Monday, July 8, 2013

Can an Interest in a General Partnership be a Security?

I have previously written here about whether interests in an LLC or an LLP can be viewed as securities.  Recently, I came across a relevant post from the Compliance Building blog examining whether interests in general partnerships can be deemed to be securities.  When structuring investments and joint venture agreements, investors should always ask whether securities laws apply to their enterprises.  This, of course, depends on whether interests in these enterprises fall under the definition of a "security" under the federal securities laws.  The answer is not always clear.  There is a body of legal opinions that for years has been interpreting and defining the scope and the meaning of a "security".  Hence, caution should be exercised.

Read below Doug Cornelius' excellent blog post.  Link to the post is found here:

Is a General Partnership Interest a Security?

Looks like a great investment?
When the SEC announced an asset freeze against Western Financial Planning Corporation and its principal Louis Schooler, I was a bit troubled by the structure of the investments in question. The firm had structured the real estate investment vehicles as general partnerships. The presumption is that a general partnership interest is not a security. So if the investments are not securities, then there can’t be securities fraud, and the Securities and Exchange Commission loses the case.
During the temporary restraining order hearing, the court was willing to accept that the interests could be securities and granted the temporary injunction and asset freeze. The court recently ruled on whether to convert the temporary restraining order into a preliminary injunction. The ruling has a detailed discussion of the law on when a general partnership interest is considered a security. In my ongoing quest to find the line between what’s a security and what’s not, I spent a few minutes looking at the decision.
The defendants make the argument that “the case law over many decades has consistently held that there is a presumption that (1) interests in general partnerships are not securities, and (2) interests in raw land held solely for market appreciation are not securities.”  The court agreed and cited three key cases.
  1. SEC v. Merchant Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007) “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 and therefore does not rely solely on the efforts of others.”
  2. Shiner, 268 F.Supp.2d at 1340 “The general rule is that units in general partnerships are not investment contracts and therefore not securities under federal law.”)
  3. McConnell v. Frank Howard Allen & Co., 574 F.Supp. 781, 784 (N.D. Cal. 1983) “There is persuasive authority for the position that if an investor in a real estate syndicate expects profits to come solely from the general appreciation of property values, then the investment is not a security.”
But like any presumption, the presumption that general partnership interests aren’t securities can be overcome.  The securities laws define “security” to include an “investment contract” and general partnership interest could be considered an investment contract.  The Supreme Court, in 1946, defined an investment contract 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.” SEC v. W.J. Howey Co., 328 U.S. 293(1946). The requirement that profits be expected “solely” from the efforts of the promoter has been given a liberal reading and has largely dropped the term “solely” from the investment contract test.
The Court summarizes the law on when general partnership interests qualify as securities and labels Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981) as the seminal case. InWilliamson, the Court devised a three part operational test for an investment contract.
A general partnership or joint venture interest can be designated a security if the investor can establish, for example, that
(1) an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or
(2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or
(3) the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.
In application of that test to this case, the SEC failed to meet the requirements of the first two tests, leaving the last test as the finale in the decision. Western Financial argued “that there’s no possibility for dependency because all the general partners do is invest in raw land and wait for it to appreciate in value.”
The SEC countered by focusing on the exit, arguing that it was up to Schooler and his firm to find suitable purchasers of the property. The defendants fought back and said that any offer to purchase would be forwarded to the partners to approve. In a telling piece of testimony, the Western Pacific employee said that was the procedure, but he had never put it to test because he had “never seen an offer during my time with Western ever come out.” That’s bad, but not necessarily securities fraud.
Ultimately, the court was most influenced by the parcels of land being owned by more than one partnership sponsored by Western Financial. The effect is that the partnership only owns a fractional interest in the land, making each partnership more dependent on Western and Schooler to manage the investment, at least with respect to the inter-partnership dealings.
At least for this court, the interests in a general partnerships that hold raw land are more likely to be considered not securities. Developed land has an operational side that would required management.  But having multiple general partnerships own the undeveloped land in common swings the interests back to the securities side.
This article is not a legal advice, and was written for general informational purposes only.  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.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Tuesday, July 2, 2013

New Hires at Startups: A List of Documents Required to Hire Employees in New York

When searching for early helpers for your startup – you look for people who are determined, committed and can really make a contribution to your team.  Once you have decided who to hire, you should be prepared to complete a variety of forms and take multiple steps to comply with applicable federal and state employment-related laws.  Here, we attempt to summarize some of the employment forms new hires should fill out after they sign their offer letter and before they start working for you.  Disclaimer: this is not an exhaustive list, only a compilation of certain documents required federally and in NY state.  Keep in mind that this information changes periodically.  We encourage you to consult with your attorney and/or accountant for the updated documents.

Here it goes:

1.  At least a week prior to hiring your first employee, set up payroll.  ADP is great for small businesses.  

2.  You will need to register for and obtain unemployment insurance and workers' compensation insurance.  You can get workers' compensation insurance (it covers on-the-job injuries) from a private insurance company or through the New York State Insurance Fund.  Also, you will need to get disability insurance that covers off-the-job injuries and illnesses.  New York is one of a handful of states that requires all employers to get off-the-job disability insurance coverage for their employees.  This requirement applies even if you have only one employee, starting at the beginning of the second month of employment.

3.  On the first day, ask your new employee to fill out the W-4 Form.  Make sure you know your new employee's full name and social security number.

4.  On or before the commencement of employment (but after the acceptance of the job offer), ask your new employee to fill out Section 1 of the I-9 Form so that you can verify their employment eligibility.  This Form is updated annually, so make sure you use the most recent one.  The I-9 Form is meant to verify the identity and employment authorization of your potential employees, so all U.S. employers must fill it out.  Once the employee completes Section 1 of the Form I-9, you have three days from the day of actual hire to fill out Section 2 of the Form.  The Form must be handwritten and must be based on original documents, NOT copies.  You must keep the Form in your files for three years.  Here are links to some more information about the Form I-9: instructions and guidance.

5.  If you use investigative consumer reports to vet employees, you must have the potential hire fill out a Federal Fair Credit Reporting Act (FCRA) Consent.

6.  At the time of hire, and before/on February 1st of each subsequent year of employment, you must provide employees with written notice of several pieces of information, under NY Labor Law Section 195 (the Wage Theft Prevention Act). The employee must sign this notice, which includes: (i) employee’s rate of pay; (ii) whether the employee will be paid by hour, shift, day, week, month, salary, piece, commission or otherwise; (iii) whether the employee will claim any allowance as part of minimum wage (e.g., tip, meal, and lodging); (iv) employee’s regular pay day; (v) official name of the employer and other names used for business; and (vi) employer’s main address and phone number.  This notice must be in English and in the language identified by each employee as his/her primary language.  There are sample notices for different types of workers (hourly wage, annual wage, etc) here.
7.  Employers must provide their employees with a wage statement/pay stub on each payday that lists hours worked, rate of pay, how the employee is paid (by the hour, shift, day, week, commission, etc.), employee’s gross and net wages, itemized deductions, itemized allowance and credits claimed by employer, if any (tip, meal, lodging, allowances, credits, etc.), employee’s name, employer’s name, address and phone number, and dates covered by payment.  An example of a wage statement / pay stub is here.   

8.  Once you start hiring employees, it is a great idea to invest in an employee handbook.  Such handbook would have the company policies regarding vacation, holidays, work hours, social media, and personal leave.

9.  The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 requires all employers to report newly hired and re-hired employees to a state directory within 20 days of their hire or rehire date.  You, as the NY employer, have to complete the online form found here within 20 days from the first day the employee performs any service for which they will be paid. This information includes employee name, address, social security number, hire date. And employer name, address, IRS identification number, if dependent health insurance benefits are available to the employee. 

10.  Last but not least, a workplace is required to have federal and state employment posters.  Posters must be placed in a conspicuous place. You can purchase the posters at your local Staples store or online.  You can determine which posters you need by following these links: federal poster requirements and New York State poster requirements.  

Have we forgotten anything?  This list may not be comprehensive, so we welcome any and all additions and corrections you may have.

This article is not a legal advice, and was written for general informational purposes only. 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. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.