Why Special Opportunities Partners 1 Is Not A Security

The Supreme Court stated in Howey, “The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”

Courts interpreting the Howey decision generally have adopted the following three-prong test:

1. Investment of money (SOP1 Partners have legal control, can amend the agreement, have operational control, have financial control, representation, and donate time and talent in addition to money);

2. In a common enterprise (SOP1 Partners have the business expertise as a group and have done their own research); and

3. With the expectation of profits based solely upon the efforts of others (SOP1 Partners went in with the expectation of control,, they are organizing their own partnership meeting, hiring their own industry experts and can hire/fire management and operate the business via simple majority vote. Partners are involved both with management decisions and with various aspects of day-to-day operation of the business).

The particular issue raised by a partnership involves the third prong of the Howey formulation. In most instances courts have determined that partnership or joint venture interests are not considered an investment contract because the participants are not dependent solely upon the efforts of others for profits. Holden v. Hagopian, 978 F.2D 1115 (9th Cir, 1992); Rivanna Trawlers Unlimited v. Thompson Trawlers, 840 F.2D 236 (4th Cir. 1988); Deutsch Energy Co. v. Mazur, 813 F.2D 15667 (9th Cir. 1987); Youmans v. Simon, 791 F.2D 341 (5th Cir. 1986); Power Petroleum, Inc. v. P&G Min. Co., 697 F.Supp 492 ( D.Colo. 1986); and Casablanca Productions v. Pace Intern. Research, 697 F.Supp. 1563 (D.Or 1988). The Partnership requires Partner involvement throughout most aspects of the business and provides mechanisms to do so.

According to another ruling, the Court said that such an investor (to be considered a security) must demonstrate that he was so dependent on the promoter or a third party that he was in fact unable to exercise meaningful partnership powers”. Williamson v. Tucker, 645 F.2D 404 (5th Cir. 1961). The Partnership document provides multiple clauses protecting Partnership powers and enabling each Partner the ability to influence and exert control.

In order to be a security, these three points must be established: “(1) an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership " (the Partnership documents weigh the power in favor of the Partners themselves); or "(2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers" (the Partnership documents provide that only Partners knowledgeable and/or experienced in business affairs are accepted); or "(3) the partner or venturer is so dependent upon some unique ("non-replaceable expertise") entrepreneurial or managerial ability of the promoter or manager that he cannot exercise meaningful partnership of venture powers" (the partnership document strongly protects Partners from dependence on non-replaceable expertise and management). Id. at 424.

The court further states:

“...a reliance on others does not exist merely because the partners have chosen to hire another party to manage their investment.” “So long as the investor retains ultimate control, he has the power over the investment and the access to information about it which is necessary to protect against any unwilling dependence on the manager.” "...a partnership can be an investment contract only when the partners are so dependent on a particular manager that they cannot replace him or otherwise exercise ultimate control.” Id. at 424 n.14. The Partnership documents have multiple strong guidelines protecting the Partners ultimate control and the ability to replace management.

Cases decided since Williamson initially have focused upon whether the partnership agreement allocates powers to the partners that are specific and unambiguous and are sufficient to allow a majority of the partners to exercise ultimate control over the partnership and its business . Matek v. Murat, 862 F.2D 720 (9th Cir. 1988); Rivanna Trawlers Unlimited v. Thompson Trawlers,

840 F.2D 236 (4th Cir. 1988); Deutsch Energy Co. v. Mazur, 813 F.2D 12567 (9th Cir. 1987); and Power Petroleum, Inc. v. P&G Min. Co., 682 F.Supp. 492 (D.Colo. 1988). If the partnership agreement so allocates such managerial authority and power, these courts have found that the presumption that the partnership interest is not a security can be rebutted only by evidence that it is not possible for the partners as a group to exercise those powers. Rivanna Trawlers Unlimited v. Thompson Trawlers Borchardt, 840 F.2D at 241 & n.7. These cases would need to be completely overturned for SOP1 to be considered a security.

1. The powers and duties of the partners of the SOP1 Partners, as a legal matter, have the responsibility and control over partnership operations, via majority vote and multiple requirements thereto throughout the LLP memorandum and signature documents.

2. Partners also retain substantial authority under the terms of the employment contract.

3. Perhaps most importantly, the partners retain the power to dismiss the Interim Administrator at any time for any or no reason, with a simple majority vote and/or override decisions or actions of the Administrator.

Finally, under Williamson part three we examine whether the partners were “so dependent on some unique entrepreneurial or management ability of the promoter or manager that ... [they] cannot replace the manager of the enterprise or otherwise exercise meaningful partnership ... powers.” Williamson 645 F.2D at 424. Appellants must show that they were dependent on some “non- replaceable expertise” on the part of the promoter or manager; that “there is no reasonable replacement for the investments’ manager.” Id. at 423.

The focus under Williamson is on the "investor’s expectations at the time of the original investment" and “is not directed at what actually transpires after the investment was made, i.e., whether the investor later decides to be passive or to delegate all powers and duties to a promoter or managing partner.” Koch, 928 F.2D at 1477; Matek, 862 F.2D at 729; Williamson, 645 F2.D at 424 n.14 (“one would have to show that the reliance on the manager which forms the basis of the partner’s expectations was an understanding in the original transaction, and not some subsequent decision to delegate partnership duties.”) The Partnership documents shift control and activities more towards the Partners, themselves, that the Interim Administrator.

Under Williamson prong one our concern and focus is on the terms of the SOP1 Partners arrangement in which partners contributed

and on whether that arrangement afforded the members legal control over the limited liability partnership...

Recent decisions have limited the second or “investor sophistication” prong of the Williamson test by examining the knowledge and

business expertise of the investors as a group. Id. contra SEC v. Professional Associates, 731 F.2D at 352.

The proper inquiry is whether the partners are inexperienced or unknowledgeable “in business affairs” generally, not whether they are experienced and sophisticated in the particular industry or area in which the partnership engages and they have invested. Koch, 928 F.2D at 1479; Deutsch Energy, 813 F.2D at 1570; Williamson, 645 F2.D at 423.

... plaintiffs were General Partners under the Original Agreement, liable for the debts of the partnership and possessing voting power to control the Partnership’s affairs. Therefore we doubt whether their initial Partnership interest was a security. See, e.g., Siewart v. Ragland, 934 F.2d 1033, 1039 (9th Cir. 1991), Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991)

The very factors that made the original Partner interest unlike a security - unlimited liability and voting control - were the focus.... See. Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991)

It should be noted that any partner in SOP1 can obligate the partnership up to $500 without majority voting and can obligate the partnership within reasonable limitations via majority vote (something a security cannot do!) Additionally, the key management, operations, accounting and legal decisions are more in the hands of the Partners than the organizer.

... under the Original Agreement , plaintiffs as General Partners had full voting power with respect to these management changes. Such changes do not meet the Supreme Court’s definition of an investment transaction. Accordingly, on these undisputed facts, we agree with the district court that entry into the Amended Agreement did not result in plaintiffs’ “purchase” of a “security”. See, Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991). The Partners are required to vote and exercise their controlling ability.

To establish a claim under the federal securities laws, plaintiffs must prove fraud “in connection with the purchase or sale of any security.” Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 733-734, 95 S.Ct. 1917, 1924, 44 L.Ed.2d 539 (1975), Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991)

All partners were liable for additional pro-rata capital contributions “at such times and in such amounts as deemed necessary by vote of the Partners.” See, Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991). (The Partners face dilution if they don't contribute to capital calls.)

“Voting” provision gave the General Partners 80% voting power on “any items of partnership business which will substantially affect the Partners.” See, Klaers v. St. Peter, 942 F.2d 535 (8th Cir. 1991). (Partners, as a whole, direct what the Administrator or Management Committee does, not the other way around!)

In sum, plaintiffs were not like holders of assessable stock or the limited partners in Goodman, with limited liability, no control over Partnership decisions, and the ability to terminate their exposure by dissolving the partnership at any time. Plaintiffs’ potential liability as General Partners was unlimited and unconditional from the beginning. See Roberts v. Peat, Marwick, Mitchell & Co., 857 F.2d 646, 650-652, (9th Cir.1988). cert. denied, - U.S. - , 110 S.Ct. 561, 107 L.Ed.2d 556 (1989), Klaers v. St. Peter, 942

F.2d 535 (8th Cir. 1991). Because the Partners actively perform tasks and services, they can still be liable, despite LLP status, by virtue of their consistent active participation.

New Case law also shows that even Limited partnerships can be EXEMPT if the investors have certain legal authority…specifically…”[1] It is possible that a limited partnership interest or a non-managing member interest in an LLC could be outside the definition of an investment contract if the economic realities indicate that the limited partner has significant and legal control of partnership management.  See Steinhardt Group v. Citicorp, 126 F.3d 144 (3rd Cir. 1997)….”

Partners have the ability to affect management decisions via simple majority vote, the ballot formats are in the memorandum, and most of the initial partners have to date been very active in both management &even certain day to day affairs. The organizer, can retain ownership of voted out of management, and most of the management &operations can easily be outsourced, this putting the partners in position to affect the operations, the main decisions &outcomes, as provided for in many places within the memorandum &signature documents!

SOP1 is also not a security under the “Risk Capital Test”.:

“...the controlling factor ...under the risk capital test will be the third factor enumerated above-- .the degree of power the investors retain to affect the success of the enterprise. "When an investor entrusts money to another but retains substantial power to affect the success of the enterprise, the investor has not 'risked capital' within the meaning of the Corporate Securities Laws." (People v. Figueroa, supra, 41 Cal.3d at pp. 738-739.)”... “The court found that it was not contemplated that

the investor would play a passive role... For this reason, the investments were not deemed securities under the risk capital test.”

“(See e.g., People ex rel. Bender v. Wind River Mining Project (1980) 219 Cal.App.3d 1390, 1400 and People v. Miller (1987) 192

Cal.App.3d 1505 (risk capital test employed); Moreland v. Department of Corporations (1987) 194 Cal.App.3d 506 and People v. Coster, supra, 151 Cal.App.3d 1188; (both risk capital and federal tests employed); People v. Figueroa, supra, 41 Cal.3d 714 and People v. Smith (1989) 215 Cal.App.3d 230)”. These cases would have to be completely overturned due to all the provisions and implementation measures and mechanisms to exercise control.

“SOP1 PARTNERS ... SHOULD NOT BE CONSIDERED A SECURITY UNDER EITHER THE WILLIAMSON OR THE RISK CAPITAL TESTS”

“The documents provided taken in their entirety ... reflect an intent to form a genuine partnership, and therefore the sale of units in this enterprise should not be deemed a security under either state or federal law.”

The cases cited herein have been researched to the present date and none have been found to have been overturned as to any of the issues relating to the determination of partnership interests being subject to regulation as a “security”.

From Partnership Agreement:

1.02 Management The Company is to be managed by the members.

12.01 Amendment Procedure Amendments to this Agreement may be proposed by the Interim Administrator or a Majority in Interest of the Members. Any proposed amendment will be adopted and effective only if it receives the consent of a Majority in Interest of the Members.

12.04.1 A simple majority vote of the Partnership Units is sufficient to allow amendment to this Agreement to (a) alter the interest of a Partner income, gain, losses, deductions, credits and distributions; or (b) initiate and execute a Reorganization (See definition of “Reorganization”).

4.11.1 Power to Incur Liabilities Each Partner shall have the authority to bind the Partnership in making contracts and incurring obligations in the name and on the credit of the Partnership in the ordinary course of the Partnership business. No Partner, however, other than the Managing Partner, shall incur any obligation in the name or on the credit of the Partnership exceeding the sum of five hundred dollars ($500) without the consent of the other Partners or, if there be one, the Management Committee. Any Partner who incurs any obligation in the name or on the credit of the Partnership in violation of this provision may be held individually liable by the other Partners for the entire amount of the obligation thus incurred. The limitation on the amount of an obligation that may be incurred by any Partner contained in this Section may be increased or decreased at any time by agreement of all Partners.

From Management Agreement:

3. Term The term of this Agreement shall be from month to month ("Term"), unless earlier terminated as provided herein.

6. Termination This Agreement may be terminated by either party upon thirty (30) days written notice to the other party. Upon such termination, ASCI shall have no further obligations nor liability hereunder. Notwithstanding such termination, Partner's obligations relating to all indemnities referred to in Section 5, above, shall survive.

From Signature Page:

7. I UNDERSTAND THAT I AM A LIMITED LIABILITY PARTNER AND AS SUCH (i) HAVE THE RIGHT AND OBLIGATION TO VOTE ON ALL MATTERS CONCERNING THE PARTNERSHIP, (ii) MAY BECOME INVOLVED IN THE DAY TO DAY MANAGEMENT OF THE PARTNERSHIP AND IN DECISION MAKING IN ACCORDANCE WITH THE TERMS OF THE PARTNERSHIP AGREEMENT.

See also “Partnership Review Pre-Conditions”, "Confidential Evaluation and Non-Disclosure Agreement", “Appendix B”, “Petition For Exemption From Securities Registration/And Declaration Of Factual Understanding”, “What Can I Do For The Partnership?”, Committee Assistance Form", "Partner Experience, Resource and Contact Form", "Exhibit C – Partner Initiated Amendments"