A recent court ruling drives home the difference between a joint venture and a security—and why it’s important for you to know the difference when you are raising money from private investors for your real estate investment opportunities.
SEC Prevails in Securities Fraud Case Involving Joint Ventures versus Securities
According to a post earlier this month on www.secactions.com, a widely read securities blog by former SEC staffer Tom Gorman, the SEC prevailed on a motion for partial summary judgment in an ongoing fraud case. The action stemmed from charges filed April 10, 2015, alleging that Mieka Energy Corporation of Flower Mound, Texas, and the company’s founder and president, Daro Ray Blankenship, fraudulently offered oil- and gas-related investments as joint ventures, when they were actually selling securities.
Additionally, the SEC charged that:
- Vadda Energy Corporation, Mieka’s publicly traded parent company, committed fraud and violated reporting requirements by deceptively touting the success of Mieka’s investments.
- By actively selling unregistered securities and receiving some $190,000 in commissions, Mieka salesmen Robert William Myers Jr. and Stephen Romo acted as unregistered agents.
Strict regulations around securities are meant to protect investors
The ruling in SEC v. Mieka Energy Corporation, Civil Action No. 4:15-cv-00300 (E.D.Tx.) determined that the joint venture contracts being offered to investors were securities, thereby triggering strict regulations designed to protect potential investors. Myers and Romo were required either to be registered broker-dealers themselves or be associated with a Commission-registered broker-dealer to earn commissions. Both men admitted they were not registered, a violation of The Securities Exchange Act of 1934, Section 15(a).
In his blog reporting the outcome of the case, Gorman chronicles the events:
“Beginning in September 2010, Mieka Energy … marketed what were called ‘joint venture interests’ nationwide to investors[1]. The offering package contained brochures, newspaper and magazine segments, a Confidential Information Memorandum, a joint venture agreement, a subscription agreement and a questionnaire. Investors were told that the funds raised in the offering would be used to drill, test and complete horizontal and vertical gas wells in Westmoreland, County, Pennsylvania. The documents also authorized the payment of offering and organizational costs and discussed a fee for Mieka Energy.”
The SEC alleged that Blankenship and Mieka raised $4.4 million from approximately 60 investors in 21 states to drill and complete the gas wells. While Mieka Energy did drill a vertical well, it was never connected and the company never drilled the horizontal well. About $850,000 was spent on development, according to Gorman’s blog, while Blankenship used the remainder of the funds for unrelated expenses and projects. He then misled investors about the company’s actions through deceptive newsletters and misleading public filings, which Blankenship signed and certified.
An issue of control
Myers and Romo were two of the salespeople involved in marketing the offering through what Gorman’s blog characterized as “extensive boiler-room type calls.” Investors were told they would be acquiring joint venture interests, but in reality, Blankenship had virtually total control and the investors had very little control resulting in a classic “investment contract”—a term which is included in the definition of a security within The Securities Act of 1933. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946), in which the U.S. Supreme Court defined an investment contract as “an investment of money in a common enterprise with an expectation of profits, based solely on the efforts of the promoter.”
In this case, the court found that the investors had practically no control over the enterprise or their investment and had limited knowledge or understanding of the venture and were therefore dependent on Blankenship’s management. In other words, Gorman said, “the investors entrusted their money in a common enterprise with the hope that a profit would be obtained through the efforts of those promoting the venture”—which falls squarely within the definition of an investment contract and is thus a security. Conversely, in a true joint venture, the parties would remain actively involved in management of their own funds.
While many real estate entrepreneurs would like to characterize what they are selling as joint ventures so they can freely advertise, they are usually selling passive investment opportunities—or securities—instead. As you can see from this article, it’s not what you say, it’s what you do that will be the ultimate test of whether you have violated securities laws. It’s always advisable to consult a qualified securities attorney to help you determine whether you are dealing with joint ventures or securities, and whether/how you can legally solicit investors, prior to offering investment opportunities to private investors.
At Syndication Attorneys, PLLC, we are happy to discuss your proposed business ventures using private investors. You can schedule a free, 30-minute consultation by clicking here.
For more information about joint ventures and securities
You may also find it helpful to read “Joint Ventures or Securities—What’s the Difference,” on the Articles page of this website. And our May 2017 monthly teleconference focuses on the topic as well.
You can access that recording by clicking here.
[1] Prior to September 23, 2013, there was no issuer exemption that allowed the type of advertising conducted by Myers and Romo, such as Rule 506(c), and in any event they could not have earned commissions unless they were licensed broker-dealers or associated persons of a licensed broker-dealer.
