SEC opinion is fodder for more securities speak

Just a few days ago the SEC rejected the notion asserted by certain tenant in common (TIC) real estate developers that a master lease and property management TIC structure did not involve securities within the meaning of Section 2(a)(1) of the Securities Act of 1933. See http://www.sec.gov/divisions/corpfin/cf-noaction/2009/omni011409.htm

At the same link is a copy of the request, prepared by Darryl Steinhouse, partner with Luce, Forward, Hamilton & Scripps, LLP of San Diego, California. Mr. Steinhouse's letter contains a solid overview of the different TIC structures and a thorough explanation of law that transactional real estate lawyers and sophisticated real estate investors will appreciate.

Does the SEC opinion letter mean that fractional vacation homes (typically structured as tenant in common transactions) are securities too? Not in my opinion. While the SEC provided no rationale for their decision in the letter, by stating this opinion the SEC must feel that each element of the test created by the US Supreme Court in SEC v. W.J. Howey (1946) 328 U.S. 293, could be met: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profits; and (4) solely from the efforts of the promoter or a third party. Later clarified in United Housing Foundation v. Forman (1975) 421 U.S. 837, 852 where the court found the "touchstone is the presence of an investment contract (security) in a common venture premised on a reasonable expectation of the profits to be derived from the entrepreneurial or managerial efforts of others."

While its true that certain flavors of fractional vacation home product (some condo hotels and others) have been structured by developers as investments where purchasers are sold on ROI rather than amenities they intend to use, most are not. Fractional vacation homes are a lifestyle purchase for most people and are generally structure by developers as such. This means that there is no expectation of profits on the part of the purchaser, only an expectation to use the property themselves.

In light of this new SEC opinion letter, developers and home owners interested in offering their property(ies) in fractional interests would nonetheless be well advised to retain counsel familiar with this area of the law in order to provide a legal structure that steers clear of the Howey elements. Buyers of fractional interests would be well advised to have counsel review the thick stack of documents necessary to effectively offer fractions and confirm that the seller has properly structured the arrangement to avoid securities implications. Beware of attorneys and real estate agents that offer to fraction a vacation property by simply forming an LLC or corporation! Read my previous post below for more detail on this.