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The U.S. Supreme Court’s Howey Decision says that an “investment contract” is an:
• investment of money due to
• an expectation of profits arising from
• a common enterprise
• which depends solely on the efforts of a promoter or third party
The SEC and state securities regulators use the Supreme Court’s four-pronged approach under the Howey case to determine if an investment is an investment contract and, therefore, a security. The, “depends solely on the efforts of a promoter or third party” above means this person is providing money, not labor or management, to the enterprise. The fact that the seller had no pre-existing relationship with the buyer would factor in, as well. For example, if you have been a trusted ranch hand for many years and the owners then sell you a part-ownership of the cattle ranch, you could just be a managing member of the LLC.
But, if a farmer is offering investors the chance to provide money in exchange for a share of the farm’s profits, that is an offer of a security. It is an investment of money in a common enterprise in which the investors expect to profit through the efforts of others.
Since the investment being offered is a “security,” the farmer could end up committing securities fraud if important facts were omitted or misstated. Since this investment fits the definition of a security, the offer must be registered. A registration statement allows the state securities Administrator to perform a background check on the issuer and requires the issuer to provide full disclosure of all risks and other material information to investors.
Sometimes the owners of an LLC forget that when the business offers shares of the LLC to non-managing members, this typically meets the definition of an offer of securities, subject to, at least, antifraud regulations and, maybe, registration requirements. Full disclosure must be provided, even if this disclosure is only for a few potential investors.