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Turnkey Real Estate Investments as Securities

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Turnkey real estate investments, whereby a sponsor or promoter buys a piece of real estate, fixes it up, sells it to an investor, and then either leases it back or manages it for them, have become extremely popular across the country for promoters and investors alike. The question that has come up, however, is whether turnkey real estate investments are actually just vanilla real estate transactions or securities in disguise. Real estate attorneys, experienced in real estate transactions, may not necessarily recognize the securities’ implications when their clients are promoting the turnkey transaction as an investment opportunity. This article addresses that issue for practicing attorneys: Are turnkey real estate investments actually securities in disguise; and, if so, how should they be legally marketed and distributed?

What Is a Security Under Federal Law? The Statutory Definition

Section 17(a) of the Securities Act makes it unlawful to engage in certain conduct “directly or indirectly” in “the offer or sale of securities.”[1] To determine whether the offer and sale of turnkey investments constitute the offer and sale of a security or an investment in real estate, it is necessary to start with the statutory definition of a “security” under the Securities Act of 1933, 15 U.S.C. §77a, et seq. (Act of 1933) and/or the Securities Acts of 1934, 15 U.S.C. §78a, et seq. (Act of 1934) (collectively “securities acts”). The term security is broad[2] and encompasses any note, stock, debenture or investment contract, just to name a few.[3] A security includes both instruments whose names alone carry well-settled meaning, as well as instruments of “more variable character [that] were necessarily designated by more descriptive terms,” such as “investment contract” and “instrument[s] commonly known as a ‘security.’” [4] While real property is not specifically included in the statutory list, this does not mean that offerings of real estate cannot be securities and, therefore, outside the purview of the requirements of the securities acts.

The statutory definition is helpful in identifying some types of securities, yet it is not exclusive.[5] The U.S. Supreme Court has consistently held that “form should be disregarded for substance and the emphasis should be on economic reality.”[6] The congressional purpose in enacting the securities laws was to regulate investments, regardless of the form and structure of the instrument,[7] in order to protect the general public. The term “security” has been defined to include documents in which there is common trading for speculation or investment. Congress included “investment contracts” in its definition of “securities” in order to encompass complex and creative investment schemes.[8] Due to the “virtually limitless scope of human ingenuity,” a security should be construed broadly enough to include almost any device or scheme that might be offered and then sold as an investment.[9]

In the specific context of turnkey real estate investments, whether such an offering constitutes an “investment contract” as defined by the Act of 1933 will undoubtedly be a fact-specific inquiry as to the stylistic details of the deal. That notwithstanding, an analysis of whether a real estate offering is a security can be distilled into one simple question: Does the offering have the characteristics of other securities? Namely, does the offering of the turnkey real estate consist of the elements that would constitute an investment contract under the securities acts?

Investment Contracts Under the Howey Test

To that end, we look first to the preeminent case regarding investment contracts, Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293 (1946). The defendants, W. J. Howey Co. and Howey-in-the-Hills Service, Inc., were corporations organized under the laws of the state of Florida. William John Howey owned large tracts of citrus groves in Florida. The Howey Co. kept half of the groves for its own use and sold real estate contracts for the other half to finance its future developments. The Howey Co. then sold the land for a uniform price per acre (or per fraction of an acre for smaller parcels) and conveyed to the purchaser a warranty deed upon payment in full of the purchase price.

The purchaser of the land could then lease it back to the service company Howey-in-the-Hills, via a service contract, which would tend to the land, and harvest, pool, and market the produce. The service contract gave Howey-in-the-Hills “full and complete” possession of the land specified in the contract and left no right of entry or any right to the produce harvested. Purchasers of the land had the option of making other service arrangements, but the Howey Co., in its advertising materials, stressed the superiority of Howey-in-the-Hills’ service. The Howey Co. marketed the land through a resort hotel it owned in the area and promised significant profits in the sales pitch it provided to those who expressed interest in the groves. In Howey, the issue was whether the contracts sold by Howey (which were basically leaseback agreements) constituted an “investment contract” within the meaning of §2(a)(1) of the Securities Act of 1933. The court found that Howey was selling “investment contract” within the meaning of Act of 1933.
The Supreme Court ruled that the contracts in Howey were “investment contracts” and determined that an “investment contract” has the following elements: 1) an investment of money; 2) in a common enterprise; 3) the investor has a reasonable expectation of profits; and 4) profits flow from the entrepreneurial or managerial efforts of others. This article briefly examines all four prongs of the Howey test, including the split among U.S. district court circuits regarding horizontal and vertical commonality under the “common enterprise” prong of the Howie test and expound upon their differences and potential applicability. This article also provides a case study examining how the U.S. Supreme Court could determine an investment contract a security under the Howey test.

It Is an Investment of Money — Although in Howey the term “money” was used, subsequent caselaw has expanded this concept to include any form of consideration with value.[10] The first prong of the Howey test, an investment of money, is rarely an issue when the courts attempt to identify investment contracts. In every decision made by the Supreme Court that recognizes the presence of an investment contract under the securities acts, the person found to have been an investor voluntarily chose to give up specific consideration in return for a separable financial interest.[11] Thus, the tangible consideration in the form of cash or like-kind credit given by investors in exchange for their interests satisfies the first prong of the Howey test.

The Investment of Money Is In a Common Enterprise — The second prong of the Howey test requires the existence of a common enterprise. [12] There is currently a split among the circuits, however, as to the requirements of the second prong of the Howey test. Circuit courts have established two different versions of commonality: 1) “horizontal commonality,” which involves the pooling of money or assets from multiple investors whereby the investors share in the profits and risk in some proportion; 2) “vertical commonality,” which focuses on the relationship of the parties. In vertical commonality, the investor’s profit or loss is subject to the efforts of the promoter putting together the deal, regardless of the existence or status of other investors. Vertical commonality can further be broken down into “broad vertical commonality” whereby the promoter’s profits are not tied to the investor’s profits and “narrow vertical commonality” whereby the promoter only profits if the investor profits.

Most circuits that have considered the issue of a common enterprise in relation to investment contracts find that the common enterprise requirement is satisfied through horizontal commonality.[13]

The Fifth,[14] Ninth,[15] and 11th circuits,[16] however, have adopted some version of vertical commonality. In vertical commonality, the investor’s profit or loss is subject to the efforts of the promoter putting together the deal, regardless of the existence or status of other investors. Vertical commonality focuses on the relationship between the investors and the promoter, not on the relationship between the individual investors.[17] Vertical commonality requires the fortunes of the investor to be “interwoven with and dependent on the efforts and success of those seeking the investment or of third parties.”[18] Within the circuits that have adopted vertical commonality under the second prong of the Howey test, two variations exist: narrow vertical commonality and broad vertical commonality.[19]

Under the Ninth Circuit’s narrow vertical commonality, there must be a direct correlation between the promoter’s success or failure and the investors’ profits or losses. Under the Ninth Circuit standard, there is no common enterprise if, for example, the promoter receives a flat commission irrespective of whether the investor makes or loses money on the underlying venture. Under “narrow vertical commonality,” commonality will be found if the promoter only profits if the investor profits. The Fifth Circuit view is not as stringent, however, finding “broad vertical commonality” where the promoter’s profits are not tied to the investor’s profits. “[T]he critical inquiry is confined to whether the fortuity of the investments collectively is essentially dependent upon promoter expertise.”[20] The 10th Circuit test of whether a common enterprise exists is not based solely on the presence of either horizontal or vertical commonality.[21] “The determining factor of a common enterprise and the economic reality of the transaction is whether or not the investment was for profit.”[22]

In the typical non-affiliate turnkey transaction, the sponsor or managing third party does not gain profits or suffer losses independent of action exercised by investors, thereby reducing the trigger of Howey’s second prong. However, if the sponsor or managing third party does gain profits or suffer losses in accordance with this (whether proportionally, causally, or maybe even correlational) should satisfy the second prong of Howey. In turnkey real estate operations, investor fortunes and profits are most likely adequately interwoven with, and dependent on, the efforts of the sponsor and third parties to the extent necessary to satisfy vertical commonality in both forms.

There Is a Reasonable Expectation of Profits from the Investment — The third prong of the Howey test requires a reasonable expectation of profits by the investor. The investors in Howey were lured into the investment not by the prospect of mere undivided ownership in land, but rather by the prospects of a return on their investment from the pooling of assets and sharing in the profits of the enterprise.[23] Profits can be in the form of capital appreciation, cash return on investment, or other earnings (including dividends or interest). The enticement of tax deferral may also constitute profits under the third prong of Howey.[24] Profits for purposes of the Howey test refers particularly to a return to the investor and not necessarily the success of the enterprise as a whole. The analysis turns on a finding that the investor is motivated by a return on his investment. In the typical non-affiliate transaction, investors purchase turnkey investments with the expectation that the property will produce continuous income through rentals and leasing, that the value of the property will appreciate, or both. Alternatively, investors may purchase turnkey investments in order to defer taxes through 1031 exchanges. Turnkey investors most certainly have an expectation of profits for the purposes of the third prong of the Howey test.

Any Profit Comes from the Entrepreneurial or Managerial Efforts of Others, Whether a Promoter or Third Party — The efforts of the promoter(s) or third party(ies) must be undeniably significant in the success or failure of the enterprise. The Howey court did not adopt this test as a bright line rule, however. Rather, the Howey court stated the test is a “flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”[25]

Technically, the fourth prong of the Howey test requires that the expectation of profits to come “solely from the efforts of [others].” While the Supreme Court used the word “solely” in its articulation of the fourth prong of Howey test, lower courts have essentially disregarded the word “solely,” instead requiring that the third-party efforts be, in the words of the Ninth Circuit, “undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.”[26] All but the First Circuit has adopted the Ninth Circuit’s liberal interpretation.[27] In S.E.C. v. Edwards, 540 U.S. 389 (2004), the Supreme Court quoted the investment contract definition from Howey and restated the four-part test as “an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others,” notably omitting the word “solely.”[28] The Edwards court emphasized that when it held that “profits” must “come solely from the efforts of others,” it was “speaking of the profits that investors seek on their investment.”[29]

Some circuit courts have further broken down the “efforts of others” into two categories when analyzing investor transactions: pre-purchase and post-purchase.[30] Pre-purchase efforts are defined as those carried out by the turnkey investor or sponsor prior to the close of the investment. Post-purchase efforts are those carried out by the third-party property and asset managers after the close of the investment. While the Supreme Court has considered investment contracts since espousing the Howey test in 1946, it has been only sparingly, and without any substantial evolution in law.[31] Additionally, the Supreme Court, has never formally distinguished pre-purchase from post-purchase efforts under the fourth prong of Howey. In order to satisfy the fourth prong of Howey, or at the very least play a significant role in the determination, the sponsor’s pre-purchase efforts must significantly impact the profits sought in the return on the investment.[32]

Pre-Purchase Efforts: Strict Application — SEC v. Life Partners, Inc.

In S.E.C. v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996), the D.C. Circuit court of appeals considered whether fractionalized ownership interests in viatical settlements were investment contracts under the Howey test. The court’s decision in Life Partners hinged on the fourth prong of Howey.[33] The S.E.C. argued that although the defendant sponsor, Life-Partners, Inc. (LPI), did not perform substantial post-purchase efforts, the court could nonetheless find that the viatical settlements at issue were investment contracts based on the pre-purchase efforts carried out by LPI. The court, however, did not agree with the S.E.C.’s position that the time of sale is an artificial dividing line.[34] Rather, the court interpreted the dividing line as a significant legal construction that should be recognized by the courts when analyzing a particular instrument under the fourth prong of Howey.

The Life Partners court reasoned that if the investor’s profits depend primarily upon the promoter’s efforts after closing, then the investor may benefit from the disclosure and other requirements of the federal securities laws. The court outlined that 1) if the value of the sponsor’s efforts had already been factored into the promotional fees or the purchase price of the investment, and 2) if neither the sponsor nor any other third party was expected to make additional efforts that would have had an impact on the failure or success of the enterprise, then the need for investor protection under the securities acts is cognizably reduced.[35] Thus, according to the Life Partners court, absent substantial post-purchase effort undertaken by the sponsor or a third party, the fourth prong of Howey cannot be satisfied.

A More Flexible Approach: S.E.C. v. Mutual Benefits Corp.

The 11th Circuit Court of Appeals, however, siding with the Life Partners dissent, declined to follow the Life Partners decision and rejected the pre-post bright-line distinction.[36] The court in S.E.C. v. Mut. Benefits Corp., 408 F.3d 737 (11th Cir. 2005), similarly faced the question of whether fractionalized ownership interest in viatical settlements were investment contracts under Howey. The Mutual Benefits Corp. court concluded that the fourth prong of Howey is not simply confined to a “forward-looking inquiry” from the point of closing. While it may be true that the “efforts of others” prong of the Howey test is more easily satisfied by post-purchase efforts of the sponsor or third parties, the court reasoned that there is no statutory or judicial authority upon which to exclude pre-purchase entrepreneurial or managerial activities from the analysis. Thus, according to Mutual Benefits Corp., the fourth prong of Howey can be satisfied even in the absence of substantial post-purchase activities undertaken by the sponsor or a third party.

With regard to turnkey real estate investments, it may be argued that the pre-purchase efforts of turnkey investors are either insignificant or analogous to a real estate investor who flips properties. Yet sponsors initially make all of the important decisions with respect to the acquisition of the property, even if the investor has the autonomy to ultimately choose from properties (and/or location) from which the sponsor has already purchased. Sponsors prepare marketing materials, documents, and websites, which include descriptions of the property and may include financial projections, overall or monthly. Finding the property and negotiating the purchase price play an important role in the short- and long-term success of the investment. All of which are pre-purchase efforts, thereby negating any claim sponsors may try to assert of the insignificance of their pre-purchase efforts. Additionally, turnkey real estate investment sales are not structured where the buyer is also the end-user. From the very beginning through closing, all of the activities undertaken by sponsors are the type of efforts that affect the “failure or success of the enterprise,” and, therefore, should satisfy the “pre-purchase efforts” under Howey’s fourth prong.

Post-Purchase Efforts — In determining whether turnkey investors have a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others, the post-closing inquiry is largely confined to the degree of actual control given to and exercised by turnkey owners, versus the degree to which this purported control is insubstantial and/or illusory.[37] Post-purchase efforts have been analyzed under two different approaches: the “written agreements” test,[38] and the “target audience” test

Under the “written agreements” test, the actual control exercised by the turnkey owner after closing is irrelevant — as long as the investor has the right to control the purchased asset, the fourth prong of Howey is not satisfied.

The Written Agreements Test: Albanese v. Florida National Bank of Orlando

In Albanese v. Florida National Bank of Orlando, 823 F.2d 408, 410 (11th Cir. 1987), the 11th Circuit examined claims from plaintiffs-investors that invested capital in an ice machine leaseback program.[39] The sponsor in Albanese agreed to place ice machines in various hotels and motels and contracted with the investor(s) to service and collect money from the machines. The Albanese court concluded that the fourth prong of Howey was satisfied, as it determined that profits were derived solely from the efforts of the corporation. In articulating its reasoning, the court stated that “the crucial inquiry [for the fourth prong] is the amount of control that the investors retain under their written agreements.”[40] The Albanese court reasoned that if an investor retains the ability to control the profitability of his or her investment through power expressly articulated in the written agreements, then the purchaser is not dependent on the sponsor or a third party for the “undeniably significant efforts” that affect the “failure or success of the enterprise and the fourth prong of the Howey test is not satisfied.”

The Target Audience Approach: S.E.C. v. Aqua-Sonic Products Corp. and United States v. Leonard

In S.E.C. v. Aqua-Sonic Products Corp., 687 F.2d 577, 582 (2d Cir. 1982), cert. denied, 459 U.S. 1086 (1982), the Second Circuit considered an S.E.C. enforcement action brought under the federal securities laws where the sponsor offered licenses to sell dental products, while an affiliate of the sponsor was described to potential investor-licensees as an optional sales agent.[41] Under that optional agreement, the investor retained the right to terminate it at any time upon 90 days written notice, and also retained ultimate control over pricing and other conditions relating to the offer and sale of the dental products, including the investor’s own right to sell the dental products within the specified territory. Notwithstanding the control, actual or apparent, that the investor possessed, the Aqua-Sonic court ultimately held that the arrangements were investment contracts and, therefore, securities.

The Second Circuit reasoned that the amount of investor control provided in the written agreements governing the investment was not determinative, emphasizing that the Howey court did not focus on whether it was somehow possible for an investor to profit without the efforts of others, or whether the investor had a theoretical right to reject the efforts of others.[42] According to the Aqua-Sonic court, the Howey court focused on whether the typical investor who was being solicited would be expected, under all the circumstances, to accept the efforts of others and be passive, or reject the efforts of others and be active.[43] Sponsors “sought to attract the passive investor for whose benefit the securities laws were enacted.”[44] In the Aqua-Sonic court’s view, the fact that an investor might retain “some legal rights over distribution does not render it unnecessary for him to have the benefits of the disclosures provided in registration statements or the protection of the antifraud provisions.”[45] “If, by contrast, the reasonable expectation was one of significant investor control, a reasonable purchaser could be expected to make his own investigation of the new business he planned to undertake and the protection of the 1933 and 1934 Acts would be unnecessary.”[46]

In United States v. Leonard, 529 F.3d 83 (2d Cir. 2008), a Second Circuit case relying on Aqua-Sonic Products Corp., “criminal charges were brought against [25] individuals involved in the marketing of investment interests in two limited liability companies.”[47] The Leonard court revisited the target audience approach from Aqua-Sonic Products Corp. and upheld a jury finding that membership interests in the LLCs constituted “investment contracts” because defendants sought out passive investors who did not actively participate in the venture. Rather than confining the inquiry to the theoretical authority given to investors in the written agreements, Leonard recognized the importance of “the factual circumstances” surrounding the transaction, the written agreements among the parties, and the actual exercise of control by the investor surrounding the investment.[48]

In reaching its conclusion, the Leonard court silently acknowledged the written agreements rationale and rejected such a limited inquiry. The court reasoned that if it confined its reasoning to “a review of the organizational documents,” it would “likely conclude that the interests…could not constitute securities because the documents would lead us to believe that members were expected to play an active role in the management of the companies.” Interestingly, the Leonard court emphasized that one of the original promoters of the investment interests at issue in that case testified at trial that the investment interests were specifically structured to minimize the possibility that the investment units would constitute securities but rather were drafted in a way “to get into…the gray areas of the securities laws.”[49]


The heart of the inquiry under Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981), cert. denied, 454 U.S. 897 (1981), and Albanese is whether the investor theoretically retains substantial control over the investment on the face of the written agreements. The problem with this approach is the emphasis on the word theoretical. Under a theoretical interpretation, turnkey investments would, most likely, not constitute investment contracts as long as the turnkey investor has theoretical control under the written agreements, even where the honest expectation and ultimate reality is one of passive investment.

If the written agreements test in Albanese was strictly applied to turnkey investments, and the actual control exercised by the investor was found to be irrelevant to the analysis, then turnkey sponsors could evade coverage of the securities laws simply by giving investors power in the written agreements, even when the sponsor is acutely aware that such powers will not, in fact, be exercised. This would simply lead to a “drafting war,” as the best tightly knit and dressed documents would be purposely structured so as to avoid the securities laws and subvert congressional intentions behind investor protections.

The focus under Williamson and Albanese is on the investors’ expectations under the written agreements at the time of investment and “is not directed at what actually transpires after the investment was made….” However, Williamson and Albanese recognize that if the power to control an investment is merely illusory, then actual control will be deemed not to exist.[50] If actual control is found not to exist after closing, then the investors/owners clearly rely on the essential managerial efforts of others, thus, signaling that the investment is a security under the fourth prong of Howey.[51] Furthermore, “under Williamson, a plaintiff may establish reliance on others within the meaning of Howey if he can demonstrate not simply that he did not exercise the powers he possessed, but that he was incapable of doing so.”[52] While seemingly straightforward, what factors will a court look at, and how much weight will each particular factor be given in determining whether an investor is “incapable” of exercising the powers the investor may have?

Under the Leonard and Aqua-Sonic Products Corp. rationale, the totality of the investment would be considered. Courts using the Leonard and Aqua-Sonic Products Corp. rationale may look at whether investors have actual control of their investment as compared with just nominally having control. The mere fact that an investor may have the ability to hire or fire a property manager or sell his or her interest in the property, in and of itself, may not necessarily be sufficient to bring an otherwise securitized transaction outside the purview of the federal securities laws. An investor possessing such authority certainly gives the appearance of the investor retaining control, and thus, would not constitute a security since the transaction would fail the fourth prong of Howey. However, the fact that turnkey investors may be lured into the investment by representations of sponsors touting their experience and expertise in property selection or management services, and investors’ reliance on sponsors’ representations of being a passive investor receiving monthly income with no management responsibilities gives weight to the counterargument that the transaction may fairly be classified as a security transaction.

If turnkey investors have nominal control only, do virtually nothing, all while third-party property and asset managers approve leases, collect and distribute the pro-rata gain and loss to investors, undertake maintenance and improvements, and carry out all other day-to-day management responsibilities, the insignificant control exercised by investors as compared to the post-purchase efforts exerted by third parties, affiliated with the seller or not, is significant for the purposes of determining whether the transaction falls under the fourth prong of the Howey test.

While turnkey investments, as commonly marketed, may generally be considered securities under the above scenario, that does not necessarily preclude some syndicated real estate investment schemes to fall outside the purview of the federal securities laws. There is an argument to be made that unless investors select the property, perform the significant pre-purchase functions, and then actively manage or exercise control over the property, turnkey investments might constitute a security, not an investment in real estate. While this may be accurate, it does seem a bit extreme. That line of reasoning would undoubtedly chill many aspects of real estate development as we know it.

In addition to the traditional analysis under the Howey test when deciding whether an instrument should properly fall within the scope of the securities acts, the U.S. Supreme Court has also applied the “context” clause in limited scenarios.[53] The “context” clause analysis considers the existence of other regulatory schemes that would govern a particular investment instrument in the event that such an instrument was found not to be a security. Using the context clause reasoning, it is clear that the regulatory schemes governing real estate transactions do not provide the comprehensive and pervasive federal regulation that govern other particular areas of law. Similarly, real estate laws currently do not require the registration and disclosure requirements of a security, nor do they contain appropriate anti-fraud provisions security laws were enabled to protect the public.

Situations where the sponsor purchases, restores, and rents out the property only to sell it to an investor and relinquish all control, straddles a grey line between a security, where the sponsor is promising returns on investment, and a real-estate transaction. Sponsors, undoubtedly, will couch the transaction as a pure sale of real estate. However, due to the nature of most turnkey investments, how they are marketed to investors, and how turnkey investments may be structured in an attempt to avoid federal law, should turnkey investments more properly be regulated under the securities laws?

A Case Study: S.E.C. v. Art Intellect, Inc.

In S.E.C. v. Art Intellect, Inc., 2013 U.S. Dist. LEXIS 32132 (D. Utah 2013), Patrick Brody and his wife, Laura Roser, created Mason Hill, a company that solicited investments in real estate. Ms. Roser was the founder and president of Art Intellect, the CEO of Mason Hill, the founder of VirtualMG, and the CEO of Mason Hill. Nevertheless, Mr. Brody largely kept his name off of any entity or property owned or controlled by Mason Hill. Ms. Roser wrote and managed all of the marketing material of Mason Hill, including the website, brochures, webinars, and press releases. She also interviewed and hired staff and had a position of control at Mason Hill.

Representatives and employees of Mason Hill solicited investors and acted on behalf of Mason Hill at the direction of Laura Roser and Patrick Brody. Neither Mr. Brody nor Ms. Roser had ever been registered in any capacity with the SEC or any other securities regulatory agency. Mason Hill did not register its offer and sales with the SEC. Mason Hill offered “The Mason Hill Real Estate Investment Model” to prospective investors, who entered into a “reservation agreement” and “real estate purchase agreement” with Mason Hill. Mason Hill solicited investors through its website, through “webinar” presentations, and through other communications with investors. Mason Hill also engaged a network of “strategic partners” to solicit investors nationwide in exchange for a “referral fee.”

The Mason Hill model offered a “turnkey” approach to real estate investing. In its promotional materials, Mason Hill promoted “[h]ow a new kind of real estate investment can produce a 14% to 26% cash-on-cash return, year after year…even if you never lift a finger to manage the properties, fix the properties or find a tenant….”[54] Specifically, Mason Hill claimed that it purchased distressed real estate at a low price, rehabilitated the properties, and secured tenants, all for the investors. In addition, Mason Hill told investors that it would collect the rents and maintain the properties. In short, it promised investors a “hassle free” option for real-estate investing.

Mason Hill claimed that it had an on-site, in-house property management team that screened and placed tenants so that the properties would already be rented, and investors could immediately obtain an income stream from a purchased property. According to Mason Hill, “[r]eliable renters want to live in these properties — tenants with a better track record of on-time payments, good employment history, and a clean background. We have an on-site property management team with a waiting list of these tenants — delivering an average occupancy rate of 93% for all of our properties.”[55] Mason Hill explained that it would manage the property after purchase, handle all maintenance, services, and rent collection, and that it would provide clients with a monthly payment and cash flow report. Although the property management service was not a requirement after the property was purchased through Mason Hill, it was offered as an incentive to prospective investors, and it was one of the features that attracted investors. Mason Hill promised investors returns that ranged from 10% to 30%, with monthly net rental profits of $650 to $1,000 or more. This was touted as a passive investment, and the court found that is what attracted and motivated investors and that, given the nature of the investment, the incentives, and the promised returns, any appreciation in value was of secondary importance.

The Security and Exchange Commission brought suit against both Mr. Brody and Ms. Roser. Summary judgment[56] was entered in favor of the SEC, with the court finding that both Mr. Brody and Ms. Roser were found to have sold securities (investment contracts) when Mr. Brody and Ms. Roser acted as broker-dealers soliciting investors to purchase turnkey real estate investment contracts. The Art Intellect court found that Mr. Brody and Ms. Roser’s action violated both the registration requirements of the Securities Act and violated §15(a) of the Exchange Act. Under the four prongs of Howey, the court analyzed as follows:

1) Investment of Money: Investors unquestionably invested money with Mason Hill.

2) Common Enterprise: The Art Intellect court determined that the economic realities in the case demonstrated that the second prong of Howey (common enterprise) was met. Mason Hill coupled the sale of real estate with Mason Hill’s management to generate promised returns. Mason Hill offered a free year of management services as added value for investors. Mason Hill, in brief, touted itself as a hassle-free investment. Its website claimed that it presented a “turnkey cash flow real estate investment.” Mason Hill represented to investors that it would generate profits through Mason Hill’s simple, five-step approach to real estate investing. Mason Hill’s literature was replete with diagrams, charts, and step-by-step illustrations presenting Mason Hill as a passive investment.

3) and 4)[57] Reasonable Expectation of Profits from Others: The profits from the investment were to be derived solely from the efforts of Mason Hill. Investors had no role in the selection of the properties and provided nothing beyond their principal investment. Mason Hill found the properties, selected the tenants, sent out monthly checks, and offered (and in the majority of cases provided) property management services to the investors. The investors expected to make a profit on the investment with Mason Hill.


Considering the more stringent oversight and disclosure requirements under securities laws, the lack of a comprehensive regulatory scheme governing real estate and real property transactions, and the lessons learned in light of the 2008 real estate crisis, courts should be flexible in their approach and equitably balance the compelling interests of both sponsors and investors, such as articulated in SEC v. Mutual Benefits Corp., and consider turnkey investments securities where applicable, i.e. whenever it would be appropriate for the protection of investors. Doing so would further the principles underlying securities laws and Congress’ original purpose in enacting the securities laws to regulate investments, regardless of the form and structure of the instrument, to prevent exploitation of investors. Much of the information surrounding novel investment schemes, such as the potential benefits of investing as weighed against the risk, is undoubtedly necessary for an investor to make informed decisions. The SEC has extensive expertise in interpreting both the securities acts and the novel, complex investment schemes that fall within the scope of federal statutory provisions and, thus, could properly protect investors’ interests.

Based upon the takeaways from this article, it is the authors’ conclusion that turnkey real estate investments, as most commonly marketed and distributed currently, are in fact securities under federal and state law because investors depend upon the entrepreneurial and managerial efforts of the sponsor or third parties for the profitability of their investments. Having said that, it is appropriate to note that there is nothing wrong with turnkey real estate investments, per se. In fact, the opportunity available for investors to leverage the professional expertise and management skills of sponsors and promoters in order to obtain, on a passive basis, investment returns, continues to remain attractive in the turnkey real estate investment world. Simply put, however, these investments need to be promoted for what they are — securities — and properly documented as either registered or exempt transactions under Regulation A or Regulation D of the securities laws. By doing so, not only do promoters and sponsors abide by the law and avoid the negative consequences identified in the cases noted earlier, but investors also have the types of disclosures in front of them which are appropriate for this type of investment. That is not to say, however, that every pre-packaged commercial real estate deal is a security. Our hope is that this article addresses the world of turnkey real estate investments as securities for attorneys representing promoters, sponsors, and investors and provides an effective rubric for their evaluation in analyzing turnkey real estate investments in today’s commercialized world.

[1] 15 U.S.C. §77q(a).

[2] See Marine Bank v. Weaver, 455 U.S. 551, 556 (1982).

[3] See 15 U.S.C. §78c(a)(10).

[4] S.E.C. v. C.M. Joiner Leasing Corp., 320 U.S. 344, 352-353, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943) (holding that the test for securities was 1) what character the instrument was given in commerce by the terms of the offer; 2) the plan of distribution; and 3) the economic inducements held out to the prospect); Id. at 351 (“Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as investment contracts, or as any interest or instrument commonly known as a ‘security.”) (internal quotations omitted).

[5] In fact, in Continental Marketing Corp. v. Securities & Exchange Com. 387 F.2d 466, 470 (10th Cir. 1967), the court looked at the economic reality of the transaction in holding that the sale of beavers was a security, as the success of the investment was “inescapably tied to the efforts of the ranchers and the other defendants and not to the efforts of the investors.”

[6] Tcherepnin v. Knight, 389 U.S. 332, 336 (1967), interpreting the term “security.”

[7] Reves v. Ernst & Young, 494 U.S. 56 (1990).

[8] S.E.C. v. W. J. Howey Co., 328 U.S. 293, 298 (1946).

[9] Reves, 494 U.S. at 60-61 (holding that Congress provided a broad definition of the term security so as to encompass “virtually any instruments that might be sold as an investment”).

[10] See, e.g., Int’l Bhd. of Teamsters v. Daniel, 439 U.S. 551, 559-60 (1979).

[11] Id. at 559; see, e.g., Knight, 389 U.S. at 336 (money paid for bank capital stock); S.E.C. v. Variable Annuity Life Ins. Co. of Am., 359 U.S. 65, 76 (1959) (premium paid for variable-annuity contract); Howey, 328 U.S. at 293 (money paid for purchase, maintenance, and harvesting of orange grove); Joiner Leasing Corp., 320 U.S. at 345-46 (money paid for land and oil exploration).

[12] The Securities and Exchange Commission, however, does not require vertical or horizontal commonality per se, nor does it view a “common enterprise” as a distinct element of the term “investment contract.” In re Barkate, 57 S.E.C. 488, 496 n.13 (Apr. 8, 2004); see also the Commission’s Supplemental Brief at 14 in S.E.C. v. Edwards, 540 U.S. 389 (2004).

[13] See, e.g., SEC v. Infinity Group Co., 212 F.3d 180, 188 (3d Cir. 2000); SEC v. Banner Fund Int’l, 211 F.3d 602, 614-15 (D.C. Cir. 2000); Teague v. Bakker, 35 F.3d 978, 986 n.8 (4th Cir. 1994); Wals v. Fox Hills Dev. Corp., 24 F.3d 1016, 1018-19 (7th Cir. 1994); Revak v. S.E.C. Realty, 18 F.3d 81, 87-89 (2d Cir. 1994); Newmyer v. Philatelic Leasing, Ltd., 888 F.2d 385, 391-93 (6th Cir. 1989) (applying horizontal commonality as the requirement that investors share or pool their funds in order to succeed in the venture).

[14] See, e.g., S.E.C. v. Koscot Interplanetary, Inc., 497 F.2d 473, 478-79 (5th Cir. 1974).

[15] See, e.g., S.E.C. v. Glenn W. Turner Enter., Inc., 474 F.2d 476, 481-82 (9th Cir. 1973).

[16] See, e.g., S.E.C. v. ETS Payphones, Inc., 300 F.3d 1281, 1283-84 (11th Cir. 2002) (recognizing “horizontal commonality” as the majority test in the circuit courts but applying precedent that broad vertical commonality is the controlling test in the 11th Circuit), rev’d. on unrelated grounds by S.E.C. v. Edwards, 540 U.S. 389, 393-97 (2004).

[17] See S.E.C. v. Unique Fin. Concepts, Inc., 196 F.3d 1195, 1199-1200 (11th Cir. 1999).

[18] Villeneuve v. Advanced Bus. Concepts Corp., 698 F.2d 1121, 1124 (11th Cir. 1983).

[19] Compare Mordaunt v. Incomco, 686 F.2d 815 (9th Cir. 1992), with Long v. Shultz Cattle Co., 881 F.2d 129 (5th Cir. 1989).

[20] S.E.C. v. Continental Commodities Corp., 497 F.2d 516, 522 (5th Cir. 1974).

[21] S.E.C. v. Merrill Scott & Assocs., Ltd., 2011 U.S. Dist. LEXIS 134010 *35 (D. Utah Nov. 21, 2011).

[22] Id. (internal quotations omitted) (citing Campbell v. Castle Stone Homes, Inc., Case. No. 2:09-CV-250 TS, 2011 U.S. Dist. LEXIS 27266, 2011 WL 902637 *4 (D. Utah Mar. 15, 2011).

[23] Howey, 328 U.S. at 300.

[24] Long v. Shultz Cattle Co., 881 F.2d 129, 132-34 (5th Cir. 1989).

[25] Howey, 328 U.S. at 299.

[26] S.E.C. v. Glenn W. Turner Enter., Inc., 474 F.2d. 476, 482 (9th Cir. 1973), cert. denied, 414 U.S. 821 (1973).

[27] See, e.g., S.E.C. v. Unique Fin. Concepts, Inc., 196 F.3d 1195, 1201 (11th Cir. 1999) (adopting the Ninth Circuit’s liberal interpretation of the word “solely” as used in the Howey test); S.E.C. v. Int’l Loan Network, Inc., 968 F.2d 1304, 1308 (D.C. Cir. 1992); Rivanna Trawlers Unlimited v. Thompson Trawlers, Inc., 840 F.2d 236, 240 n.4 (4th Cir. 1988); Goodwin v. Elkins & Co., 730 F.2d 99, 103 (3d Cir. 1984), cert. denied, 469 U.S. 831 (1984); S.E.C. v. Prof. Assocs., 731 F.2d 349, 357 (6th Cir. 1984); Kim v. Cochenour, 687 F.2d 210, 213 n.7 (7th Cir. 1982); S.E.C. v. Aqua-Sonic Prods. Corp., 687 F.2d 577, 582 (2d Cir. 1982), cert. denied, 459 U.S. 1086, (1982); Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981), cert. denied, 454 U.S. 897 (1981); Aldrich v. McCulloch Prop., Inc., 627 F.2d 1036, 1040 n. 3 (10th Cir. 1980); Fargo Partners v. Dain Corp., 540 F.2d 912, 914-15 (8th Cir. 1976).

[28] Edwards, 540 U.S. at 393-97.

[29] Id.

[30] See S.E.C. v. Mut. Benefits Corp., 408 F.3d 737 (11th Cir. 2005); S.E.C. v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996).

[31] See, e.g., Edwards, 540 U.S at 389; Reves, 494 U.S. at 56 (1990); Landreth Timber Co. v. Landreth, 471 U.S. 681, 684 (1985); Weaver, 455 U.S. at 552; Daniel v. Int’l Bhd. of Teamsters, 439 U.S. 551, 552 (1979); United Housing Foundation v. Forman, 421 U.S. 837, 845 (1975); Knight, 389 U.S. at 336; SEC v. Variable Annuity Life Ins. Co. of Am., 359 U.S. 65, 76 (1959) (analyzing investment contracts under the Howey test).

[32] Howey, 328 U.S. at 298-99; Mut. Benefits Corp., 408 F.3d at 743-44.

[33] Life Partners, Inc., 87 F.3d at 538.

[34] Id. at 545-49.

[35] Id.

[36] S.E.C. v. Mut. Benefits Corp., 408 F.3d 737, 743 (11th Cir. 2005).

[37] Albanese v. Fla. Nat’l Bank of Orlando, 823 F.2d 408, 410 (11th Cir. 1987); Williamson v. Tucker, 645 F.2d 404, 419-24 (5th Cir. 1981).

[38] In Williamson v. Tucker, the Fifth Circuit determined whether general partnership interests in a real estate development scheme were securities. In dictum, the court applied a three-part test to determine whether a general partnership interest that on its face creates a true partnership is a security. Id. at 404. Under the test, a general partnership or joint venture interest can be designated a security if “1) an agreement among the parties leaves so little power in the hands of the partner that the arrangement-in-fact distributes power as would a limited partnership….” The first prong of Williamson has widely become known as the written agreements test. Under this test, the Williamson court declared that “[i]n each case the actual control exercised by the purchaser is irrelevant.” As long as the investor “has the right to control the asset he has purchased, he is not dependent on the promoter or on a third party for ‘those essential managerial efforts which affect the failure or success of the enterprise.’” Id. at 421.

[39] Albanese, 823 F.2d at 409-10.

[40] Id. at 410.

[41] S.E.C. v. Aqua-Sonic Prods. Corp., 687 F.2d 577 (2d Cir. 1982).

[42] Id. at 582-85 (emphasis added).

[43] Id.

[44] Id. at 585.

[45] Id.

[46] Id.

[47] United States v. Leonard, 529 F.3d 83 (2d Cir. 2008).

[48] Id.

[49] Leonard, 529 F.3d at 89.

[50] Albanese v. Fla. Int’l Bank of Orlando, 823 F.2d 408, 412 (11th Cir. 1987); Williamson v. Tucker, 645 F.2d 404, 424 (5th Cir. 1981); see also SEC v. Aqua-Sonic Prods. Corp., 687 F.2d 577, 583-84 (2d Cir. 1982).

[51] See Albanese, 823 F.2d at 412.

[52] Long v. Shultz Cattle Co., 881 F.2d 129, 134 (5th Cir. 1989).

[53] Congress prefaced the list of securities defined in the securities acts with the phrase “unless the context otherwise requires.” 15 U.S.C. §78c(a); see also S.E.C. v. National Securities, Inc., 393 U.S. 453, 466 (1969); Weaver, 455 U.S. at 555, 558-59.

[54] S.E.C. v. Art Intellect, Inc., 2013 U.S. Dist. LEXIS 32132 at *12 (D. Utah 2013).

[55] Id. at *13.

[56] Mr. Brody and Ms. Roser were permanently enjoined from violating §17(a) of the Securities Act of 1933, 15 U.S.C. §77q(a); §10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b), and Rule 10b-5 thereunder, 17 C.F.R. §240-10b-5; §§5(a) and 5(c) of the Securities Act, 15 U.S.C. §§77e(a), (c); and §§15(a) and 15(b) of the Securities Exchange Act of 1934, 15 U.S.C. §§78o(a)-(b).

[57] The Art Intellect court only used a three-part test in its analysis.


Dr. Laurence J. PinoDr. Laurence J. Pino is a commercial attorney focusing his representation on business, investment, and securities law. He earned his bachelor’s from the University of Notre Dame, his J.D. from New York University School of Law, and his Doctorate in Business Administration from the University of Florida. He is currently admitted in Florida, California, and New York.



Sean M. Southard is a commercial attorney focusing his representation on litigation, transactional matters, and optimization of business solutions. He graduated from the University of Scranton and Temple University School of Law and is admitted to practice in Florida and Pennsylvania.