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Securities Issues in Real Estate Investments February 2010 Presented by: Erin Joyce Letey 4810-6298-0357 Riddell Williams P.S. 2 Overview w Sources of securities law w What is a security? w How might a real estate transaction involve a security? w If a real estate transaction involves a security, what are the regulatory requirements? w What are some of the exemptions from securities registration that might apply in a real estate transaction? w What are some of the common mistakes made by companies raising funds? w What are some of the recent problems / unique issues presented by real estate related offerings? Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA Speaker 22: 1 Erin Joyce Letey of Riddell Williams P.S.

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Securities Issues in Real EstateInvestments

February 2010

Presented by:Erin Joyce Letey

4810-6298-0357

Riddell Williams P.S. 22

Overview

w Sources of securities law

w What is a security?

w How might a real estate transaction involve a security?

w If a real estate transaction involves a security, what are the regulatory requirements?

w What are some of the exemptions from securities registration that might apply in a real estate transaction?

w What are some of the common mistakes made by companies raising funds?

w What are some of the recent problems / unique issues presented by real estate related offerings?

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 1Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 33

Sources of Securities Law – Both Federal and State

Federalw Statutesw Securities Act of 1933

w Securities Exchange Act of 1934

w Rules and Regulations of the SECw Policy and interpretative releases, no-action letters

Statew RCW 21.20 – Securities Act of WAw WAC 460-44Aw Each state has separate set of securities

regulationsw State where your investor resides is the relevant

state for state securities law purposes

Riddell Williams P.S. 44

“Security” Defined

w “Security” is defined as “any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.” RCW 21.20.005(12)(a).

w Federal definition nearly identical. Section 2(a)(1) of 1933 Act.

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 2Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 55

“Note”: Presume it is a security

w A “note” (including promissory notes, debentures, convertible debt, etc.) is presumed to be a security under the family resemblance test established in Reves v. Ernst & Young

w A note may be excepted from the definition of “security” where the note strongly resembles one of the listed types of notes that are not considered securities

w Notes that are not considered securities include:w Note delivered in consumer financingw Note secured by a mortgage on a homew Short-term note secured by a lien on a small business or some of

its assetsw Note evidencing a “character” loan to a bank customerw Short-term notes secured by an assignment of accounts

receivable, or w Note that simply formalizes an open-account debt incurred in the

ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized)

Riddell Williams P.S. 66

“Note”

w Other factors considered in question of whether a note is a security:

w Motivation of parties

w Reasonable expectations of the investing public

w Plan of distribution

w Presence of another regulation regime

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 3Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 77

“Investment Contract”

w Serves as a catch-all to embrace all arrangements that look like a security

w Four elements of an “investment contract”:w An investment of moneyw In a common enterprisew With an expectation of profitsw Solely from the efforts of others

w E.g. investment in real estate coupled with management agreement

w Form disregarded for substance, and emphasis is placed on economic reality

w SEC v. W. J. Howey Co., 328 U.S. 293 (1946)

Riddell Williams P.S. 88

Basics of Securities Regulation

w Securities laws regulate both the offer and sale of a security

w Every offer and sale of securities must either be registered or exempt from registration

w Other areas of regulation: registration or exemption of every broker-dealer, securities salesperson, investment adviser or investment adviser representative

w Prohibition on fraudulent conduct, i.e., misrepresentations or failure to disclose material information

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 4Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 99

Private Offerings: Exemptions available

w Section 4(2) and RCW 21.20.320(1): Sales not involving a public offering -Very limited application

w Regulation D – Primary exemption used for private offeringsw Rule 504w Rule 505w Rule 506

w Rule 147 – Intrastate offering

Riddell Williams P.S. 1010

Rule 504

w Maximum Offering amount: $1,000,000

w Number of non-accredited investors: 20 in WA

w Investor qualification: In WA, sophistication or suitability

w General solicitation or advertising: No

w Sales commissions: No

w Limitations on resale: Yes

w Issuer disqualifications: Yesw Prior securities violations, fraud convictions, etc. by issuer, director,

officer, GP, promoter, or 10% owner

w Filing (SEC) – within 15 days after first sale (unless relying on Rule 147)w File Form D electronically on SEC Edgar system

w Filing (WA) – at least 10 business days prior to first sale in WA:w Copy of electronic Form D (or Notification of Claim Exemption)w Representation that sales have yet to occur in WA, andw $50 filing fee

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 5Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 1111

Rule 505 – Rarely Used

w Maximum Offering amount: $5,000,000w Number of non-accredited investors: Up to 35 (but information

requirements for non-accredited investors make this impractical for a typical private offering)

w Investor qualification: In WA, sophistication or suitabilityw General solicitation or advertising: Now Sales commissions: OK, if sales to accredited investors

or by registered broker-dealersw Limitations on resale: Yesw Issuer disqualifications: Yesw Filing (SEC) - within 15 days after first salew File Form D electronically

w Filing – within 15 days after first sale in Washington:w Copy of electronic Form D

w Date of first sale in Washington (cover letter), and

w $300 filing fee

Riddell Williams P.S. 1212

Rule 506 – Most Common Exemption

w Offering amount: Unlimitedw Number of non-accredited investors: Up to 35 (but

information requirements for non-accredited investors make this impractical for a typical private offering)

w Investor qualification: Sophistication if non-accredited w General solicitation or advertising: Now Sales commissions: Permittedw Limitations on resale: Yesw Issuer disqualifications: Now Filing (SEC) - within 15 days after first salew File Form D electronically

w Filing – within 15 days after first sale in Washington:w Copy of electronic Form D

w Date of first sale in Washington (cover letter), and

w $300 filing fee

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 6Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 1313

Form D Filing Process – Practical Considerations

w Form D must be filed electronically with the SEC, on paper with states

w For a 506 offering, due 15 days after first sale – first sale is the date on which the first investor is irrevocably contractually committed to invest (deposit of funds into escrow = sale, even if the offering closes at a later date)

w GIVE YOURSELF ENOUGH TIME:

w Need to obtain Edgar Access Codes for issuer (the entity issuing the securities) with the SEC first

w Electronically submit Form ID to SEC, together with notarized authentication document (www.filermanagement.edgarfiling.sec.gov/)

w Upon acceptance of Form ID by SEC (1-2 business days), issuer receives a “CIK” code via e-mail – issuer must return to website and use CIK to generate EDGAR access codes

w Form D filed electronically at www.onlineforms.edgarfiling.sec.gov/

w Washington requires copy of electronically filed Form D; some other states still require manually signed Form D (print Form D prior to submission for signature)

Riddell Williams P.S. 1414

Other Washington Exemptions

w “Whole Mortgage” Exemptionw RCW 21.20.320(5) exempts:w Any transaction in a bond or other evidence of indebtedness

secured by a real or chattel mortgage or deed of trust, or by an agreement for the sale of real estate or chattels, if the entiremortgage, deed of trust, or agreement, together with all the bonds or other evidences of indebtedness secured thereby, is offered and sold as a unit

w Not available where:w Transaction involves partial interestw There is more than one purchaser, orw Transaction does not involve debt

w Isolated Transaction (Limited Offering Exemption)w Limited to 3 sales during the prior 24 months

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 7Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 1515

Common Mistakes – Issues in Raising Funds

GENERAL SOLICITATIONw Prohibited activities: w Advertisingw Website posting w Purchasing a list of accredited investors w Offering by mass email to a certain group or club, even if you are

a member and even if you are confident they are accreditedw e.g., all of the members of your country club, or all the attendees of

this conference

w Asking any third party, such as a finder or business broker, to do these prohibited activities on your behalf.

w Key: Investors must have pre-existing personal or business relationship with you, your company or your management

w Relationship must be of sufficient length and duration that you can evaluate their financial position and suitability

Riddell Williams P.S. 1616

Common Mistakes, Cont.

DISCLOSURE ISSUESw Need to disclose to your investors all material facts about the

investmentw Cannot omit to state any material facts necessary in order to

make the statements made not misleadingw At a minimum, include:

Description and details regarding the propertyBios of managementUse of proceedsRisksIndustry / market information (including a discussion of competitors, if relevant)Description of terms of securitiesLimitations on transferMaterial agreements (and any agreement with related parties)Financial statements

w If you don’t want to disclose something because you believe it will make your investor less likely to invest, it is material

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 8Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 1717

Common Mistakes, Cont.

w Common items that may be seen as misrepresentations or material omissions:w “Guaranteed” returnw Secured investmentw Fee disclosuresw Bankruptcy / defaults by management

BROKER DEALER ISSUESw Payment of commissions to non-registered broker/dealerw Any person engaged in the business of effecting transactions in

securities for the account of others is a brokerw Hiring “finders” or business brokers that are not registered as

broker/dealers is risky, and depending on exemption, not permittedw Employees of issuer with job of finding investors, who are paid

commission for such sales, may be considered brokers

NON-COMPLIANCEw Failure to file or late Form Dw Note: Some practitioners believe WA exemption is arguably lost if

Form D is not filed timely

Riddell Williams P.S. 1818

TIC Developments

w SEC “No Assurance” letter to Omni Brokerage, Inc., Argus Realty Investors, L.P., and PASSCO Companies, LLC, issued January 14, 2009

w Involved “sponsor” entity purchasing income-producing real property

w Sponsor sold undivided tenant-in-common interests to up to 35 individuals in return for cash and assumption of debt on property

w Investors purchased TIC interests subject to 20-year Lease with Master Tenant, a property management agreement, and asset management agreement.

w Attorneys for TIC sponsor argued TIC interest was not an “investment contract” under federal securities law – SEC rejected.

w If TIC interest is a security, it may be a disqualified property for purposes of a tax-deferred exchange under IRC §1031, investors have rescission rights, sponsor and brokers subject to civil and criminal liability.

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 9Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 1919

Condo / Hotel

w Depending on how structured, securities laws may apply

w Sale of condo, no intent to occupy or restricted use of unit, coupled with mandatory management/rental agreement, turns purchase of real estate into investment contract

w Investment of money in a business enterprise where profit (rental income) comes solely from the efforts of the developer’s management of the property = investment contract = security

w If securities laws apply:

w Disclosure obligations

w Exemption needed

w Accredited investors

w Limitations on manner of offering – no advertising!

w If no exemption, purchasers have rescission rights

Riddell Williams P.S. 2020

Condo/Hotel: How to Avoid Application of Securities Laws

w Intrawest No-Action Letter, 2002w Keep rental management program completely separate from sales program –

real estate sales personnel cannot promote the investment nature of the condo

w Sales materials cannot discuss the economic or tax benefits from entry into a rental arrangement or provide rental information

w Can mention program but limited to the following statement: “Ownership may include the opportunity to place your home in a rental arrangement”

w Entry into real estate purchase and sale completely independent from decision to enter into rental management agreement, and real estate purchase must be binding first

w Rental program is voluntary

w Condo owners free to use any rental management company

w No pooling of rents

w Rental program cannot provide projections of rental income or occupancy rates – can provide historical raw data only

w Do not compensate real estate sales personnel for rental agreements entered into by condo purchasers

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 10Erin Joyce Letey of Riddell Williams P.S.

Riddell Williams P.S. 2121

w Vail Resorts No-Action Letter, April 25, 2007

w SEC denied no action relief to Vail Resorts

w Program structured similarly to Intrawest except Vail offered dues reductions, free furniture and complimentary ski season passes as participation “incentives” to purchasers who had already signed a binding contract (not limited to those that affirmatively inquired about a rental pool)

Questions?

Please contact us any time with additional questions.

Erin Joyce [email protected]

Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA

Speaker 22: 11Erin Joyce Letey of Riddell Williams P.S.