Please disregard my previous duplicative post of Installment #2, here is the latest installment, #3:<div><br></div><div><p class="MsoNormal"><b><span style="font-size:16.0pt">Limited Liability Companies for Films</span></b></p>
<p class="MsoNormal"><b><span style="font-size:16.0pt">By Mary Ellen Tomazic</span></b></p>
<p class="MsoNormal"><span> </span></p>
<p class="MsoNormal"><span> </span></p>
<p class="MsoNormal"><span>III. LLC Financing and
Securities Fraud – a Case Study</span></p>
<p class="MsoNormal"><span><span> </span></span></p>
<p class="MsoNormal"><span>If somehow your film LLC
membership offerings still do not come under any state or federal exemption, or
you do not want to go through the filings and notifications required for the
exemptions. A recent case involving the selling of film company LLC memberships
outlines the tests that courts use to determine whether an offering is a
security, aside from any possible exemptions. <i>United States v. Leonard, <a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn1" name="_ftnref1" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><b><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA">[1]</span></b></span></span></span></a></i>
held that in determining whether LLC memberships were `securities’ requiring
registration under state and federal securities laws, a “totality of the
circumstances” test should be used, rather than a literal reading of the LLC’s
organizational documents. A “case-by-case” analysis of the “economic realities”
of the transaction underlying the transfer of the LLC interests was required.
In the <i>Leonard</i> case, sellers of
interests in companies formed to finance the production and distribution of
motion pictures were convicted of criminal conspiracy, mail fraud and
securities fraud. Their independent sales office (ISO) contacted investors by
phone and sent them offerings by mail which included a brochure, operating
agreement, subscription agreement, risk disclosure sheet, and instruction
sheet. The information contained in the offerings was ruled to be material misrepresentations
of fact under the federal securities law. The sellers were found to have
intended to deceive the investor “members” that their money would be spent on
pre-production, rather than on sales commissions. The offering materials did
not reflect the hefty commissions of 45% taken by the ISO, but seemed to
indicate that the commissions would be no more than 20% of the unit price.<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn2" name="_ftnref2" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:
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mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA">[2]</span></span></span></span></a>
</span></p>
<p class="MsoNormal"><span><span> </span>The sellers’ appeal turned on the
issue of whether the LLC memberships offered by the sellers were “securities”.
Their argument was based on the organizational documents of the LLC, which
would by a literal reading lead the court to believe that the members were
expected to play an active role in the management of the film companies. In the
organization documents, the members’ managerial and voting rights, did not
accrue until the LLCs were “fully organized”, and so-called “interim managers”
initially held legal control rights, deciding almost every single significant
issue prior to the completion of fundraising – the script, the director, the
casting and crew, the scoring, and even the editing of the picture. The vast
majority of the investor “members” did not actively participate in the
ventures, exercising almost no control. In fact, the members solicited to invest
in the film venture had no particular experience in film or entertainment, and
would have had difficulty taking over their formal managerial rights in the
companies after they were fully organized. The court found that the managerial
rights recited in the organization documents were hollow and illusory. The
court cited the case of </span><i><span style="mso-fareast-font-family:"Times New Roman";mso-bidi-font-family:"Times New Roman";
color:black;background:white">SEC v. Aqua-Sonic Prods. Corp.,<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn3" name="_ftnref3" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><b><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:"Times New Roman";mso-hansi-theme-font:
minor-latin;mso-bidi-font-family:"Times New Roman";color:black;background:white;
mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA">[3]</span></b></span></span></span></a>
</span></i><span style="mso-fareast-font-family:"Times New Roman";mso-bidi-font-family:
"Times New Roman";color:black;background:white"><span> </span>distinguishing between companies that seek the
“passive investor” and situations where there is a reasonable expectation of
“significant investor control.”<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn4" name="_ftnref4" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[4]</span></span></span></span></a> The
court in <i>Aqua Sonic </i>stated that the
securities laws were enacted for the benefit of the passive investor, and that
where there was a reasonable expectation of investor control, the protection of
the 1933 and 1934 Acts<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn5" name="_ftnref5" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[5]</span></span></span></span></a> would be
unnecessary.<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn6" name="_ftnref6" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:"Times New Roman";mso-hansi-theme-font:
minor-latin;mso-bidi-font-family:"Times New Roman";color:black;background:white;
mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA">[6]</span></span></span></span></a>
</span></p>
<p class="MsoNormal"><span style="mso-fareast-font-family:"Times New Roman";mso-bidi-font-family:"Times New Roman";
color:black;background:white"><span>
</span>Witnesses testified in the Leonard case that the LLCs were structured to
minimize the possibility that the memberships would be seen as securities, with
the summary sheet sent to potential investors reciting that the memberships
were not passive investments, and that although motion picture expertise was
not required, members should have such general business, financial, and
investment experience as to intelligently exercise their managerial and voting
rights. In actuality the members played an extremely passive role in the
management and operation of the companies. At trial, members testified that
they voted, at most “a couple of times.”<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn7" name="_ftnref7" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[7]</span></span></span></span></a> The
members did not appear to have negotiated any terms of the LLC agreements, but
rather were presented with the subscription agreements on a
“take-it-or-leave-it” basis. The court concluded that despite the
organizational documents drafted to suggest active participation by members,
the defendants sought and expected passive investors for their movie companies,
and therefore the interests they marketed constituted securities. The Second
Circuit Court of Appeals affirmed the convictions of the sellers for fraud
under the federal securities laws for their material misrepresentations to the investors.
Although they deferred to toe District Court’s determination that the investors
would not have purchased the investment had they known that 45% of the sales
price went to commissions, they remanded the case for recalculation of the
value of the securities for restitution purposes, reasoning that the investment
may not have been entirely without value.<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn8" name="_ftnref8" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[8]</span></span></span></span></a><i></i></span></p>
<p class="MsoNormal"><span style="mso-fareast-font-family:"Times New Roman";mso-bidi-font-family:"Times New Roman";
color:black;background:white"><span>
</span>The <i>Leonard </i>case is the latest
in a line of cases which have attempted to define what kind of interests
constitute securities, and especially the relatively new type of interest in an
LLC. The key in most of the cases hinges on the control actually exercised by
the members, and not just what is purported by the offering and organizational
documents. An investment contract constituting a security under the Securities
Act is one in which 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.<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn9" name="_ftnref9" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[9]</span></span></span></span></a><span> </span>There are at least two cases in which LLC
interests were not found to be securities because of the control retained over
the enterprise by the members.<a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftn10" name="_ftnref10" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:14.0pt;font-family:"Calibri","sans-serif";
mso-ascii-theme-font:minor-latin;mso-fareast-font-family:"Times New Roman";
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
color:black;background:white;mso-ansi-language:EN-US;mso-fareast-language:EN-US;
mso-bidi-language:AR-SA">[10]</span></span></span></span></a> With a
small film LLC where the members all exercise managerial control and help form
the bylaws and organizational documents of the company, there should not be any
question that the membership interests are not securities. It is when outside
investors are solicited and buy into the company that the elements of a
security are present; in that case, the several exemptions for small or private
offerings in an LLC mentioned earlier should be claimed by the promoters of the
movie venture.</span></p>
<p class="MsoNormal"><span> </span></p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"><span> </span></p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"><span> </span><span class="apple-style-span"><span style="font-size:10.0pt;font-family:"Verdana","sans-serif";
color:black">Mary Ellen Tomazic is an attorney in Cleveland specializing in
entertainment</span></span><span style="font-size:10.0pt;font-family:"Verdana","sans-serif";
color:black"><br>
<span class="apple-style-span">issue such as copyright, trademarks, contracts and
licenses for musical</span><br>
<span class="apple-style-span">groups and filmmakers.</span><br>
<br>
</span><span style="font-size:10.0pt;font-family:"Verdana","sans-serif""></span></p>
<p class="MsoNormal"> </p>
<div><br clear="all">
<hr align="left" size="1" width="33%">
<div id="ftn1">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref1" name="_ftn1" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[1]</span></span></span></span></a>
529 F.3d 83 (2d Cir. 2008).</p><p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref2" name="_ftn2" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[2]</span></span></span></span></a> <i>Id.</i> at 86.</p></div>
<div id="ftn3">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref3" name="_ftn3" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[3]</span></span></span></span></a>
687 F.2d 577, 582 (2d Cir. 1982).</p>
</div>
<div id="ftn4">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref4" name="_ftn4" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[4]</span></span></span></span></a> <i>Id.</i> at 585.</p>
</div>
<div id="ftn5">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref5" name="_ftn5" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[5]</span></span></span></span></a>
Securities Act of 1933, 15 U.S.C. §§77a -77aa (2010).</p>
</div>
<div id="ftn6">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref6" name="_ftn6" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[6]</span></span></span></span></a> <i>Id.</i></p>
</div>
<div id="ftn7">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref7" name="_ftn7" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[7]</span></span></span></span></a> <i>Leonard, </i>at 89.</p>
</div>
<div id="ftn8">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref8" name="_ftn8" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[8]</span></span></span></span></a><i>Id.</i> at 93.</p>
</div>
<div id="ftn9">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref9" name="_ftn9" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[9]</span></span></span></span></a> <span class="apple-converted-space"><span style="font-family:"Arial","sans-serif";
color:#222222;background:white"> </span></span><span class="apple-style-span"><i><span style="mso-bidi-font-family:Arial;color:#222222;background:white">SEC v. W.J.
Howey Co.,</span></i></span><span class="apple-style-span"><span style="mso-bidi-font-family:Arial;color:#222222;background:white"> 328 U.S.
293, 90 L.Ed. 1244, 66 S.Ct. 1100, 1103 (1946). </span></span></p>
</div>
<div id="ftn10">
<p class="MsoFootnoteText"><a href="file:///C:/Users/Maryellen/Documents/Limited%20Liability%20Companies%20for%20Film%20-%20Installment%20III.docx#_ftnref10" name="_ftn10" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span style="font-size:10.0pt;font-family:"Calibri","sans-serif";mso-ascii-theme-font:
minor-latin;mso-fareast-font-family:Calibri;mso-fareast-theme-font:minor-latin;
mso-hansi-theme-font:minor-latin;mso-bidi-font-family:"Times New Roman";
mso-bidi-theme-font:minor-bidi;mso-ansi-language:EN-US;mso-fareast-language:
EN-US;mso-bidi-language:AR-SA">[10]</span></span></span></span></a>
See <i>Great Lakes Chemical Corp. v.
Monsanto Co.,</i> 96 F.Supp.2d 376 (D.Del. 2000) and <i>Keith v. Black Diamond Advisors, Inc.,</i> 48 F.Supp. 2d 326 (S.D.N.Y.
1999).</p>
</div></div></div>