Securities & Exchange Commission v. Merchant Capital, LLC

Rule of Law:

An investment scheme structured as a general partnership constitutes an investment contract, and therefore a security, if the investors are led to expect profits solely from the efforts of others. This is determined by the economic reality of the arrangement, where partners lack substantive power due to the partnership agreement, their inexperience in the specific business, or their dependence on the promoter's essential managerial efforts.

Facts:

• Steven Wyer and Kurt Beasley, who had no experience in the debt-purchasing industry, formed Merchant Capital, LLC to buy, collect, and resell charged-off consumer debt.
• Merchant solicited 485 members of the general public, who also lacked industry experience, to invest over $26 million in 28 separate RLLPs.
• Recruiters told potential partners their duties would be limited to checking boxes on ballots, despite partnership agreements formally granting them powers like approving large transactions and removing the manager.
• Merchant, acting as the sole managing partner for all 28 RLLPs, pooled the investors' funds to purchase fractional interests in debt portfolios owned and managed by a third-party company, New Vision.
• The ballots Merchant sent to partners to approve debt purchases contained only the issuer's name, face value, and price, which was insufficient information for an informed business decision.
• By June 2002, Wyer and Beasley knew the RLLPs were performing poorly but continued selling new partnership interests through November 2002 without disclosing this negative performance.
• Offering materials touted Wyer's business experience but failed to disclose his recent personal bankruptcy, which resulted from the failure of a business he presented as relevant experience.
• In October 2002, Merchant received a cease-and-desist order from the State of California for selling identical unregistered securities but did not disclose this to new investors.

Procedural Posture:

• The SEC brought an enforcement action against Merchant Capital, LLC, Wyer, and Beasley in the U.S. District Court for the Northern District of Georgia.
• After a bench trial, the district court entered judgment in favor of the defendants.
• The district court concluded that the RLLP interests were not 'investment contracts' and therefore not securities under federal law.
• The district court also found, in the alternative, that the defendants had not committed securities fraud.
• The SEC, as the plaintiff, appealed the district court's final judgment to the U.S. Court of Appeals for the Eleventh Circuit.