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LLC Interests May Constitute 'Securities'

By Robert S. Reder

On June 11, 2008, the Second Circuit Court of Appeals, in affirming convictions for securities fraud and conspiracy to commit securities and mail fraud, ruled in U.S. v. Leonard, 2008 WL 2357233 (2nd Cir., June 11, 2008), that interests in various limited liability companies (“LLCs”) constituted “securities” for purposes of the federal securities laws. In so ruling, the court cited the U.S. Supreme Court's “repeated instruction to prize substance over form in our evaluation of what constitutes a security.” The Leonard analysis is instructive of the process that a court will follow in considering the status of non-traditional securities, such as LLC interests, under the federal securities laws.

The Leonard case arises from sales by defendants Paul Dickau and Nanci Silverstein of interests in two LLCs named Little Giant and Heritage Film Group, which they had formed to finance the production and distribution of movies. Interests in the LLCs were dubbed investment “units” and were priced at $10,000 each. Each sale of a unit generated a hefty commission of 42%-45% of the sale price; however, the offering memoranda used to market the LLC interests reflected a rate of no more than 20%. A federal jury returned guilty verdicts based on the misleading disclosures in the offering memoranda. The Second Circuit affirmed the convictions.

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