Are Undeveloped Lots Securities?

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As we recently found out from the CA Court of Appeals decision in People v. Dunham, undeveloped lots of land may be “investment contracts” and therefore, “securities”.

A brief summary of the facts of this case are as follows:  Ronald Duane Dunham convinced several elderly persons in 2004 through 2007 to invest over a million dollars into the purchase of undeveloped lots of land in Cherokee Village, Arkansas and/or support his real estate development efforts.  There was no fund created.  Purchases were made individually.  According to the court opinion, Dunham told the investors that “he would increase land values through the marketing and development of a retirement community.”  There were many misstatements in Dunham’s promises, which coupled with other misdeeds by Dunham, resulted in a criminal and civil lawsuits being filed against him.  In 2014, a jury convicted Dunham of 20 counts of grand theft, elder theft, and securities fraud.  Although the Court of Appeals reversed six out of 20 counts relating to grand theft (because it was a lesser included offense of elder theft), it affirmed the other convictions, including the securities fraud counts.

This case illustrates the ever more resilient nature of the Howey test that can put just about any investment scheme into the realm of securities laws.  As a way of background (just in case you haven’t heard enough about it yet), the US Supreme Court ruled in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) that an investment contract can be a security if it represents investment of money (or other consideration) in a common enterprise with an expectation of profits to be derived solely from the efforts of the promoter or a third party.  Hundreds of pages of legal analysis have been written since then about the Howey Test.  The test has been applied to find receipts for Scotch whiskey barrels, pairs of mating chinchillas, and the sale of beavers raised at a ranch all to be investment contracts.  More recently, the Howey Test has been applied to the initial coin offerings to find that digital tokens that investors received in exchange for their money were securities. 

Similarly here, the court looked at the Howey Test to determine whether the undeveloped lots were securities.  As the court noted:

“Here, like in Howey, Dunham offered investors an opportunity to contribute money and to share in the profits of a Cherokee Village retirement community, which would be managed, sold, and partly owned by Dunham. The lots represented the victims’ “shares in [the] enterprise.” (Howey, supra,328 U.S. at p. 300.) None of the California victims had any ability to develop homes in Arkansas, and they expected “Dunham and company” to sell their lots for them.  The victims were relying on Dunham to bring professional management, homebuilding, and financing experience to the project.”

They all expected a return on their investment.  Even though there was no investment fund or other syndication company created, and there was no management contract between Dunham and the victims, it was clear from the presentations, seminars, and marketing materials that the victims placed their trust in Dunham to develop the lots in order to increase their value. 

This case reminds us once again to disregard form for substance and focus on the economic reality when analyzing whether any investment is an “investment contract” and therefore is a “security”.  Even undeveloped land can be such.  What else?

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else’s views except for the author’s.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.  

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