the district court found to the c ontrary , this was clea r er ror. 9 23 m anager of a

viable goin g concern. W e conclude that the partners in fact la cked the pow er to re m ove Me rc hant. T he ne xt p ow er

r es er ve d to the partne rs w as the abil ity to ap pr ove a ll obl igatio ns o ve r $500 0. I f thi s po w er w as r ea l, it

w as asub stanti al one . T he pr im ar y bus ine ss o f ea chpartne rs hip w as pur ch as ing f ra ct ion al iz ed

int er es ts i n pool s of de bt tha t ge ne ra lly

e xc ee de d $5 000 in v al ue . H ow ev er , a s sh ow n by Merchant’ s tenure as MG P, the ballot right also did no t give the partners m eanin gf ul c ontro l ov er

the ir inv es tm en t. Fi rs t, Me rc hant c ontro lle d ho wm uc h in fo rm at ionappe ar ed in the ba llo ts, an d di d no t su

bm it suf fi ci en t i nf orm at ionf

or the partne rs to be able to m ak e m eanin gf ul d ec isi ons to a

ppr ove or dis ap pr ove de bt p ur ch as es . E ac h ba llo t 9 ind ic at ed onl y the f ac e va lue of

the de bt p ool , the pr ic e pe r dol lar of de bt, a nd the na m e of the iss ue r. T his inf

orm at iona t m ost

gave the partne r the pr ic e of the poo l and the nam e of the issuer. But unrebutted testim ony at trial e stablish ed that m uch m or e da tais ne ce ssary

to m ak e aninf

orm ed de ci sio n a

bout howm uc h ade bt p ool is really worth. T he SE C’ s expert testified that m any fac tors go in to the price that shou ld b e pa id f

or ade bt p ool , in ad dit ionto the na m e of the iss ue r: the r ep utatio n of the iss ue r, howthe a cc ount s w er e se le ct ed f ro m the iss ue r’ s po ol, the ge ogr ap hic24

dis tr ibu tio n, the te rm s of

the c ar dhol de r ag re em en ts, howold the de bt i s, w he n th e la st pa ym en t was , and whet he r a p aym en t was ev er m ad e, am on g m an y ot he rs . A fo rm er a sso ci at e of

Wy er ’ s, Mi tc h B oni lla , w ho a lso ope rate s ade bt p ur ch as ing com pany , te stified to the sam e ef fect. Finally , the def

endants’ ow n witness, F red How ard, testified that when he buy s debt, he considers the last paym ent date, when the c re dit c ar d w as iss ue d, the his tor y of the a cc ount , a nd the loc at ionof the ac co unt . T h e o n l y t e s t i mo n y s up p o rt i n g t h e s u f f i c i e n c y o f t h e b a l l o ti n f

o rma t i o n c a me fr om Wy er , w ho t es tif

ie d th at the inf orm at ionc ont ai ne d inthe ba llo ts w as e noug h to allow a partner to m ake an inform ed decision. But Wy er, besides being an in te res te d wi tn es s, was no t an au th or it y on th e d eb t p ur ch as in g b us in es s. He adm itted that NewVision had sole respons ibilityfor purchasing debt po ols. N ew Vis io n o nl y

pa ss edon th e n am e o f th e is su er an d t he pri ce o f th e p oo l t o M erch an t. Wy er the re fo re ha d li m ite d e xpe ri en ce in pur ch as ing de bt p ool s, a nd h is t es tim ony doe s no t c al l i nto que sti on the c onvi nc ing te sti m ony of the ind ustry part ic ipants , inc lud ing that of

H ow ar d, he ad

of N ewV isi on. Wy er ’ s te sti m ony is al so co ntr ad ic te d by

the partne rs hip appl ic at ionit se lf . I n an in fo rm at ion al se ct ion , the application in form ed partners that “ [a] m ong th e m any criter ia that m ay

be analy zed be fo re apoo l of

de bt i s purc ha se d are the f oll ow ing : the num

be r of ti m es the de btMoreove r, the fa ct that Merc hant did not possess any information about the 10 char acte ristics of the debt pools shows that the pa rtners’ ability

to inspect books and re cords c ou ld n ot c ur e the la c k o f m e anin g fu l in fo rm atio n in the ba llo ts. Th e monthl y state me nts Me rc ha nt s e nt t o th e pa

rt ne rs a lso did

no t c ur e the la c k o f i nf

or matio n. Th e se state me nts me re ly showed what debt pools the partner ships alrea dy had intere sts in, and thus came too late to have a meaning ful impact on the ba llot decision. 25 has been placed, the state of residency of the custom er, and when the debt wa s i n cu rr ed . Th es e f

ac t o rs an do t h er s s h o u l db e t ak en i n t o ac co u n ti n t h e R LLP ’s an al y sis of

the pot en tia l f

uture r ec ove ry

of ade bt p ortf

oli o. ” T he ba llo ts s en t t o partners contained none of this inform ation, and therefore did no t perm it partners to m ak e aninf

orm ed de ci sio n a

bout de bt p ur ch as es . T he de fe ndants ne ve rthe le ss arg ue ( an d th e dis tr ic t c ourt f ound ) that the ba llo t gave partne rs c ontro l ov er the bus ine ss b ec au se Me rc hant p as se d ona ll the inf orm at ionit

r ec ei ve d to the partne rs . T ha t do es not , how ev er , e sta bli sh tha t the ba llo t pr oc es s w as m eanin gf ul. I t m ay

ha ve m ad e busi ne ss s en se f or Me rc hant t o outso urce the debt purchase decisions to NewVision. N ewVision certainly had m or e ex pe rie nc e in th e b us in es s t ha n a ny of Me rch an t’s p rin ci pa ls or a ny RLLP partne rs did . B ut M er ch an t, ha vin g de le ga te d th e pow er to m ak e de bt b uy ing decisions , c annot claim

that the partners also possessedthat power. Bec ause Ne w V isi on w as in poss es sio n of a ll the r el ev an t i nf

orm at ionf

or m ak ing de bt b uy ing de ci sio ns, it

a nd n ot the partne rs w as r es pons ibl e fo r de ci din g w ha t de bt t o pur ch as e. T he partne rs ha d no inf orm at ionw ithw hic h to m ak e a m eanin gf ul 1026

de ci sio n. Se co nd, be sid es the f

ac t tha t the ba llo ts w er e co m ple te ly de voi d of m eanin gf ul i nf orm at ion , the partne rs ha d no w ay to fo rc e Me rc hant t o he ed the re sul ts o f the pr oc es s. T he S E C’ s e xpe rt te sti fi ed , ba se d onasam ple of ba llo tin g da ta forfiv e p art ne rs hi ps , th atMerc ha nt rep eat ed ly abu se d t he ba ll ot in g p ro ces s. Merchant purchased m ore debt than the ballots authorized thirty tim es; purchased debt before ballots wer e sent six tim es; and purchased before the ten-day return pe ri od e xpi re d se ve nty -thr ee ti m es . I n part be ca use the partne rs ha d no abil ity to re m ove Me rc hant, the y

a lso la ck ed

the pow er

to fo rc e Me rc hant t o a

bid e by the re sul ts o f the ba llo ts. Fi na ll y , th e v ot in g p ro ces s was ti lt edin Merc ha nt ’s fav orfro m th e v ery st art . The par tnership agreem ent providedthat unreturned and un voted ballo ts wer e voted in favor of m anagem ent. Until October 2002, the ballots had o nly a signature lin e, a nd n o “ no” box . E ve n a ft er that, the ba llo ts a lw ay s c ont ai ne d in suf fi ci en t inf orm at ionf

or inv es tor s to m ak e inf

orm ed de ci sio ns. T he le ve rs of the vot ing pr oc es s w er e thu s inMe rc hant’ s hands fr om the ve ry be gin nin g. I t ha d c ontro l ove r the inf

orm at ionin the ba llo ts, did not ha ve a ny inc en tiv e to h ee d th e re sul ts o f ba llo ts, a nd w as a ssure d of vic tor y in an y ba llo tin g any

w ay be ca use of the de fa ult ru l es . Un s u rp ri s i n g l y, no b al l o tev erwe n tag ai n s tMe rc h an t ’s d ec i s i o n s . We27

therefore conclude that the vot ing process was a sham and did no t give partners m eanin gf ul c ontro l ov er

the ir inv es tm en t. Me rc hant i nsi sts that w e ar e re str ic te d to the te rm s of the partne rs hip ag re em en t i n a

ppl y ing the f

ir st W ill ia m son fa ct or , a nd arg ue s th at be ca use the ap pr ova l auth or ity

w as inc lud ed

in the te rm s, the dis tr ic t c ourt ha d no c hoi ce but to co nc lud e that i t w as m eanin gf ul. Me rc hant r el ie s onRi vannaT raw le rs U nlt d. v. Thom pson Tr aw lers, Inc. , 840 F. 2d 23 6 (4th Cir. 1988). That c ase followed W illiam son in concludin g that the relevant scope of the investm ent contract an al y sis is the e xpe ct at iona t the ti m e of the a gr ee m en t, r athe r than po st- inv es tm en t de ve lop m en ts tha t m ay

c onst itu te ala te r de le ga tio n of pow er . S ee id. a t 24 0- 41 (“ the m ere choice by

a partner to rem ain passive is no t sufficient to create a se curi ty int er es t” ). Me rc hant arg ue s th at the w ay the ba llo t pr oc es s turn ed out in pr ac tic e is n o in dic at ionof howm uc h po w er

the partne rs r et ai ne d a t the inc ep tio n: the partne rs m igh t si m

ply ha ve de ci de d th at

Me rc hant w as doi ng a

goo d j ob, a nd ha d no de sir e to r ec tif

y the pr obl em s w iththe ba llo tin g. Ouran al y si s i s, h owe ve r, fu ll y co ns is te nt wit h Wil li am so n. It is tru e th atwe ar e lim ite d to a sse ssi ng the e xpe ct at ion s of c ontro l a t the inc ep tio n of the i n v e s t me n t . Wi l l i a ms o n , 6 4 5 F . 2 da t4 2 4 n . 1 4 . B u tw e a r e n o tl i mi t e dt o t h e t e rms of the partne rs hip a gr ee m en t i n a sse ssi ng those e xpe ct at ion s of c ontro l. P ost -28

investm ent events can serve as e vidence of how m uch power partners reser

ved at t h e i n c e p t i o n . S e e Al b a n e s e , 8 2 3 F . 2 da t4 1 2 ( 1 1 t h C i r . 1 9 8 7 ) ( l o o k i n g t o “ r e a l i t y” of partne rs ’ c ontro l ov er

pla ce m en t of

ic e m ac hin es a s e vid en ce of a m ount of co ntr ol p re se nt at i nc ep tio n) ; R ivannaT raw le rs , 840 F . 2d at 24 2 ( usi ng a ct ua l po stin ve st m en t re pl acement o f m an ag ers as e vi de nc e o f de gr ee o f co nt ro l at in cep ti on ). It is difficult to im agine how a court could determ ine how m uch power the partners

“ in f ac t” r et ai ne d un de r the a gr ee m en t w ith out loo kin g to som e ex te nt at po stinv es tm en t e ve nts . Af

oc us o n th e bare te rm s of the le ga l a gr ee m en t w oul d a lso be inconsi stent with the subs tance over f orm principle of How ey , and would be an invit ation to artful m anipulatio n of busin ess form s to avoid investm ent contract status . S ee W ill ia m son, 645 F . 2d at 41 8. H er e, the ope ratio n of

the ba llo tin g pr oc es s r ev ea le d th at the partne rs f

ro m the ve ry be gin nin g la ck ed

pow er to co ntr ol M er ch an t’ s a ct ion s. T he ba llo tin g process wa s a sham

because the partner ship agreem ent contained no way to force Merchant to conduct a m eaningful ballo t. T he agreem ent did no t require a part ic ular fo rm

of ba llo t, w hic h m eant tha t M er ch an t c oul d c ontro l the inf orm at ion partne rs r ec ei ve d. A nd the partne rs ha d no oth er inf lue nc e ove r Me rc hant b ec au se the y la ck ed apr ac tic al r em ova l po w er . T he y the re fo re c oul d no t f

or ce Me rc hant t o giv e the m am eanin gf

ul am ount

of inf orm at ionor

to re spe ct

the r es ult s of

the29

ba llo ts. R ivannaT raw le rs pr es en te d an e nti re ly dif fe re nt c as e. I t de al t w itha sim ple j oin t ve nture a rr an ge m en t r ule d by m aj or ity vot e w he re , “ [s ] ign if

ic an tly , on tw o se parate oc ca sio ns the e xte rn al m an ag er s w er e re pla ce d” a nd o n on e oc ca sio n

“ one of the pr om ote rs . . . w as r em ove d a s m an ag ing partne r. . . a nd r ep la ce d w itha m an ag em en t c om

m itt ee of partne rs . ” Ri vannaT raw le rs , 840 F . 2d at 24 2. T he general partner s in that case alw ay s had the power to rem ove the m anager, had subs tanti al c ontro l ov er

the bus ine ss, a nd m ad e a de ci sio n to te m por ar ily de le ga te som e dut ie s to am an ag er . H er e the RL L P partne rs la ck ed the abil ity

to re m ove or co nt ro l t he m an ag er fro m th e in cep ti on of t he en te rp ris e. Nor d idth e RLLP partne rs e ve r ex pe ct

to ta ke a n a ct ive r ole in m an ag ing the bus ine ss, a s th e re cr uit er s r ep re se nte d th at

the partne rs ’ dut ie s w oul d be li m ite d to c he ck ing abox o n t h e b a l l o t s t h a tw e r e p e r i o d i c a l l y s e n tt o t h e m. T he r em ai nin g po w er s–the abil ity to ins pe ct

boo ks and r ec or ds, part ic ipate in com m ittees, and ho ld m eetings–d id not on their own give the partners the potential to c ontro l M er ch an t’ s m an ag em en t of the bus ine ss, a nd thus do n ot c ontri but e to the W ill ia m son an al y sis . W e ha ve pr ev iou sly he ld tha t “ the opp ortun ity to ins pe ct .

. . r ec or ds” a nd an “ obl igat[ ion ] to giv e pe ri odi c ac co unt ing s” of inc om e an d ex pe nse s di d no t be ar

on an in ve sto r’ s a

bil ity to co ntr ol the pr of

ita bil ity of the inv es tm en t, a nd w er e the re fo re ir re le vant f ro m the pe rs pe ct ive of

inv es tm en t30

co ntr ac t ana ly sis . A lbane se , 823 F . 2d at 41 1 n. 4. H er e, the ins pe ct iona nd m ee tin g rights m ight h ave helped the partners m ake m ore inform ed decisions, if the partners al so h ad the abil ity

to ef fe ct ua te tho se de ci sio ns. B ut b ec au se the appoi ntm en t, ap pr ova l, a nd r em ova l po w er s w er e ill usor y , the se oth er

pow er s ha d no independ ent salience. T he li m ite d e xte nt o f the partne rs ’ pow er s m ak es thi s c as e sim ilar to Albanese v. Fla. Nat’ l Bank, 823 F. 2d 40 8 (11th Cir. 1987). T here the prom oter sold ice m achines and service contracts to individ ual investo rs. Id. at 411. E ven thou gh som e of the contrac ts allowed the investors to sp ecify the location of the ice m achine or re fuse to consent to the ice m achine being m oved, w e concluded that the ins tr um en ts w er e inv es tm en t c ontra ct s. I d. a t 41 2. W e fo und that the abil ity to af fe ct the pla ce m en t of

the ic e m ac hin es w as too ins ubst an tia l t o pr ec lud e inv es tm en t c ontra ct

status be ca

use the inv es tor s st ill de pe nde d onthe pr om ote r fo r m ost of the c ru ci al bus ine ss t as ks, inc lud ing “ fi ndi ng the loc at ion s, c ontra ct ing w iththe hot el s and o the r ins tit uti ons, se rv ic ing the m ac hin es , a nd a cc ount ing f or the pr of its . ” I d. I n th e ca se of

the RL L Ps , the partne rs ’ c ontro l w as e ve n le ss subs tanti al . T he re w as no ana log ue to the A lbane se partne rs ’ li m ite d a bil ity to control the location of the ice m achines. Me rchant reta ined respons ibilityfor ever y busi ne ss d ec isi on o f co nse que nc e; c oul d no t be r em ove d; and w as not sub j ec t t oWe a lso fi nd it s ig nif ic ant o n th is s c or e that Me rc ha nt r e pr e se nte d to I RA 11 a dmi nis tr ator s th at th e RL L P in te re sts we re lim ite d p art ne rs hip int e re sts . 31 an y oth er f orm of c ontro l by

the partne rs . InA lbane se , it

w as a lso e as ie r to r em ove the m an ag er than it w as in thi s ca se . T houg h r em ova l w as onl y f or c au se , the se rv ic e co ntr ac t w as be tw ee n a sin gle inv es tor

a nd the pr om ote r. S ee id. a t 41 2. I n a ddi tio n to the c au se req ui rem en t, t he RLLP pa rtn ers als o fa cedth e d is pe rs io n a nd un an im it y ba rri ers . Be ca use the RL L P partne rs c oul d no t r em ove or oth er w ise c ontro l M er ch an t, the ar range m en t i n f

ac t di str ibu te d po w er

a s w oul d ali m ite d partne rs hip , a nd the f ir st W ill ia m son fa ct or

w as sa tis fi ed . 11

B. W er e the RL L P part

ne rs so i ne xpe ri en ce d and unkno w le dge ab le in busi ne ss affa irs that they

we re incapable of intellig ently exerc ising partnership or venture pow er s? T he se co nd W ill ia m son fa ct or a sks w he the r “ the partne r or ve nture r is s o ine xpe ri en ce d and unkno w le dge ab le in busi ne ss a ff ai rs that he is inc ap ab le of int el lig en tly

e xe rc isi ng h is p ar

tne rs hip or

ve nture pow er s. ” W ill ia m son, 645 F . 2d at 424 . I f the partne r is i ne xpe ri en ce d in“ busi ne ss a ff ai rs , ” w e w ill f

ind a re la tio nshi p of

de pe nde nc y

on the pr om ote r supp ortin g af ind ing of inv es tm en t co ntr ac t, e ve n if

the partne r poss es se s so m e pow er s un de r the a rr an ge m en t.I t mi g ht b e argue d in any e ve nt t hat g e ne ra l bu sin e ss e xpe ri e nc e is m or e e a sil y 12 transfe rre d to a re al estate venture , beca use re al estate transac tions are c ommon feature s of many businesses. Howe ver, w e nee d not addre ss that issue in this case ; it is clea r her e that g ener al bu sin e ss e xpe ri e nc e do e s n ot h ave any signif ic ant o ve rl a

p w iththe de bt p ur c ha sin gbu sin e ss. 32 The district court er

roneouslyapplied this fac tor by looki ng to th e general busi ne ss e xpe ri en ce of

the partne rs . H ow ey

it se lf f oc use d onthe e xpe ri en ce of investo rs in the particular business, not their general business experience. In fi ndi ng tha t the or an ge gr ove plu s se rv ic e co ntr ac t w as a n in ve stm en t c ontra ct , the Co urt sa id, “ [the inv es tor s] a re pr ed om inantl y bus ine ss and p ro fe ssi ona l pe opl e w ho l ac k th e know le dge , ski ll an d e qui pm en t ne ce ssary f or the c ar e an d c ult ivatio n of citrus trees. ” H owey , 328 U. S. at 296, 66 S. Ct. at 1102. Sim ilarly , in A lbanese, we found it si gnificant that “ [e] ven thou gh som e plaintiffs we re e xperienced busi ne ssm en , non e of

the m ha d any e xpe ri en ce in pla ci ng, m an ag ing , or se rv ic ing ic e m ach in es .” Alb an es e, 82 3 F .2dat 4 12 . W il li am so n i s n ot to th e co nt rary. T he re the c ourt he ld tha t i t w as “ cl ear that the pla int if fs ha d th e busi ne ss experience and kn owledge adequate to the exerc ise of partnership powers in a r eal es ta te j oin t ve nture . ” W ill ia m son, 645 F . 2d at 42 5. T he pla int if fs the re not

onl y w er e hig h c or

por at e ex ec uti ve s inalarg e busi ne ss, but a lso ha d be eninv olv ed

in oth er sim ilar re al e state ve nture s. 12 A f oc us o n e xpe ri en ce in the part ic ular busi ne ss i s a lso m or e co nsi ste nt w ith33

the How ey

test. T he ultim ate question is whether the investors were led to expect pr of its sol el y f ro m the e ff orts o f oth er s. R eg ar dle ss o f inv es tor s’ ge ne ra l bu sin es s ex pe ri en ce , w he re the y

a re ine xpe ri en ce d inthe part ic ular busi ne ss, the y a re li ke ly to b e re ly ing sol el y

on the e ff

orts o f the pr om ote rs to obt ai n th ei r pr of its . S ee a lso L ong v. S hul tz Cattl e Co . , 881 F . 2d 1 29, 134 n. 3 ( 5thCi r. 198 9) ( int er pr et ing W ill ia m son to f

oc us o n th e ex pe ri en ce in the part ic ular busi ne ss, not bus ine ss i n ge ne ra l, a nd n oti ng tha t “ an y hol din g to the c ontrary

w oul d be inc onsi ste nt w ith How ey itself”). In this case, the SE C presented uncontradicted evidence that the indiv idual partne rs ha d no e xpe ri en ce in the de bt p ur ch as ing bus ine ss. T he y w er e m em

be rs of the ge ne ra l pu

bli c, a nd i nc lud ed

ar ai lr oa d r et ir ee , ahou se w if e, a nd a nur se . T he ir poss ible general business exp erience is not sig nificant in this case. T hey we re rely ing so lely

on Merchant to operate the business, as evidenced by the fac t that one hun dr ed

pe rc en t of

the partne rs c hose Me rc hant a s M G P. I n H ow ey , the Su pr em e Co urt f

ound a n in ve stm en t c ontra ct

upo n m uc h le ss e vid en ce of de pe nde nc e: w he re onl y

85% of the or an ge gr ove a cr ea ge sol d w as m an ag ed by the pr om ote r. H ow ey , 328 U . S. a t 29 5, 66 S . Ct . a t 11 01. Me rc hant c ont en ds tha t the partne rs ’ la ck of pr ee xis tin g e xpe ri en ce is ir re le vant b ec au se a ny one w ithge ne ra l bu sin es s e xpe ri en ce c ane as ily le ar n to be34

suc ce ssf ul i n th e de bt p ur ch as ing bus ine ss. T ha t arg um en t i s no t su ppor te d by the reco rd , and to th e ex te nt th e d is tri ctco ur t re li edon it , th e co ur t cl earl y erre d. B o n i l l a , af

o rmera s s o c i a t e o f

Wye r ’s wh o o p e r a t e s ad e b tp u r c h a s i n g c o mp a n y, te sti fi ed that so m eo ne ne ed s tw o y ears of e xpe ri en ce to be suc ce ssf ul i n th e busi ne ss. H e an d th e SE C’ s e xpe rt sa id tha t a

gr eat de al of

sop his tic at ionis ne ce ssary to part ic ipate e ff

ec tiv el y in the bus ine ss. T he ir

te sti m ony

is supp orte d by the indis putablycom

plicated nature of the business. A succ essful debt pu rchaser m ust m ak e se nsi tiv e pr ic ing de te rm inatio ns o f fi nanc ia l i nstrum en ts, ba se d ona m ult itu de of

f luc tuatin g f

ac tor s, a nd a lso m

ust c ult ivate r el at ion shi ps w ith soph ist ic at ed

f inanc ia l i nst itu tio ns. T he onl y pe rs on who t es tif

ie d th at inv es tor s c oul d e as ily

le ar n th e busi ne ss w as Wy er , a nd h is t es tim ony is unava ili ng f

or tw o r ea sons . F ir st, his e xpe ri en ce is aty pical. He had extensive prior experience and relations hips in the financial se rv ic es ind

ustry . H e adm itt ed

that hi s pr ior

bus ine ss i nvol ve d bu ild ing relationship s with financial service s play ers, which m eant that he wa s both m ore lik el y to unde rs tand the bus ine ss and b ette r sui te d to c ult ivate the r el at ion shi ps necessary to operating a successful debt pu rchasing bus iness. Mer chant presented no e vid en ce that R L L P partne rs ha d si m ilar ex pe ri en ce . Mo re ove r, e ve n w ith Wy er ’ s he ad

start , he w as not

asuc ce ssf

ul p ar tic ipant i n th e de bt p ur ch as ingThe investors’ inexperience is one rea son why the fa ct that a theor etical br eaka way 13 pa rt ne rs hip c ou ld h ave fo un d d e bt p oo ls t o p ur c ha se in “ on e -o ff ” sa le s f or a s li ttl e a s $ 25 ,0 00 is no t si g nif ic ant. Th e me re ava ila

bil ity of su c h p oo ls d oe s n ot d e mon str ate tha t a pa rt ne rs hip c ou ld have purc ha se d th e m at a pr ic e that w ou ld h ave a llo we d th e m to make a pr of it, muc h le ss a

pr of it simil ar to what was re prese nted by Merc hant at the ince ption of the investment. See Howe y , 328 U.S. at 300, 66 S. Ct . at 1104. 35 ind ustry . T he his tor

y of Me rc hant’ s op er at ionof

ade bt p ur ch as ing bus ine ss i s on e of unm itigated failure. Wy er’ s experience thus showed noth ing abou t how m uch tim e is n ec es sary

to de ve lop a ct

ua l e xpe rt ise in the de bt p ur ch as ing ind ustry . T he second W illiam son factor w as also present here. 13

C. W ere the partners so dependent on Merc hant’ s entrepreneurial or m anagerial ab ili ty that the y c oul d no t r ep la ce it

or oth er w ise e xe rc ise m eanin gf

ul p ow er s? T he thi rd f ac tor a sks w he the r “ the partne r or ve nture r is s o de pe nde nt o n som e unique entrepreneurial or m anagerial ability of the prom oter or m anager that he c an not r ep la ce the m an ag er

of the e nte rp ri se or

oth er w ise e xe rc ise m eanin gf

ul partne rs hip or

ve nture pow er s. ” W ill ia m son, 645 F . 2d at 42 4. T he f ir st W ill ia m son fa ct or

a na ly ze s th e pow er s th e partne rs pr ac tic al ly r et ai n un de r the ar range m en t w iththe pr om ote r. T he thi rd f ac tor pr ovi de s th at , e ve n if

the arrangem ent gives the partners som e prac tical control, the instrum ent is an in ve st m en t co nt ract if t he in ve st or s h av e n o re al is ti c al te rn at iv e to th e m an ag er. Se e A lbane se , 823 F . 2d at 41 2.36

T he S E C a dm its that M er ch an t ha d no spe ci al ski ll in the de bt p ur ch as ing busi ne ss. I nst ea d it

a rg ue s th at

e ac h in div idu al RL L P partne rs hip ha d no reas on ab le alt ern at iv e to Merc ha nt be cau se th e p owe r to rem ov e Me rch an t as MGP wa s illuso ry , and because of the fac t that the twenty -eight partnerships’ m oney wa s tie d up in a co m

m on p ool . W e ha ve a lr ea dy dis cu sse d th e fo rm er , so w e nowf oc us on the la tte r. Me rc hant t ook the c ap ita l c ontri but ed by the tw en ty -e igh t partnerships, pooled it, and then po oled it further w ith capital raised by Ne w V isi on. The district court r ej ected the SE C’ s posi tion, finding that an RL LP that co ul d b reakaway

wou ldha ve reas on ab le alt ern at iv es forne w m an ag em en t. A ssu m ing ( co unt er fa ct

ua lly ) that an R L L P co uld br eak aw ay , w e co nc lud e that the dis tr ic t c ourt di d no t c le ar ly e rr w ithr es pe ct

to the a va ila

bil ity of a lte rn at ive s f

or new m anagem ent. E vidence at trial showed that alter native m anagers approached Merchant expressing a w illing ness to m anage an RL LP . Merchant also showed that N ewV isi on h ad

poo le d R L L P funds of

it s own. I t i s no t be y ond the r ea lm of poss ibi lity

that a br eakaw ay

RL L P co uld

have j oin ed

a nothe r pool that w oul d have al low ed it to re co up the r et

ur ns tha t w er e ex pe ct ed

a t the inv es tm en t’ s in ce pti on. Fo r a dif fe re nt r ea son, how ev er , the RL L P partne rs did not ha ve a ny r ea lis tic al te rn at ive to m an ag em en t by Me rc hant ( in a ddi tio n to ha vin g no pr ac tic al abil ityFor instance, a

bsent termination, Merc hant could only call bac k debtor a ccounts that 14 had not y et enter ed collec tion and upon which no pay ments had bee n made in the pr evious 60 da y s. 37 to r em ove Me rc hant) . T ha t i s be ca use Me rc hant e ff

ec tiv el y ha d pe rm an en t c ontro l ove r ea chpartne rs hip ’ s a sse ts. Me rc hant p ool ed the partne rs hip s’ a sse ts and invested th em

in poo ls of accounts owned by Ne w V ision . Merchant had a ser vice co ntr ac t w ithN ewV isi on tha t gave Me rc hant a r igh t t o th e re tur

n of de bt a cc ount s onl y in ce rt ai n li m ite d c ir cu m stanc es , or upo n te rm inatio n of

the e nti re c ontra ct . 14 Be as le y a dm itt ed a t tri al that the partne rs hip s ha d no c ontra ct ua l r igh t t o de m an d the return of the debtor acc ount s. T hus, even if an individu al partnership m anaged to replace Me rchant, it would find that its m aj or assets we re tied up in frac tional share f orm in a N ewV isi on d eb t po ol. Merchant asserts that the n-select process developed byMerc hant with Ne w V isi on and E A M a llo w ed partne rs hip s to obt ai n th ei r share s inlarg e de bt p ool s, and poin ts to RLL P-19 as an exam ple of the n-select proce ss working. T he district co urt a gr ee d, but

c le ar ly e rr ed . I n th e fi rs t pl ac e, the n- se le ct pr oc es s di d no t e xis t unt il w el l a ft er

the S E C’ s in ve sti ga tio n ha d be gun, a nd l ong af te r al l of the offer ings o f RL LP interests. T hen, once developed, the n-selec t process wa s an av ai la ble m eans f

or part iti oni ng d eb t po ols . B ut i t di d no t pr ovi de the partne rs hip s with the right to obt ain their debt poo ls from Ne w V ision . That r ight was38

Me rc hant’ s a lon e, a nd i t w as c ir cu m sc ri be d by the te rm s of

the se rv ic e co ntr ac t. RL L P- 19 i s no t a

c ount er ex am

ple . B y the ti m e RL L P- 19 w ith dr ewin 2004 , y ears a ft er

the e ve nts r el ev an t he re , Me rc hant’ s si ste r co m pany , Me rc hant Managem ent, had taken over N ewVision’ s role in m anaging th e debt pools . In ad dit ion , by

that po int , Me rc hant h ad no i nte re st i n r es ist ing r ep oss es sio n of the de bt p ool s: the w ith dr aw al of one of the RL L Ps both he lpe d it s pr ospe ct s inthe SE C investigatio n and didnot hu rt it financially , since it had alr eady rec omm ended liquid at iona nd the re w er e no m or e tr an sa ct ionf ee s to e ar n. T o sh owthat the partne rs c oul d r ep oss es s th ei r de bt p ortf oli os, Me rc hant (and the dis tr ic t c ourt) r el ie d onte sti m ony f ro m N ewV isi on’ s he ad , F re d H ow ar d, to the e ff ec t tha t he w oul d have be enw ill ing to al low a n in div idu al RL L P to wit hd raw i ts de bt oracco un ts us in g t he n-s el ectpro ces s, ev en th ou gh th e RLLP m igh t no t have ha d ac ontra ct ua l r igh t t o do so. H ow ar d’ s te sti m ony about w ith dr aw al w as , how ev er , r el ev an t on ly to the pe ri od a ft er

Me rc hant, a lon g w ith Ne w V ision and EA M, developed the n-select proce ss. T he n-select process w as de ve lop ed

a ft er the S E C i nve sti ga tio n be gan, w iththe appare nt p ur pose of de m onstratin g to the S E C tha t the ind ivi dua l partne rs hip s c oul d r em ove the ir a sse ts fr om the poo l ( thu s bo lst er ing the a rg um en t tha t the partne rs hip int er es ts w er e not se curi tie s) . B ef

or e that t im e, it

w as not e ve n po ssi ble f

or a n in div idu al RL L P to39

withdrawits accounts, because there wa s no way to convert the RLL P’ s frac tional sh are i n t he po ol in to co nc ret e an d p or tabl e d eb to r acc ou nt s. An d a ll of t he RLLP of fe ri ngs too k pl ac e be fo re the de ve lop m en t of the n- se le ct

pr oc es s. T hus, e ve n if How ard had been w illing to rem it the debtor accounts, he had no m eans by which to d o so . H ow ar d’ s te sti m ony the re fo re did

not e sta bli sh tha t the partne rs ha d a re as ona ble a lte rn at ive to Me rc hant at the ti m e of the ini tia l i nve stm en t, a nd the district court clearly

err ed in concludi ng oth erw ise. A nothe r pr ac tic al li m itatio n onthe partne rs ’ abil ity to fi nd an a lte rn at ive to Me rc hant w as the f

ac t tha t E A M w as in ac tua l po sse ssi on o f the de bto r ac co unt s, and had a contract w ith NewVision that lim ited the circum stances under which Ne w Vi s i o n co u l dre p o s s es s t h em. Th i s m ea n s t h at , e v en cr ed i t i n g Ho wa rd ’s te sti m ony that he w oul d have be enw ill ing to re m it de bto r ac co unt s inhis po ss es si on to an in di vi du al RLLP, th e d efen da nt s p ro du cedno ev id en ce t ha t EAM w oul d have be enw ill ing to re tur n de bto r ac co unt s to N ewV isi on tha t w oul d have en ab le d H ow ar d to se nd the m to anRL L P. A s ar es ult , H ow ar d’ s te sti m ony did not es ta bli sh tha t i ndi vid

ua l R L L Ps ha d apr ac tic al m eans o f obt ai nin g th ei r ac co unt s fr om E A M, a nd thus did

not e sta bli sh tha t the y

ha d ar ea sona

ble a lte rn at ive toThe fa ct that EAM coope rate d with the development of the n-sele ct proc ess does not 15 constitute signific ant evidenc e to the contr ary . Both Mer chant a nd New V ision were inter ested in demonstratingto the SEC that the indivi dual par tnerships could re move their a ssets from the pool. The coope ration of their contra ctual par

tner EAM in de velopingthis process does not de mon str ate that E AM wo uld have be e n w ill ing , a s a

g e ne ra l matte r, to r e tur

n d e bto r a c c ounts wher e the ter

ms of the servic e contr act with Ne w Vision were not satisfied. In addition, the withdrawa l of RL L P-19 occur red a fter ma

nag ement of the debtor a ccounts ha d shifted from Ne w Vi sio n a nd EA M to Me rc ha

nt M ana g e me nt. 40 m an ag em en t by

Me rc hant. 15 T he RL L Ps ’ la ck

of ar ea lis tic a lte rn at ive to Me rc hant w as pr es en t f ro m the inc ep tio n of

the a rr an ge m en t be tw ee n M er ch an t and the partne rs . S ee W ill ia m son, 645 F. 2d at 42 4 n. 14. Wy er a dm itt ed that he a nd B ea sle y

int en de d f

ro m the be gin nin g to poo l c ap ita l f ro m m ult ipl e partne rs hip s. T he partne rs hip a gr ee m en t al so ex pr es sl y

ga ve Merc ha nt th e au th or it y to co nt ract wit h a th ird pa rty serv ic e. T he re fo re , f

ro m the be gin nin g, RL L P partne rs ha d no r ea lis tic a lte rn at ive to m an ag em en t by

Me rc hant, a nd the thi rd

W ill ia m son fa ct or

w as a lso pr es en t.

D . Co nc lus ion : R L L P int er es ts w er e inv es tm en t c ontra ct s Fo r al l of the se r ea sons , the RL L P int er es ts w er e inv es tm en t c ontra ct s covered by

the feder al securities law s. T he partners had the power s of lim ited partne rs , sin ce the y

ha d no abil ity

to re m ove Me rc hant and the pur porte d auth or ity to a ppr ove pur ch as es w as il lus or y . T he y w er e co m

ple te ly ine xpe ri en ce d inthe de bt purchasing in dustry . Finally , e ven if they could have rem oved Merchant (w hichBe cause we f ind that the Wil liamson factor s were prese nt, we nee d not addre ss, and 16 expressly do not decide, whether

the Will iamson presumption ag ainst investment contrac t status inv ari a bly a pp lie s to RL L Ps, L L Cs, and L L Ps. 41 the y c oul d no t) , the y

ha d no r ea lis tic a lte rn at ive to Me rc hant a s m an ag er be ca use their debt poo ls wer e in fra ctional form with a c om

pany whose only

contractual re la tio nshi p w as w ithMe rc hant. 16 Be ca use the RL L P int er es ts w er e inv es tm en t c ontra ct s, a nd the de fe ndants sol d th e int er es ts w ith out f ili ng a r eg istratio n st at em en t, the de fe ndants vio la te d th e reg is tra ti on pro vi si on s o f th e se cu rit ie s l aws . See SEC v . Con ti ne nt al Tob acco Co ., 463 F.2d 137 , 155 (5th Cir. 1972 ).

IV . S ec ur iti es f

ra ud

W e turn next to the SEC’ s contentio n that the defendants also comm itted se curi tie s f

ra ud i n th e m ar

ke tin g of tho se int er es ts. T he S E C a lle ge d th at the de fe ndants vio la te d se ct ion10( b) of the E xc hange A ct

a nd s ec tio n 17 (a ) of

the Se curi tie s A ct . 15 U . S. C. § 77 q( a) , 15 U . S. C. § 78 j (b ). T o pr ove a10( b) vio la tio n, the S E C m

ust sho w( 1) m at er ia l m isr ep re se ntatio ns o r m at er ia lly m isl ea din g om iss ion s, ( 2) in co nne ct ionw iththe pur ch as e or sa le of se curi tie s, ( 3) m ad e w ithThe scope of liability under Sec tion 10(b) and Rule 10b-5 is the same. See SEC v. 17 Z andfor d, 535 U.S. 813, 816 n.1, 122 S. C t. 1899, 1901 n.1 (2002). 42 sc ie nt er. Aaro n v . SEC, 44 6 U.S. 6 80 , 69 5; 10 0 S . Ct. 1 94 5, 1 95 5 (1 98 0) . To 17 show a violation o f section 17(a)(1), the SE C m ust prov e (1) m aterial m isr ep re se ntatio ns o r m at er ia lly m isl ea din g om iss ion s, ( 2) in the of fe r or sa le of se curi tie s, ( 3) m ad e w ithsc ie nte r. I d. a t 69 7, 100 S . Ct . a t 19 56. F ina lly , to show that the de fe ndants vio la te d se ct ion17( a) (2 ) or 17( a) (3 ), the S E C n ee d on ly sho w (1) m aterial m isrepresentations or m aterially m isleading o m issio ns, (2) in the off er or sa le of se curi tie s, ( 3) m ad e w ithne gli ge nc e. I d. a t 70 2, 100 S . Ct . a t 19 58. The district court concluded that the defendants m ade no m aterial m isr ep re se ntatio ns o r om iss ion s inm ar ke tin g th e RL L P int er es ts, a nd a lso co nc lud ed

that the de fe ndants did

not a ct w ithsc ie nte r. T he dis tr ic t c ourt di d no t address whether or not the defendants had acted with negligence. “ Mixed questio ns of law and fact, such as questio ns of m ateriality , scie nter, and reliance, invo lve assessm ents peculiarly within the province of the trier of f act and hence are rev ie wab le un de r th e cl earl y erro ne ou s ru le .” Luca s v . Fla . Powe r & Lig ht Co ., 765 F. 2d 1 039, 104 0- 41 ( 11th C ir . 198 5) . Af ind ing w ill be he ld c le ar ly e rr one ous onl y w he n “ the r ev ie w ing c ourt onthe e nti re e vid en ce is le ft w iththe de fi nit e an d fi rm c onvi ct ionthat a

m ist ak e ha s be enc om

m itt ed . ” U nit ed

S ta te s v. U . S. G y

psum43

Co . , 333 U . S. 364 , 395 , 68 S . Ct . 525 , 542 ( 1948 ). I n th is o pin ionw e ad dr es s on ly issues in volv ing whether there we re m isrepresentations or om issio ns of m aterial m atte rs , le av ing the dis tr ic t c ourt t o r ec onsi de r sc ie nte r iss ue s onr em an d.

A . P ro j ec tio ns and o m iss ionof

pe rf orm an ce inf

orm at ion The te st for m ateriality

in the securities fraud context is “ whether a re as ona ble m anw oul d a tta chim

portanc e to the f

ac t m isr ep re se nte d or

om itt ed in de te rm ini ng h is c our se of a ct ion . ” S E C v . Carr iba A ir , 681 F . 2d 1 318, 132 3 ( 11th Ci r. 198 2) ( ci tin g T SC I ndus . v. N orthw ay , 426 U . S. 438 , 449 , 96 S . Ct . 212 6, 213 2 (1976)). T he SE C first c laim s that Merchant m ade proj ections for the perform ance of the partne rs hip s th at

w er e m at er ia lly

m isl ea din g. “ St at em en ts r eg ar din g pr oj ec tio ns o f fu tur e pe rf orm an ce m ay

be a ct ion ab le und er

S ec tio n 10 (b ) or

Ru le 10b- 5 if the y a re w or de d a s gu ar an te es or a re sup porte d by

spe ci fi c state m en ts o f fa ct . . . or if the spe ak er

doe s no t ge nui ne ly

or r ea sona bly be lie ve the m . ” K ow al v. IBM C orp. ( In re I BM Corp. Sec . L itig.), 163 F.3d 102, 107 (2d Cir. 1998). S ee also Rubin stein v. Collins, 20 F.3d 160, 166, 168 (5th Cir. 1994); Kow al v. MC I Com m unication s Corp., 16 F.3d 1271, 1277 (D .C. Cir. 1994 ). T he SE C ar gues that Me rc hant p ro m ise d in ve sto rs a3. 2% quart er ly or 16. 5% a nnua l r et

ur n onc ap ita l, an d th at tho se r et ur ns w er e unr ea sona

ble giv enthe hig h f

ee s c harg ed

by Me rc hant44

an d othe r se rv ic e pr ovi de rs . T he dis tr ic t c ourt f

ound that the se pr oj ec tio ns w er e not m at er ia lly m isleading. W e divide our analy sis, and address first the proj ections m ade before June 200 2. W e co nc lud e that the dis tr ic t c ourt di d no t c le ar ly e rr w ithr es pe ct

to the partne rs hip int er es ts o ff er ed pr ior to June 200 2. F ir st, the de fe ndants did not guarantee a r ate of r eturn. T he partnership agreem ent explicitlyadvised partners that the returns we re not guaranteed. T he agreem ent also recognized that the return m igh t be gr eate r or

w or se : i t pr ovi de d f

or a50- 50 s pli t of

pr of its le ft a ft er tho se distribu tions , but also disclosed th at the return m ight b e less, and that partners m igh t i n f ac t l ose the ir

e nti re c ap ita l c ontri but ion . Se co nd, the dis tr ic t c ourt a lso did not c le ar ly e rr in de te rm ini ng tha t the proje ctions were initiallym ade in good faith and had a re asonable basis. Evidence in the r ec or d su

ppor ts M er ch an t’ s c ont en tio n th at the pr oj ec tio ns w er e not unreasonable when m ade. Ne w V ision provided Merchant with the m odels it us ed to c al cu la te the pr oj ec te d r et ur n onthe inv es tm en t, a nd M er ch an t us ed tho se m odels to calculate its internal projec tions . Merchant cla im s that the projec ted re tur ns f ai le d to m at er ia liz e in p ar t be ca use the partne rs hip s be gan op er at ing soo n af te r Se pte m

be r 11, 200 1. F urthe r, Wy er te sti fi ed that the pr oj ec te d r et

ur n w as so hig h pr ec ise ly

be ca use the bus ine ss w as r isky , a nd the f ac t tha t the inv es tm en tsThe be speaks c aution doctrine ha s a statutory equivalent in the sa fe ha

rbor pr ovided by 18 the Private Sec urities L itigation Refor m Act. 15 U.S.C. § 78u-5; Bryant v. Avado B rands, Inc., 187 F.3d 1271, 1276 ( 11th Cir. 1999). Be cause this case is not a private ac tion, we apply the judicially cre ated be speaks c aution doctrine instea d. 45 unde rp er fo rm ed

did not ne ce ssari ly

de m onstrate that the e xpe ct ed r et ur n a t the inc ep tio n w as unr ea sona

ble . T hus, vie w ing the e vid en ce a s aw hol e, w e do n ot believe that the district court clearly err ed in determ ining that the proje ctions were not ini tia lly m ad e in g ood fa itha nd w ithar ea sona ble ba sis . T he ini tia l pr oj ec tio ns w er e al so r en de re d im m at er ia l by

the a cc om

pany ing ca uti onary langua ge . I n th is c ir cu it w e adhe re to the be spe ak s c au tio n do ctri ne in as se ssi ng the m at er ia lity

of f or w ar d- loo kin g st at em en ts. “ Whe n an of fe ri ng 18 doc um en t’ s pr oj ec tio ns are a cc om panie d by m ea nin gf ul c au tio nary

state m en ts and specific w arnings of the risks in volv ed, that language m ay be sufficient to render the alleged om issio ns or m isrepresentations imm aterial a s a m atter of law. ” Sa ltz be rg v. T M S te rl ing /Aust in A sso cs . , 45 F . 3d 3 99, 399 ( 11th C ir . 199 5) . T he cau ti on ary la ng ua ge m

us t b e m ean in gf

ul : b oi le rp la te wil l n ot su ffi ce. Id . A dis cl ai m er

doe s no t pr ovi de pe r se im m uni ty , pr ec ise ly

be ca use the dis cl ai m er

m ust be m eanin gf

ul and t ai lor ed

to the r isk s th e busi ne ss f ac es . T he be spe ak s c au tio n doc tr ine is ult im at el y

sim ply “ shor thand f or the w el l- es ta

bli she d pr inc ipl e that a state m en t or

om iss ionm

ust be c onsi de re d inc ont ex t, so tha t a cc om pany ing46

s t at emen t s m ay re n d eri ti m m at er i al as a mat t ero f l aw .” Kau fman v . Tru m p ’s Castle Funding (In re D onald J. Tr um p Casino Sec. Litig. ), 7 F. 3d 35 7, 364 (3d Cir. 1993 ) (c ited in Saltzberg, 45 F.3d at 399). He re, the offer ing do cum ents includ ed m eaningful caution ary language that inf orm ed inv es tor s of

the r isk inh er en t i n th e inv es tm en t and r en de re d th e pr e- June 2002 proje ctions imm aterial. Abolded sectio n titled “ Risk Factors” w arned that

“ be co m ing aG en er al P ar tne r is o nly

appr opr ia te f

or tho se pe rs ons ca

pable of withstanding the risk of losing their entire c apital contributi on.” I t advised that there ar e “ no assurances” that any am ount of debt “ can actually be rec overed.” It not ed the r isk ine ss o f the m ar

ke t, not ing that “ [t ] he de bt c oll ec tio n bu sin es s is int en se ly c om pe tit ive ” an d th at

“ [a ] n e co nom ic downturnof a ny se ri ous pr opor

tio n or ana tio na l c ri sis c oul d a dve rs el y a ff ec t the abil ity

to co lle ct de bt i n [ sic ] ati m el y basis.” F inally , it observed that Merc hant “ has a lim ited operating hi story ” and that its “ fi nanc ia l ob

j ec tiv es m

ust , the re fo re , be c onsi de re d sp ec ulativ e. ” T his ca uti onary langua ge , spe ci fi ca lly

ta ilo re d to se ve ra l of

the r isk s f

ac ed by the de bt pur ch as ing bus ine ss, r en de re d th e pr oj ec tio ns i m m at er ia l a s am atte r of

law , e ve n if the y w er e m isr ep re se ntatio ns. W e ne xt a ddr es s w he the r the dis tr ic t c ourt c le ar ly e rr ed in fi ndi ng tha t the pr oj ec tio ns m ad e af

te r June 200 2 w er e not

m at er ia lly

m isl ea din g. T he S E C a lso47

argues that, a fter June 2002, Mer chant m ade m aterially m isleading o m issio ns when it kne wthat the partne rs hip s’ bus ine ss m ode l w as not suc ce ed ing , y et

c ont inu ed

to se ll RL L P int er es ts w ith out dis cl osi ng the la ck

of suc ce ss o r the spe ci fi c re as ons why the busin ess was f

ailing. T he test for m ateriality of an om issio n is “ whether a re as ona ble m anw oul d a tta chim

portanc e to the f

ac t om itt ed

in de te rm ini ng a co ur se of a ct ion . ” K en ne dy

v. T al lant, 710 F . 2d 7 11, 719 ( 11th C ir . 198 3) . I t i s we ll establish ed that a m aterially m isleading o m issio n of past perform ance inf orm at ionoc curs w he n apr om ote r m ak es opt im ist ic state m en ts a bout the prospects of the bus iness bu t fails to include past perform ance inform ation that wou ldbe us efu l t o a reas on ab le in ve st orin ass es si ng th os e st at em en ts . See, e.g ., Carr iba Air, 681 F.2d at 1323-24 (m aterial om issio n where failed to disclose that high ly sim ilar predec essor busin ess had gon e bankrupt); No. 84 Em ploy erT eam ste r Joi nt C ounc il Pe nsi on T ru st F und v. A m . W es t H old ing Co rp . , 320 F . 3d 920, 935 ( 9thCi r. 200 3) ( m at er ia l om iss ionw he re a ir lin e pa int ed r osy pic tur e of fi nanc ia l pr ospe ct s, w hil e know ing it ha d un dis cl ose d sp ec if

ic pr obl em s, inc lud ing m ai nte nanc e iss ue s and an F A A inv es tig at ion ); Ru bin ste in, 20 F . 3d at 17 0 (o pti m ist ic state m en ts tha t om it known su bst an tia l a dve rs e fa ct s are a ct ion ab le unde r an tif

ra ud p ro vis ion s) . A ddi tio na lly , ge ne ra l c au tio nary langua ge doe s no t render om issio n of specific adverse histo rical f acts im m aterial. See , e .g. , I n re48

W estingh ouse Sec. Litig. , 90 F. 3d 69 6, 710 (3d Cir. 1996 ) (gener al cautionary language did not render m isrepresentations imm aterial where m anagem ent knew about sp ecific negative events that had already occurre d); Rubinst ein, 20 F. 3d at 171 (“ [T ] he inc lus ionof

ge ne ra l c au tio nary

langua ge r eg ar din g apr ed ic tio n w oul d not excuse the alleged failure to revea l known m aterial, adverse f acts”). The S EC established th rough un rebutted testim ony that the defendants knew their busin ess m odel was not succeeding as early as June 2002 . The S EC ’ s expert showed that the partnerships in the aggregate w ere operating at 89% of benchm ark in June , a nd 7 7% thr ee m onths l at er . T he de fe ndants w er e al so aw ar e of the poo r pe rf orm an ce . T he S E C p ro duc ed a n e m ai l i n w hic h th e de fe ndants dis cu sse d th e po orpe rfo rm an ce o f RLLP-5 in Ju ne , when itwas c ol le ct in g a t 5 5% o f be nc hm ark . Be as le y a lso a dm itt ed

that the y kne wthat the partne rs hip s w er e pe rf orm ing poo rl y w he n th ey

sol d th e la te r int er es ts. Y et the de fe ndants c ont inu ed to se ll the int er es ts thr oughN ove m

be r 2002 w ith out

dis cl osi ng the poo r pe rf

orm an ce of

the int er es ts that ha d a lr ea dy

be ensol d, or

the spe ci fi c re as ons fo r the poo r pe rf orm an ce . T he partnership m aterials contained only the sam e general disclos ures of risk that had been present from

the beginni ng. T hese warnings d id not include, for e xam ple, Me rc hant’ s be lie f that c oll ec tio ns h ad suf fe re d inthe w ak e of

S ep te m be r 11, 200 1, or that the le ve l of

f ee s M er ch an t w as c oll ec tin g ha d pr ev en te d th e partne rs hip s49

fr om be ing pr of

ita ble , giv enthe c oll ec tio n r at e in the f ir st s ix t o ni ne m onths. Instead, a long side the general cautionary language, the m aterials continued to paint a rosy

picture of the business’s prospects. The intere sts were called

“ E ve rg re enH ighY ie ld RL L Ps . ” T he partne rs hip a gr ee m en t pr om ise d r et ur ns o n capital of 3.2% per quarter or 16.5% per y ear. T he risk disclos ure im plied unwarr anted optim ism . It said that Merchant “ is confident th at it has done its v ery best to m itigate these risks.” I t also represented that there w as no assurance Merchant “ will continue to be successful in th e purchase and sale of distressed de bt. ” T his im

pli ed , c ontrary

to fa ct , that M er ch an t ha d be ensuc ce ssf ul i n th e p u r c h a s e a n ds a l e o f

d i s t r e s s e dd e b t . I n i t s d e s c r i p t i o n o f t h e d e b ti n du s t ry, Merchant said that the “proje cted growth of cr edit card debt illustrates the potenti al gr ow th r at e of

the de bt i ndus tr

y , ” w ith out

dis cl osi ng tha t M er ch an t’ s op er at ing his tor y c ontra dic te d th at

a sse ssm en t. Inthi s c ont ex t, Me rc hant’ s om iss ionof the pe rf orm an ce his tor

y of the existing RL LP s was m aterially m isleading, and not cured bythe general ca ution ary langua ge in the r isk

dis cl osur e. S ee K ow al , 16 F . 3d at 12 77 ( no d uty to dis cl ose pr ojec ti on s, b utif d o d is cl os e p ro jecti on s, “ it s d is cl os ur e m us t b e fu ll an d fa ir” ). Wha t m ay

on ce h av e b een a go od fai th pro jecti on be cam e, wit h e xp eri en ce, a m aterially

m isleading o m issio n of m aterial f act. A s the Fifth Circuit hasBe cause this former F ifth Circuit opinion was issued before the close of business on 19 Se pte mbe r 3 0, 19 81 , it

is b ind ingpr e c e de nt. 50 re co gni ze d, “ [t ] o w ar

n th at the unt ow ar d m ay

oc cur w he n th e ev en t i s c ont ing en t i s prudent, to caution th at it is onlypossi ble for the unfavorable events to happen w he n th ey

ha ve a lr ea dy

oc curr ed is de ce it. ” Ru

bin ste in, 20 F . 3d 1 60, 171 ( quot ing Huddleston v . H erm an & Mac Le an, 640 F. 2d 53 4, 544 (5th Cir. M arch 9, 1981 ), 19 af f’ d inpart , r ev ’ d inpart

by H er m an& Ma cL ean v. H uddl es ton , 459 U . S. 375 , 103 S. Ct. 683 (198 3)). H ere, unfavorable events had already occurre d when Me rc hant m ad e its opt im ist ic state m en ts, w hic h m ad e tho se state m en ts m at er ia lly m isl ea din g. Me rc hant’ s on ly

a rg um en t i n r es pons e (whic h th e dis tr ic t c ourt a cc ep te d) is that the S E C’ s e xpe rt

te sti fi ed that M er ch an t ha d be entr uth fu l and a cc ur at e in i ts di sc lo su res to it s p art ne rs . This ex pe rt, h owe ve r, ha d a li m it eden ga ge m en t. At trial the expert testified that his assignm ent was thre efold: (1) to determ ine whether the m onthly

state m en ts t o th e partne rs w er e co nsi ste nt w iththe a ct ua l transa ct ion s; (2) to determ ine whether the financial transactions of the partnerships were co nsi ste nt w iththe r ep re se ntatio ns i n th e partne rs hip of fe ri ng d oc um en ts; a nd ( 3) to assess the ov erall f

inancial perform ance of the par tnerships, and whether that pe rf orm an ce w as c onsi ste nt w ithMe rc hant’ s pr oj ec tio ns. T his a ssi gnm en tTh e e xpe rt te sti fi e d, “ Iwa s n ot o n a

fr a ud de te c tio n mi ssi on . A nd

fr a ud c an a ssume 20 differ ent forms outside of just the interna l handling of money and the f inancial r eporting .” The expert thus made clea

r that his eng ag ement wa s limi ted to analy zing the par

tnerships’ fina

ncial transac tions and how they confor med to the terms of the partne rship ag ree ment, and not whethe r the de fe nd ants ma de any

oth e r m ate ri a l mi sr e pr e se ntatio ns or omi ssi on s in

the of fe ri ngmate ri a ls. 51 inc lud ed , a s th e dis tr ic t c ourt pu t i t, de te rm ini ng “ w he the r the f inanc ia l transa ct ion s of the partne rs hip s w er e co nsi ste nt w iththe dis cl osur es that w er e co nta ine d inthe partne rs hip of

fe ri ng d oc um en ts. ” S E C v . Me rc hant C ap ita l, L L C, 400 F . S upp. 2d 1336 , 1357 (N. D. Ga . 2005). When Merchant asked this expert whether he had unc ove re d e vid en ce of

f ra ud, the e xpe rt

r ep lie d th at

he ha d no t, but

w as c ar ef

ul t o em pha siz e that hi s in ve sti ga tio n w as li m ite d to “ the int er na l handl ing of

m one y a nd the f inanc ia l r ep ortin g, ” an d di d no t pr es um e to a sse ss whe the r the of fe ri ng m aterials as a

whole m ade fr audulent representations to the partners. H e later 20 spe ci fi ca lly

te sti fi ed that hi s a ssi gnm en t di d no t a ddr es s w he the r Me rc hant accu rat el y

di sc lo se d l os se s o r pr ojec ti on s t o i nv es to rs in th e o ffer in g m at eri al s. Fr om thi s te sti m ony , it

is cl ear that the e xpe rt

a na ly ze d on ly

w he the r the partne rs hip s’ f

inanc ia l transa ct ion s w er e co nsi ste nt w iththe of fe ri ng m at er ia ls, not w he the r the of

fe ri ng m at er ia ls c ont ai ne d su ff ic ie nt i nf orm at ionabout

pa st perform ance so as to m ake their proj ections not m aterially m isleading. The fact t h at t h i s ex p er td i dn o tfi n dfr au dt h er ef o re d i dn o ts up p o rt t h e d i s t ri ct co u rt ’s co nc lus ionthat the pr oj ec tio ns m ad e af te r June 200 2 w er e not

m at er ia lly52

m i s l ea d i n g . B ec au s e t h e e x p er t ’s t es t i m o n y d o es n o ts up p o rt t h e d i s t ri ct co u rt ’s co nc lus ion , a nd b ec au se the oth er e vid en ce of

m at er ia l om iss ionin the partne rs hip m at er ia ls i s ov er

w he lm ing , the dis tr ic t c ourt c le ar ly e rr ed in de te rm ini ng tha t the post -June 200 2 om iss ion s w er e not m at er ia l.

B. Wy er’ s previous b ankruptcy T he S E C a lso a rg ue s th at it w as m at er ia lly

m isl ea din g f

or Me rc hant t o om it m en tio n of

Wy er ’ s pe rs ona l bankr

upt cy . T he dis tr ic t c ourt di d no t sp ec if ic al ly m ak e a fi ndi ng o n th e m at er ia lity of the f ai lur e to d isc los e the bankr upt cy , but im plicitlyfound that it was not m aterial in concluding across the bo ard that Me rc hant h ad

m ad e no m at er ia l m isr ep re se ntatio ns o r om iss ion s. W e hol d th at thi s too was clear er

ror. W e have previously

held that a failure to disclose the bankruptcyof a sim ilar pr ed eces so r co m

pa ny is a m at eri al om is si on . Carri ba Air, 6 81 F.2d at 1 32 3- 24 . M er ch an tat t emp t s t o d i s t i n g u i s h Ca rr i b a A i r o n i t s fa ce , a rg u i n g t h at Wy er ’s personal bankrup tcy

wa s related to a dire ct m arketing busi ness, entirely distin ct fr om the de bt p ur ch as ing bus ine ss tha t M er ch an t w as or ganiz ing . W e co nc lud e that, und er

the f ac ts i n th e re co rd , ar ea sona ble inv es tor

w oul d ha ve be enint er es te d inWy er ’ s pr ev iou s pe rs ona l bankr upt cy , a nd tha t i t w as thu s53

m at er ia lly

m isl ea din g to om it the inf orm at ion . Wy er

a nd M er ch an t pu t hi s experience in issue by

toutin g, in great deta il, Wy er’ s busi ness experience. Wy er and Beasley

repre sented that they

had “ m ature, diverse busin ess experience”; that Wy er had “ 27 y ears of experience in the sales and m arketing of financial services pr oduc ts” a s a“ co nsul tant t o f inanc ia l i nst itu tio ns i nvol ve d inc onsum er le ndi ng an dco l l ec t i o n s ” a n das “ Pr es i d en tan dCE O o f [ Wy erCr ea t i v e C o m m u n i ca t i o n s ], an integrated direct m arketing com pany focused on the financial services indust ry .” Wy er ’ s ve ry

r ec en t pe rs ona l bankr

upt cy ( in 2 000) r es ult ed

f ro m the f ai lur e of thi s busin ess of which he w as CE O, and which he touted in the offering m aterials as re la te d and a s r el ev an t e xpe ri en ce . I nf orm at ionabout

Wy er ’ s qu al if

ic at ion s to ok on a dde d si gni fi canc e be ca use Me rc hant w as m ar

ke tin g th e int er es ts t o pe opl e w ith l i t t l e e x p er i en ce i n t h e d eb tp u rc h as i n g i n du s t ry, wh o wo u l db e r el yin g o n Wy er ’s expertise to generate their returns. Knowle dge of Wy er’ s previous b ankruptcy cl earl y w oul d have be enhe lpf

ul t o ar ea sona

ble inv es tor

a sse ssi ng the qua lity

a nd ex te nt o f thi s e xpe ri en ce . S ee Carr iba A ir , 681 F . 2d at 13 23- 24; S ue z E qui ty In ve sto rs , L . P. v. T or ont o- D om ini on B an k, 250 F . 3d 8 7, 98- 99 ( 2d C ir . 200 1) (m isr ep re se ntatio n of

pr inc ipa l m an ag er ’ s qu al if ic at ion s, inc lud ing om iss ionof pe rs ona l bankr

upt cy , w oul d be m at er ia l i f pr ove n) ; S E C v . E nte rp ri se s S olu tio ns, In c. , 142 F . S upp. 2d 5 61, 575 -7 6 ( S. D . N . Y . 200 1) ( m at er ia lly m isl ea din g to f

ai l t oIn light of our conclusion on the ba sis of the fac ts and circ umstances he re that Wy er’ s 21 previous per sonal bankruptc y was mate rial, we need not in this case decide whether , and under wh at c ir c ums tanc e s, a

pr e vio us ba

nk ru ptc y in a n unr e late d b us ine ss w ou ld b e mate ri a l. Merc hant ar g ues that we should not consider the c ease and desist orde r bec ause it wa s 22 not entere d into evidence . Be asley , howeve r, admitted its exi stence , admitted rec eivingit, and admitted that it required Me rcha nt to stop selli ngunreg istered se curities in California.

54 disclos e bankruptcy

of prom oter’ s prior busin ess). See also Gill v. Thre e D im en sio n S y s. , I nc . , 87 F . S upp. 2d 1 278, 128 2 n. 2 ( M. D . F la . 200 0) (m isrepresentation of subs tantial busi ness experience of prom oter suppo rted 10b-5 claim ). Cf. 17 C.F .R. § 229.401 (f) (1) (instructing registrant to dis close federa l bankrupt cy

petition s of director or e xecutive officer in previous five y ears where

“ m aterial to an e valuation of the ability or integrity ” of such director or of ficer ). It w as the re fo re am at er ia l om iss ion . 21

C. Om issio n of cease and desist o rder Fi na lly , the S E C a lle ge s th at it w as m at er ia lly

m isl ea din g to om it the ex ist en ce of

ac ont em por an eo us c ea se a nd d es ist or de r that pr ohi bit ed

Me rc hant from selling id entical unregistered securities in California. Bea sley adm itted re ce ivi ng the or de r in O ct obe r 2002 , a nd M er ch an t c ont inu ed se lli ng the partne rs hip int er es ts at i ssu e he re unt il N ove m be r 2002 . T he dis tr ic t c ourt di d no t

22 spe ci fi ca lly

c onsi de r thi s arg um en t, tho ugh it w as m ad e in the dis tr ic t c ourt.55

W e find that it was c lear e rror not to count th is as a m aterial m isrepresentation. T he existence of a state cease and desist o rder a gainst id entical instrum ents is clearly

relevant to a r easonable investo r, who is naturally interested in whet he r m an ag em en t i s fo ll owi ng th e la w in m ark et in g t he sec ur it ie s. See , e.g., SE C v. P hy sicians Guardian U nit Inv. T rust, 72 F. Supp. 2d 1342 , 1351 (M. D. Fla. 1999 ) (a lle ga tio n th at

pr om ote r fa ile d to dis cl ose e xis te nc e of state c ea se a nd d es ist or de r supp orte d se curi tie s f ra ud c la im ); S E C v . P ar o, 468 F . S upp. 635 , 646 (N .D .N .Y . 1979) (m aterial om issio n when fa iled to dis close cease and desist o rders en te re d by

f ed er al a nd s ta te c ourts a ga ins t si m ilar pr ed ec es sor int er es ts) . S ee a lso Br eard v. S ac hnof

f & W eave r, L td. , 941 F . 2d 1 42, 143 -4 4 ( 2d C ir . 199 1) ( fa ilure to dis cl ose that ke y

f inanc ie r an d gu ar an tor

ha d pl ed gui lty to fr au d inc onne ct ion wit h s im il ar s ch em e, if

pro ve n, was m at eri al ); Zel l v . Int ercapi ta l In co m e Sec ., Inc ., 675 F. 2d 1 041, 104 6 ( 9thCi r. 198 2) ( pr oxy state m en t m igh t be m at er ia lly m isleading if failed to disclo se law suits charging viol ations of state and federal se curi tie s law s and i f tho se law sui ts b or e on i nve stm en t a dvi sor ’ s m an ag em en t ab ili ty ). T he om iss ionw as a ll the m or e m isl ea din g be ca use Me rc hant’ s partne rs hip m at er ia ls s pe ci fi ca lly

a nd r ep eate dly

r ep re se nte d th at

the RL L P int er es ts w er e not se curi tie s.56

V . Co nc lus ion

W e thu s ho ld tha t the RL L P int er es ts w er e inv es tm en t c ontra ct s c ove re d by the federa l securities law s, and w e re verse the j udgm ent of the district court in that re gard . W e al so h old

that the de fe ndants m ad e m at er ia l m isr ep re se ntatio ns and om iss ion s inthe m ar

ke tin g of tho se int er es ts a s e num er at ed above ; w e hol d th at

the dis tr ic t c ourt c om

m itt ed c le ar e rr or in co nc lud ing oth er

w ise . W e be lie ve the dis tr ic t c ourt i s inthe be st p osi tio n to de ci de the sc ie nte r an d r em ed ie s is sue s on re m an d ; h o we v er , i n l i g h to f o u r h o l d i n g s ab o v e, we v ac at e t h e d i s t ri ct co u rt ’s hol din gs w ithr es pe ct

to sc ie nte r an d r em ed ie s, a nd r em an d f or r ec onsi de ratio n in lig ht o f thi s op ini on. T he dis tr ic t c ourt f

ound that the de fe ndants did

not a ct w ithsc ie nte r. I n li ght of our rever sal on the inv estm ent contract and m ateriality issues, the district court shou ld r ec onsi de r w he the r the de fe ndants m et the standard

f or sc ie nte r in this ci rc uit , w hic h is sa tis fi ed by asho w ing of

“ se ve re r ec kle ssn es s. ” Br y an t v. A va do Br an ds, I nc . , 187 F . 3d 1 271, 128 2 ( 11th C ir . 199 9) . I n m ak ing thi s de te rm inatio n, the dis tr ic t c ourt sh oul d c onsi de r, int er a lia , the na tur e of

de fe ndants ’ om iss ion s and m isrepresentations; whether the defe ndants h ad any busin ess reason, a

part from evading the securities laws, for adopting a bus iness form that divid edTh e op ini on Wy e r p e rs on a lly

re c e ive d is of

c ours e re le va

nt i n th is r e g ard . A lso 23 rele vant ar e the opinions Wy er r ece ived from How ard, insofa r as they assessed doc uments that wer e identica l to or substantially simil ar to the of

fer ing materials in the instant ca se. The district c ourt sh ou ld a lso c on sid e r H ow ard ’s te sti mony that he ha d a dv ise d Wy e r a nd B e a sle y tha t so me states wer e investig atingwhether the RL L P interests were secur ities under state la w. Our mention of c erta in matters for the district court to consider on rema nd with respec t 24 to scienter a

nd reme dies is not intended to be exclusive or to limit the scope of the district cour t’s 57 inv es tor s in to tw en ty -e igh t se parate partne rs hip s, w he n th ey a dm itt ed int en din g to pool the m oney

all along; whether the defe ndants h ad a re ason to em ploythe sham ba llo tin g pr oc ed

ur e, apart f ro m e va din g th e se curi tie s law s; whe the r the a dvi ce of co unse l the y

r ec ei ve d w as ba se d onaf ull a nd c om

ple te dis cl osur e of

the na tur e of the RL L P int er es ts; w he the r the pr om ote rs ha d an in ce nti ve to pr olo ng the 23 busin ess past the poin t of viabilityin order to continu e collecting fees; and w hether that incentive helped exp lain why they failed to disclose kno wn perf orm ance inf orm at ionf

or int er es ts s old

be tw ee n June a nd N ove m be r 2002 , a s w el l a s w hy t h e y fa i l e dt o d i s c l o s e t h e c e a s e a n dd e s i s to r d e r a n dt h e p r i o r

b a n kr up t c y. Ce rt ai n qu es tio ns o f re m edy r em ai n to be de ci de d onr em an d a s w el l. T he district court origin ally

concluded that even if securities fraud had been es ta bli she d, no r em ed ie s w er e w ar rante d. T he dis tr ic t c ourt sh oul d r ec onsi de r thi s conclusio n in lig ht of this o pinio n and in lig ht of its reconsideration of the scienter iss ue . T he dis tr ic t c ourt sh oul d a lso r ec onsi de r w he the r inj unc tio ns, dis gor ge m en t, an d pe na lti es a re w ar

rante d. 24inquiry

on rema nd. Nor do we intend any expression of opinion on the ultim ate r esolution of sc ie nte r o r r e me die s is su e s, pr e fe rr ingfo r t he dis tr ic t c ourt

to a dd re ss s ame in t

he fi rs t in sta

nc e in light of this opinion. 58 REVERSED IN PART, VACATED IN PART, AND REMANDED.