The Colorado Supreme Court rejected the Colorado Appellate Court’s finding that the Colorado Securities Commissioner failed to prove a heightened standard that a general partnership was an investment contract subject to federal and Colorado securities laws. The court proclaimed that the definitive case from 1981, Williamson v. Tucker, does not require starting with a “strong presumption” that a general partnership is not a security. The court remanded the case to the trial court for further findings consistent with this opinion (Chan v. HEI Resources, Inc., June 27, 2022, Hart, M.).
Why the Colorado lower courts rationalized Williamson against the Colorado Securities Commissioner. The case basically involves whether the Colorado Securities Commissioner can deem a general partnership an “investment contract” under Colorado and federal securities law to hold it accountable to those laws, particularly the Colorado securities laws. The definitive test is the U.S. Supreme Court SEC v. Howey case from 1946, in which the court found an investment contract if there was: (1) a contract, transaction, or scheme whereby a person invests his or her money; (2) in a common enterprise; and (3) is led to expect profits [substantially] derived from the entrepreneurial or managerial efforts of others.” The crux of the test for a general partnership has always hinged on the third prong because general partnerships typically manage and control themselves so, therefore, do not expect profits from the efforts of outside promoters or managers. This combined with Williamson’s holding that appeared to start with a strong presumption that general partnerships are not investment contracts resulted in the Colorado trial and appellate court’s ruling against the Colorado Securities Commissioner on this general partnership being an investment contract.
Colorado Supreme Court’s disagrees with lower courts read on Williamson. The Colorado Supreme Court, however, debunked the appellate court’s holding, declaring that neither federal nor Colorado securities laws impose a heightened burden of proof and, moreover, neither does Williamson. Instead, “what Williamson recognized, and we accept here, is simply that a venture operating as a bona fide general partnership will likely not satisfy the third prong of the Howey investment contract test because general partners are not passive investors.” The court went on to say that the Williamson opinion elaborated three distinct factual scenarios that could demonstrate that a general partnership might, in fact, meet the Howey test. And, as said by the court, these scenarios precisely mandate a court to look beyond the mere reading of the third prong’s text to look at the economic realities of the particular general partnership involved, i.e., to scrutinize not the form, but the substance, of the particular general partnership. The court stated, for example, that the general partners might not have the experience and sophistication to run the partnership without the help of more experienced, outside promoters or managers.
The Colorado Securities Commissioner set forth the following questions to determine the general partnership’s experience and sophistication:
- Do the partners generally have some prior business experience?
- What was the nature of that experience, both in their investing and in their other business dealings?
- Are the partners otherwise financially sophisticated?
- Did the partners hold themselves out as being experienced in business?
- Do the partners in fact have experience in the same type of business venture or industry?
- Is the nature of this particular venture such that industry- or venture specific experience would be essential?
- Did the partners consult counsel or indicate that they would do so?
- Did the partners in fact exercise partnership powers?
- Did the partners previously invest in one of the defendant’s businesses?
- How did the partnership acquire its members? and
- How much meaningful access to information about the venture is available to the partners
The case is No. 2022 CO 36.