Commercial Litigation and Arbitration

RICO/PSLRA Bar — Whether LLC Interests Constitute Securities = Fact Question — Measuring Time for 2-Year Continuity Requirement

From Automated Teller machine Advantage LLC v. Moore, 2009 U.S. Dist. LEXIS 68724 (S.D.N.Y. Aug. 6, 2009):

[LLC Interests as Triggering PSLRA Bar]

The PSLRA "bars private causes of action under RICO for predicate acts that describe conduct that would otherwise be actionable as securities fraud." Thomas H. Lee Equity Fund V, L.P. v. Mayer Brown. Rowe & Maw LLP, 612 F. Supp. 2d 267, 281 (S.D.N.Y. 2009); see also 18 U.S.C. § 1964(c). "A preliminary issue is whether the scheme involved 'securities,' as that term is defined by the Securities Act of 1933 [and] the Securities and Exchange Act of 1934." OSRecoverv. Inc. v. One Groupe Int'l. Inc., 354 F. Supp 2d 357, 369 (S.D.N.Y. 2005).

LLC membership interests are not "securities" unless they meet the definition of an "investment contract" set forth in SEC v. W.J. Howey Co., 328 U.S. 293, 300 (1946) (the "Howey test"). See Keith v. Black Diamond Advisors. Inc., 48 F. Supp. 2d 326, 332 (S.D.N.Y. 1999). To satisfy the Howey test, there must be '"[i] an investment of money [ii] in a common enterprise [iii] with profits to come solely from the efforts of others.'" Endico v. Fonte, 485 F. Supp. 2d 411, 412 (S.D.N.Y. 2007) (quoting Howey, 328 U.S. at 300). The third prong of the Howey test is not met if, at the time of the investment, the investor possesses a "'reasonable expectation . . . of significant investor control.'" United States v. Leonard, 529 F.3d 83, 88 (2d Cir. 2008) (quoting SEC v. Aqua-Sonic Products Corp., 687 F.2d 577, 585 (2d Cir. 1982)); see also Endico, 485 F. Supp. 2d at 415 n.16.

At this stage of the case when no discovery has occurred, the Court cannot determine whether the Wolfson Group's LLC membership interests in ATMA are investment contracts. Even assuming, arguendo, that the Wolfson Group invested money in a common enterprise, it appears from the Amended Complaint that, at the time of its initial investment into ATMA, the Wolfson Group had a "reasonable expectation of significant investor control" based upon its rights under the LLC Agreement. See Great Lakes Chemical Corp. v. Monsanto Co., 96 F. Supp. 2d 376, 392 (D. Del. 2000) ("to determine whether a member's profits are to come solely from the efforts of others, it is necessary to consider the structure of the particular LLC at issue, as provided in its operating agreement"). For example, the Wolfson Group had the right to appoint two of the three members of the Board and the right to "remove, with or without cause, any of its appointees to the Board." (LLC Agreement § 6.1(a)); see Monsanto, 96 F. Supp. 2d at 390 ("the court finds that the [plaintiff's] profits from [the LLC company] did not come solely from the efforts of others" because, among other reasons, plaintiff retained the "power to remove any [m]anager with or without cause"). The Wolfson Group also possessed "full access" to ATMA's "books, records, and properties." (LLC Agreement § 11.1); see Nelson, 173 F. Supp. 2d at 166 ("[p]laintiffs had access to investment information"); see also Hirsch v. DuPont, 396 F. Supp. 1214, 1222 (S.D.N.Y. 1975) ("by virtue of their managerial powers and express rights of inspection, [plaintiffs] could inform themselves as to the condition of the business and, through their efforts, promote its success"). And, the Wolfson Group retained the power to dissolve ATMA by written request. (See LLC Agreement § 12.2); see also Monsanto, 96 F. Supp. 2d at 392 (members of LLC company not passive investors where, among other things, they "had the power . . . to dissolve the company" under the LLC agreement).

Whether or not the ATMA membership interests are ultimately determined to be investment contracts is "more appropriately addressed in a summary judgment motion." Jones v. Deutsche Bank AG, No. 04 Civ. 5357, 2005 WL 2007892, at *2 (N.D. Cal. Aug. 12, 2005).

(2) RICO Continuity [Measuring 2 Years]

Defendants argue, among other things, that Plaintiff fails "to show how the alleged RICO scheme satisfies the [closed-ended] continuity requirement inasmuch as there was no more than 9½ months during which [P]laintiff was involved in funding ATM purchases"; "[t]his duration fails to meet the minimum two years necessary to find closed-ended continuity"; and although "[P]laintiff seeks to extend the time period by referencing several emails, receipt of a final periodic revenue payment and receipt of a final monthly report occurring after [September 29, 2006]," this "argument should be rejected because, as a matter of law, the predicate acts ended when [P]laintiff decided not to invest further money in the ATM Venture after September 26, 2006." ***

Plaintiff counters persuasively, among other things, that it "alleges 128 predicate acts — all essential to the successful operation of the ATM Sales Enterprise — which were committed from November of 2005 through January of 2008" which is "a period of more than two years"; "the ATM Sales Enterprise victimized other purchasers besides [Plaintiff]"; and "Defendants incorrectly argue that this Court should simply ignore any predicate acts not directly associated with the sales of the [Placed ATMs] and consider all other predicate acts as a 'cover-up' of the sales." ***

A period of at least two years is "typically required to constitute a 'substantial period of time,'" Physicians Mut. Ins. Co. v. Grevstone Servicing Corp., No. 07 Civ. 10490, 2009 WL 855648, at *7 (S.D.N.Y. Mar. 25, 2009), but "a scheme's duration alone is not dispositive [and] the court must examine the overall context in which the acts took place," Pier Connection, Inc. v. Lakhani, 907 F. Supp. 72, 78 (S.D.N.Y. 1995) (internal quotations omitted). Courts also consider the "number and variety of predicate acts, the number of both participants and victims, and the presence of separate schemes." DeFalco v. Bernas, 244 F.3d 286, 321 (2d Cir. 2001). ***

...Defendants' argument that "the predicate acts ended when [P]laintiff decided not to invest further money in the ATM Venture after September 26, 2006," ... is unpersuasive because Defendants' alleged post-September 2006 acts of mail fraud and wire fraud — which involved, among other things, the forwarding to Plaintiff of fictitious Monthly Reports purporting to show the transaction history of Plaintiff's Placed ATMs ... — were part of the same fraudulent scheme and "lulled [the Wolfson Group] into not seeking a return of [its] money." Local 875 I.B.T. Pension Fund v. Pollack, 992 F. Supp. 545, 567 (E.D.N.Y. 1998); see also OSRecoverv, 354 F. Supp 2d at 374 ("[t]hese alleged acts were not simply an effort to cover up or conceal past conduct, but were additional acts of fraud").

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