Opinion ID: 2452400
Heading Depth: 1
Heading Rank: 3

Heading: The Minnesota View

Text: The Supreme Court of Minnesota recently declined to adopt the Federal view set forth in Howey , as being exclusive under its securities laws. See State of Minnesota v. Investors Security Corporation, 297 Minn. 1, 209 N.W.2d 405 (1973). Perhaps the pioneer case of what constitutes an investment contract is set forth in State v. Gopher Tire & Rubber Co., 146 Minn. 52, 177 N.W. 937 (1920). There the Minnesota Supreme Court stated: The purpose of the statute is to protect the public against imposition. It is a new form of regulatory law which, in the course of a few years, has swept over 33 states. It has been said that its popular name indicates the evil at which it is aimed, that is, speculative schemes having no more basis than so many feet of blue sky, . and that it is intended to put a stop to the sales of shares in visionary oil wells, nonexistent gold mines, and other `get-rich-quick' schemes, calculated to despoil credulous individuals of their savings. It is a proper and needful exercise of the police power of the state and should not be given a narrow construction; for it was the evident purpose of the Legislature to bring within the statute the sale of all securities not specifically exempted. The Minnesota Court then went on to say: It is better to determine in each instance whether a security is in fact of such a character as fairly to fall within the scope of the statute.... We agree with the general approach taken by the Minnesota Supreme Court that the definition of a security within the meaning of the Arkansas Securities Act should not be given a narrow construction, and that it is better to determine in each instance from a review of all of the facts, whether an investment scheme or plan constitutes an investment contract, or a certificate of interest or participation in a profitsharing agreement, within the scope of the statute. In applying these principles to the facts in the case at bar, we are convinced that the so-called joint venture interests purchased by the Appellants constituted securities within the meaning of the Arkansas Securities Act. This transaction simply cannot be characterized as the sale of an interest in real estate. The entire scheme for marketing and managing the apartment complex was put together in one single package by Rector-Phillips-Morse. That corporation and its affiliates organized, constructed, managed and controlled the properties of the joint venture. The units were sold to investors as a tax shelter and upon the basis that the entire project would be constructed, managed and controlled by Rector-Phillips-Morse or its affiliated companies. However, the risk of loss of money actually invested was placed squarely on the investors, not only for their capital contributions, but also for any additional cash that would be required to make the payments to keep the property from going into foreclosure. In no sense was this a partnership in which a number of persons expected to pool their talents and capital and reap the benefits from their own expertise and abilities. The Stuttgart 221 investors were mere passive contributors of risk capital who placed their money in an investment program labeled a joint venture. However, the wording of the Trust Agreement and the Joint Venture Agreement, set forth a clear wall of difference between the promoters and the investors. Legal scholars whose expertise is in security matters have opined that certain general partnership and joint venture units may be securities. See 1 Loss, Securities Regulations 503-506 (2d ed. 1961); Soward, Fed.Sec. Act in 11 Business Organizations-Securities Regulation § 2.01[12] (1971), and Long, Partnership, Limited Partnership, and Joint Venture Interests as Securities, 37 Mo.L.Rev. 581 (1972). By this holding, we hasten to add that by no means are all general partnerships or joint venture units securities within the meaning of the Arkansas Securities Act. It is not the label that determines whether these units are securities, but the economic substance of the financing of the venture. Here, Rector-Phillips-Morse put the entire transaction together in a package. That package included the FHA commitment, the land, the construction of the apartments, the management of the apartments, the collecting of the rent, the making of the payment, and even granting to the trustee the authority to sell the entire complex. The investors were strictly passive investors who were buying an interest in a tax shelter with apparently a long-term hope of realizing capital gains on their investments. In short, when the transaction is examined as a whole, it constitutes the sale of securities within the meaning of the Arkansas Securities Act.
Section 7 of the Arkansas Securities Act, Ark.Stat.Ann. § 67-1241 (Repl.1966) provides that it is unlawful for any person to offer or sell any security in this state unless (1) it is registered under the Act, or (2) the security or transaction is exempted pursuant to Section 14 of the Act, Ark.Stat.Ann. § 67-1248 (Supp.1975). It is admitted by all concerned that the Stuttgart 221 joint venture investment program was not registered under the Act, and it is likewise admitted that the Appellees did not file for an exemption from registration as required by Section 14(f), Ark.Stat.Ann. § 67-1248(f) (Supp.1976). The Appellees contend that the transactions involving the Stuttgart 221 units were exempt from registration requirements as being one involving a private offering. Ark.Stat.Ann. § 67-1248(b)(9) describes this exemption as follows: (9) any transaction pursuant to an offer directed by the offeror to not more than twenty-five (25) persons (other than those designated in paragraph (8) of this State during any period of twelve (12) consecutive months, whether or not the offeror or any of the offerees is then present in this State, if (A) the seller reasonably believes that all the buyers in this State are purchasing for investment, and (B) no commission or other remuneration is paid or given directly or indirectly for soliciting any prospective buyer in this State; ... Ark.Stat.Ann. § 67-1248(f) provides: (f) Before any transaction sr all be executed as an exempted transaction under Section 14(b)(9), (10) or (11) a proof of exemption must be filed with the Commissioner. The proof of exemption shall contain a statement of the grounds upon which the exemption is claimed and a declaration of which subsection of Section 14 [this section] the exemption is claimed under. For every such proof of exemption filed with the Commissioner there shall be paid to the Commissioner a filing fee of ten dollars ($10.00). As heretofore stated, no proof of exemption was filed by Rector-Phillips-Morse, and therefore, the Appellees rely upon Rule 8(f)(3) of the Securities Commissioner of the State of Arkansas, effective September 1, 1972, which provides: The filing requirements of Section 14(f) [§ 67-1248(f)] are not applicable where five persons or less form a corporation or limited partnership, or enter into a trust agreement and receive the securities which are issued pursuant to the incorporation, where the requirements of Section 14(b)(9) are otherwise complied with. If this Rule is to apply here, the Appellees must first prove that they did not receive any commission or other remuneration for soliciting prospective buyers of the joint venture units which we have determined to be securities. Admittedly, Rector-Phillips-Morse put together the package which comprised the Stuttgart 221 project. It then contacted individuals by means of the confidential information and solicited the purchase by those individuals of units in this project. In the confidential information it was stated that Rector-Phillips-Morse intended to receive a profit of approximately $48,000.00. Because of cost overruns, it appears that the actual amount received was approximately $28,000.00. This includes a fee in the sum of $20,306.00 for consulting services received from the proceeds of the joint venture units sold to the investors. In addition, provisions were made for an additional payment of $100.00 per year for consulting relationship. It was admitted that $20,000.00 of the consulting fee was paid when liquid assets in the form of payment for these units first became available. Upon the showing of a sale of a security, the burden of proof shifts to the seller to show that the security was either registered, or was not required to be registered under the terms of the Arkansas Securities Act. A necessary ingredient in this showing is that no commission was paid, either directly or indirectly, for the solicitation for the sale of the security. We find from the evidence that the Appellees have not met this burden. Indeed, the record is silent as to whether or not any employees of Rector-Phillips-Morse actually received commissions based solely upon the sale of these joint venture units, but the record is clear that Rector-Phillips-Morse itself did receive over $20,000.00 in cash for consulting fees. When all of the evidence is viewed even in a light most favorable to the Appellees, we cannot escape the conclusion that Rector-Phillips-Morse did, in fact, receive remuneration, both direct and indirect, for the solicitation and sale of the joint venture units. Therefore, the Appellees' contention that the securities were exempt from registration pursuant to Rule 8(f)(3) of the Arkansas Securities Commissioner must fail. Because of the finding that such remuneration was paid, the question of whether or not more than five persons received securities becomes moot. Moreover, in this connection we would note that Rule 8(f)(3) is designed to permit the formation of small numbers of investors into their own designed business venture, such as a family store, without the filing of other documents to perfect an exemption under the Arkansas Securities Act. Rule 8(f)(3) was not designed for use by a promoter to create a venture in which the promoter was to receive direct or indirect commissions, fees, or other remunerations in connection with the organization, development and operation of the enterprise.
The Appellants are knowledgeable, experienced businessmen, and are registered stock brokers. Both are college graduates, and have maintained personal investments in securities of up to $100,000.00. The Appellees did not contact the Appellants to sell them joint venture interests in the Stuttgart 221 project. Rather, both were seeking income tax shelters and upon hearing of this project, they took the initiative and contacted the Appellees. The Appellants do not seek rescission of the purchase based upon any fraud or misrepresentations. In fact, they candidly admit that the project is doing extremely well. Their primary reason for seeking rescission is apparently that the Internal Revenue Service has not granted them the income tax deductions which they claimed. However, the Appellants have taken personal tax deductions during the years they have owned an interest in this project, in an amount in excess of their capital contribution. After enjoying the benefits of such income tax deductions, they now seek a court of equity to refund their purchase price and pay them interest and attorneys' fees, not because of any fraud or misrepresentation, but rather because of non-compliance with technical registration requirements. In Lane v. Midwest Bank Shares Corp., 337 F.Supp. 1200 (E.D. Ark.1972) District Judge, and now Circuit Judge, Henley held that the sophistication and relative knowledge of the buyer were relevant considerations in determining his reliance upon representations. Judge Henley found it difficult, even unrealistic, to apply conventional blue sky laws concepts to the aggressive investor in the Lane litigation. He concluded the Federal Rule 10b-5 and the Arkansas Securities Act should not be applied to rescue the buyer from the results of his own improvidence. Security laws are aimed at qualifying the doctrine of caveat emptor not to establish a scheme of investors' insurance. List v. Fashion Park, Inc., 340 F.2d 457, 463 (2nd Cir. 1965). Certainly it is not the intention of the Arkansas Securities Act to grant knowledgeable buyers of securities an undue advantage over sellers who are substantially less informed in the field. It was never intended that the securities laws be used as a tool of sophisticated investors to invest in projects or promotional schemes and reap the tax benefits accruing from such ownership, and then have the option several years later to determine whether they want to retain the investment or get their money back with interest while presumably retaining the tax benefits. Likewise, a party to a contract for the purchase of stock may, of course, be barred from maintenance of an action for rescission by laches, unless he acts promptly to repudiate the contract within a reasonable time after discovery of the facts entitling him to rescind. 12A Fletcher Cyc. Corp. § 5610. When a state statute of limitations applies to equitable as well as legal actions, it is clear that laches may still bar a plaintiff in equity before the expiration of the state statuteat least where the state statute does not provide otherwiseand perhaps (since laches is a matter of equity jurisprudence) even when it does. Ill Loss, Securities Regulations 1777. Here the Appellants purchased their interest in November of 1972. At the time of the purchase, the Appellant Schultz considered that the interest he was purchasing could be subject to securities registration requirements, but did not discuss this with the seller. No one ever represented to the Appellants either personally or in the confidential information that the interests were securities, either registered or exempt from registration. In fact, according to the testimony of the Appellees' officers, the possibility that the interests which they were selling might be securities or might need to be registered had not occurred to them. Each of the Appellants deducted a total of $30,000.00 on their 1972 and 1973 personal income tax returns. Even after suit was filed in January 1975, the Appellants reported an additional tax deduction of $21,400.00 on each of their 1974 returns. Likewise, after the filing of the suit, they each accepted $3,100.00 in income from the project during 1975. In applying the doctrine of laches, delay is measured from date of constructive knowledge, not just actual knowledge of the facts entitling the plaintiffs to bring suit. It is well settled that when the question of laches is in issue, the plaintiff is chargeable with such knowledge as he might have obtained upon inquiry, provided the facts already known to him were such as to put the duty of inquiry upon a man of ordinary intelligence. Johnston v. Standard Mining Co., 148 U.S. 360, 13 S.Ct. 585, 37 L.Ed. 480 (1897); Smith v. Olin Industries, Inc., 22A Ark. 606, 612, 275 S.W.2d 439 (1955). If this doctrine falls upon men of ordinary intelligence, it certainly would apply a fortiori in this situation, where two well-educated and highly experienced and knowledgeable stock brokers are concerned. A simple inquiry to Rector-Phillips-Morse would have revealed this information at the time of the sale in 1972. The delay of the Appellants in bringing this matter to the attention of the Appellees, worked to the prejudice of the Appellees, not only in that had it been brought to their attention before the sale, then for a payment of a $10.00 filing fee an exemption presumably could have been obtained, but also prejudiced the present marketability of the Schultz and Watkins interest. In tax shelter investments the attractiveness of the investment is based in large measure upon the front-end tax deductions which can be taken during the first few years after construction. These front-end deductions of over $100,000.00 for the interests owned by the Appellants have now been exhausted. When all of these factors are considered, we agree with the Chancellor below that the conduct of the Appellants, particularly in light of their training and experience, did not constitute the exercise of good faith and reasonable diligence, and that based upon the doctrines of laches and estoppel the doors of the equity court were justifiably closed to them. In making this finding of estoppel and laches, we are not in any way opening the door to schemes of promoters of unregistered and non-exempt securities whereby they can trap investors into waiving their rights by receiving dividends or taking tax benefits from their investments. Rather, it should be emphasized that these findings are made solely on the basis of the particular circumstances presented by this case. The judgment of the Chancery Court is affirmed. GEORGE ROSE SMITH and BYRD, JJ., dissent. FOGLEMAN, J., not participating.