Securities Division

More information on some specific securities

Interests in limited liability companies

A limited liability company (LLC) may be managed by its members or a manager. A.R.S. § 29-681. Interests in manager-managed liability companies are securities. See Nutek Information Systems, Inc. v. Arizona Corporation Commission, 194 Ariz. 104, 977 P.2d 826 (Ct. App. 1998), review denied, cert denied 528 U.S. 932.

Not only are the ownership interests of the limited liability company securities, but sometimes the business of the LLC is investing in securities. For example, hedge funds are sometimes limited liability companies. The company raises money by selling membership interests and then uses the money raised to invest in securities. In Arizona, the manager of an LLC that invests in securities may be an investment adviser and may need to license under the Investment Management Act of Arizona.

Interests in limited partnerships

Generally, a limited partner has no right to manage or control the partnership business. See A.R.S. § 29-319.. Thus, limited partnership interests are securities. See S.E.C. v. Murphy, 626 F.2d 633 (9th Cir. 1980), McGreghar Land Co. v. Meguiar, 521 F.2d 822 (9th Cir. 1975).

Not only are the limited partnership interests securities, but sometimes the business of the limited partnership is investing in securities. For example, hedge funds are sometimes limited partnerships. The partnership raises money by selling limited partnership interests and then uses the money raised to invest in securities. In Arizona, the general partner of a limited partnership that invests in securities may be an investment adviser and may need to license under the Investment Management Act of Arizona.

Investment contracts

Any time a transaction is structured so that a person invests money in a common enterprise with an expectation of earning a profit from the efforts of someone else, the transaction probably involves a security known as an investment contract. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

Almost any type of product can be included in an investment contract, which includes, but is not limited to:

• Assignments of notes secured by mortgages are securities – State v. Brewer, 26 Ariz. App.408, 549 P.2d 188 (Ct. App. 1976).
• Apple trees and management agreement are an investment contract – Rose v. Dobras, 128 Ariz. 209, 624 P.2d 887 (Ct. App. 1981).
• Master videotape and production service agreement are an investment contract – Vairo v. Clayden, 153 Ariz. 13, 734 P.2d 110 (Ct. App. 1987); Sullivan v. Metro Productions, Inc., 150 Ariz. 573, 724 P.2d 1242 (Ct. App. 1986).
• Art master and distribution and marketing agreement are an investment contract – Daggett v. Jackie Fine Arts, Inc., 152 Ariz. 559, 733 P.2d 1142 (Ct. App. 1986).
• Viatical settlement contract is an investment contract – Siporin v. Carrington, 200 Ariz. 97, 23 P.3d 92 (Ct. App. 2001).
• Note and property agreement are an investment contract – ACC Decision No. 69705
• Oil and gas investment is an investment contract – ACC Decision No. 69234
• Gold grub stake is an investment contract – ACC Decision No. 68159
• Diamond consignment program is an investment contract – ACC Decision No. 67551

Notes

When you borrow money, you are selling a note to the person lending you the money.

Both the Securities Act of 1933 and the Arizona Securities Act define security to include “any note.”  In some contexts, the courts have determined that a note should not always be considered a security.  An analysis of court interpretations in order to understand when a note may not be a security is a time consuming and complicated task.  The main thing you need to know is that you need to consider securities laws when you sell a note; you may wish to consult a securities attorney.

The Arizona Supreme Court has said that all notes are securities and must register unless the Arizona Securities Act provides an exemption.  See State v. Tober, 173 Ariz. 206, 841 P.2d 206 (1992).  Many transactions in which you borrow money (sell a note) are probably exempt from registration requirements because they are private placements, such as borrowing from a close relative, or sales to institutional buyers, such as borrowing from a bank or savings institution.

For purposes of Arizona antifraud provisions, an Arizona court of appeals has adopted what is commonly known as the Reves test to determine when a note is not a security.  See MacCollum v. Perkinson, 185 Ariz. 179, 913 P.2d 1097 (Ct. App. 1996).  The Reves test was created in 1990 by the United States Supreme Court in Reves v. Ernst & Young, 494 U.S. 56 (1990).  Prior to that time, federal courts used a variety of tests to determine when a note was not a security.  Not all states have adopted the Reves test for notes; some use tests developed by federal or state courts prior to Reves.

While the Reves test involves a three-step analysis, it is essentially based on the consideration of four factors.  No one factor is dispositive.

• Examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it.  If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a security.  If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash flow difficulties, or to advance some other commercial or consumer purpose, the note is less sensibly described as a security.
• Examine the plan of distribution to determine whether there is common trading for speculation or investment.  The requisite common trading is established if the instrument is offered and sold to a broad segment of the public.
• Examine the reasonable expectations of the investing public with respect to whether the note is an "investment."  Instruments are considered securities on the basis of public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not securities.
• Examine whether some factor significantly reduces the risk associated with the instrument, rendering application of securities laws unnecessary.  Alternative regulatory schemes, collateral, and insurance are all capable of reducing the risk sufficiently to render the protection of federal securities laws unnecessary.

For additional information, see SEC - Broken Promises - Promissory Note Fraud.

Variable Annuities

Variable annuities are securities.  Federal law preempts state securities registration requirements with respect to the variable annuity product. The variable annuity is a covered security. But any person who offers or sells variable annuities in or from Arizona must be registered as a dealer or salesman. A.R.S. §§ 44-1843.02(D) and 44-1848(A).

For additional information about variable annuities, see:

FINRA Spring 2002 – Reminder - Suitability of Variable Annuity Sales

SEC – Variable Annuities: What You Should Know

Viatical and Life Settlements

Viatical settlements or life settlements involve an interest in someone’s insurance policy.  The purchaser of the product receives a portion of the insurance benefits when the insured individual dies. The amount of return on the investor’s money depends on how long it takes for the insured individual to die.

Viatical and life settlements are securities.  Arizona law includes viatical and life settlements in the statutory definition of security. A.R.S. § 44-1801(26). Additionally, an Arizona court of appeals has held that viatical settlements are investment contracts. See Siporin v. Carrington, 200 Ariz. 97 (Ct. App. 2001).

Arizona law provides an exemption from registration for viatical or life settlement investment contracts. See A.R.S. § 44-1850.  If you offer or sell these types of investments in or from Arizona, however, you must register as a dealer or salesman.

For additional information, see SEC – Viatical Settlement

Arizona Statutes and Rules

Federal Securities Laws

The information provided on this web site is not comprehensive, is not offered as legal advice, and is not a substitute for competent legal counsel.  The Securities Division recommends that you consult with a securities attorney.