District Court Rejects SEC Argument that General Partnership Interests in Joint Ventures Are Securities

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[authors: William M. Regan, Jason F. Clouser]

The Securities and Exchange Commission brought an enforcement action against defendant Geodymanics, Inc. and others alleging fraud in connection with four oil and gas exploration and drilling ventures, each of which was governed by a separate but comparable joint venture agreement. The U.S. District Court for the District of Colorado granted Geodynamics’ motion to dismiss on the ground that the general partnership interests purchased by investors were not “investment contracts” – and thus not “securities” – within the meaning of the federal securities laws.

Under the Securities Act of 1933 and the Securities Exchange Act of 1934, a “security” includes an “investment contract,” which in turn is defined as “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”

A general partnership interest is presumed not to be an investment contract because a general partner typically takes an active part in managing the business. That presumption can be overcome by evidence showing that the general partner was somehow precluded from exercising his or her control and supervision powers.

The SEC argued that defendants’ alleged fraud precluded the general partners from exercising their control rights. In particular, the SEC argued that defendants controlled the information necessary for informed voting, concealed their misappropriation of funds, and misrepresented the status of projects.

The court rejected the SEC’s argument on the ground that the parties’ joint venture agreement on its face gave the general partners sufficient control over the business such that the joint venture agreement could not be considered an “investment contract.” The alleged fraud by defendants could not retroactively convert an ordinary general partnership interest into a security.

SEC v. Shields, No. 11-02121 (D.Colo. Sept. 6, 2012).