In an amicus brief filed in the Ninth Circuit, the SEC contends that a series of related contracts involving the sale and rental management of hotel rooms in a hotel that the promoters were constructing constituted investment contracts under the federal securities laws when from the time the sales commenced the purchasers had so little use or control of the rooms that they had no practical alternative but to rely on the promoters to rent the rooms and obtain profits, which were shared between the purchasers and the promoters. Allowing to stand the district court's holding that there was not the sale of a federal security would impermissibly allow a promoter to avoid the coverage of the federal securities laws by artificially dividing a single investment transaction into ostensibly separate parts, and including written disclaimers falsely stating that there is no investment expectation. Salameh v. Tarsadia Hotel, CA-9, No. 11-55479.
Language in the sales agreements disclaiming any investment expectation should not be given any weight, argued the SEC, because the economic and practical reality demonstrates that the transactions were investments. The existence of an investment contract turns on the economic and practical realities of the transaction, said the SEC and not the legal formulations or contract terminology the parties may use.
According to SEC as amicus, the district court misapplied the Howey test by treating the room sales and the rental program as separate transactions. Parties cannot escape the federal securities laws by artificially dividing a securities investment into a series of ostensibly discrete transactions. The SEC said that courts must ascertain the general scheme of profit seeking activities that was explicitly or implicitly offered to induce the purchase, citing the seminal Ninth Circuit ruling in Hocking v. Dubois, 885 F.2d 1449, 1457-58 (9th Cir. 1989) (en banc) where the full Ninth Circuit, applying the Howey test, recognized that condominium sales offered in conjunction with rent pooling or rental management agreements can constitute an
If the economic and practical realities indicate that multiple agreements in fact comprise a single transaction or package, reasoned the SEC, they must be analyzed together to determine if they constitute an investment contract. The room sales and rental management program plainly constituted a single transaction, said the SEC. an investment in a hotel enterprise. Further, there is no dispute that each purchase required an investment of money that exposed the purchaser to a risk of financial loss. The SEC also said that a common enterprise exists because the Rental Management Agreement establishes a revenue-sharing
arrangement for each participating room between the promoter and the unit owner. It is also apparent, said the SEC, that the plaintiffs were led to expect profits from the promoters efforts.
From the time of the room sales, said the SEC, the plaintiffs were precluded for all practical purposes from exercising any meaningful control over their rooms. The promoters had reserved such authority for themselves. Moreover, the Rental Management Agreement expressly provided the promoters with exclusive authority to manage, operate, market and rent the owner’s room. Hocking teaches that the essential showing of an expectation of profit from the essential efforts of others is established where the purchaser demonstrates a practical “inability to exercise meaningful powers of control or to find others to manage his investment,” notwithstanding any appearance of legal control that the parties’ written agreements may suggest.