A battle is underway in a federal district court in Florida between the SEC and Carl Ruderman, the disgraced former CEO and Chairman of 1 Global Capital, LLC, over whether allegedly fraudulent investments issued by 1 Global Capital are “securities” for purposes of applying federal securities laws. The outcome of this issue will be important to the scores of investors nationwide who have sued their financial advisors for recommending the 1 Global Capital investments. Some of the claims those investors have alleged, including claims for the sale of unregistered securities, will turn on whether or not the 1 Global Capital investments qualify as “securities” under securities laws.
Ruderman initiated the pending legal battle by filing a motion to dismiss the SEC’s case against him on the grounds that the SEC does not have jurisdiction to prosecute the case due to the non-securities nature of the investments at issue. In response, the SEC has argued that the investments are promissory notes, that “notes” are presumed to be securities for purposes of federal securities laws, and that Ruderman has failed to rebut that presumption.
Both parties have invoked Reves v. Ernst & Young, 494 U.S. 56, 65 (1990) in support of their positions. Reves is the seminal federal case when it comes to analyzing whether a “note” is a security. Ruderman argues that the 1 Global Capital investments are not securities because they fall under two categories of notes that Reves specifically identified as not being securities: “short-term notes secured by a lien on a small business or some of its assets,” and “short-term notes secured by an assignment of accounts receivable.” The SEC counters that, while 1 Global Capital may have used investor funds to make secured loans to small businesses, including loans secured by accounts receivables, the investments that 1 Global Capital issued to investors cannot themselves be considered secured loans to a small business or loans secured by accounts receivable.
The SEC further argues that the dispositive test of whether a note, including one secured by the assets of a small business or by accounts recievable, is a security is the “family resemblance” test adopted by the Supreme Court in Reves. The family-resemblance test examines: (1) the motivations of the buyer and seller; (2) the plan of distribution; (3) the reasonable expectations of the investing public; and (4) the existence of an alternate regulatory regime. Reves, 494 U.S. at 66-67. If a note fails the family resemblance test, it is deemed to be a security for purposes of federal securities laws.
According to the SEC, all four Reves factors weigh in favor of finding that the 1 Global Capital notes are securities: the first factor is satisfied because investors were motivated by the “high single digit” or “low double digit” rate of return that 1 Global Capital offered; the second factor is satisfied because the 1 Global Capital investments were “offered and sold to a broad segment of the public”; the third factor is satisfied because investors viewed the 1 Global Capital investments as passive investments generating safe returns; and, the fourth factor is satisfied because there is no alternative regulatory scheme protecting the investors.
As an alternative argument, the SEC asserts that the 1 Global Capital investments are “investments contracts,” which are also included in the definition of “security” under federal securities laws. The SEC relies on the Howey test, which defines an “investment contract” as (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profits to come solely from the efforts of others.
The federal court presiding over the case is now in receipt of all of the parties’ legal briefs; however, a date still needs to been set for an oral argument. The date will likely be after June 2019 as the parties have been ordered to, and are scheduled to, mediate the case in June 2019.