A limited liability partnership (LLP)1 is a relatively new form of business organization that offers the tax advantages of a partnership while shielding its partners from liability for certain partnership obligations.2 Every state now permits the formation of LLPs.3 Literally thousands of LLPs have been formed in the last few years.4
The conventional wisdom has been that ownership interests in LLPs are not securities.5 Unfortunately, the conventional wisdom is based on a myriad of myths and misconceptions about LLPs.6 Moreover, despite the conventional wisdom, some government authorities have taken the position that certain LLP interests may constitute securities.7 Recent enforcement actions clearly demonstrate that LLP status does not shield LLP entities, their agents, or their investors from securities law liability. These developments signal an opportunity for litigators and should serve as a warning for transactional lawyers.
At least twenty-two states have taken the position that LLP interests may be securities.8 Legislators in three states have adopted statutes that expressly state certain LLP interests are securities.9 Six jurisdictions have passed legislation or promulgated regulations that imply LLP interests are securities.10 State securities agencies in five states have indicated in no-action letters or interpretive opinions that some LLP interests may be securities.11 Authorities in as many as eleven jurisdictions have taken action against individuals or entities offering LLP interests alleging state securities law violations.12 The number of states initiating enforcement actions against LLPs, their promoters, their agents, or their investors may well be much larger. Many trial and administrative opinions are unreported.13 In addition, some decisions are not readily accessible or digested. As a result, there may be many more orders and decisions relating to alleged violations of the securities laws in connection with LLP offerings that are neither reported nor readily available.
Whether an LLP interest is a security is of great practical importance to practitioners.14 The classification of an LLP interest as a security triggers, among other things, possible securities registration requirements, broker-dealer registration requirements, securities fraud liability, and in some situations disclosure obligations.15 The United States Securities Exchange Commission (SEC), state securities commissions, and private parties
may bring suit for securities law violations.16 Criminal liability may even be imposed under some circumstances.17
This Article explores when an interest in an LLP may constitute a security. Part II discusses why certain LLP interests may be deemed securities. Part III explores the myths and misconceptions about LLPs that have spawned the conventional wisdom that LLP interests are not securities. The Article describes common assumptions about LLPs and explains why many of these generalizations are not only inaccurate, but dangerous as well. For example, the conventional wisdom has caused some practitioners to overlook possible securities law applicability. In addition, the conventional wisdom has led fraudulent promoters to package their investment products as LLPs in attempts to evade the securities laws. Part IV identifies certain characteristics that may increase the risk of an LLP interest being deemed a security. Part IV then briefly outlines some practical steps that lawyers may take to reduce the risk of securities law violations in connection with an LLP offering.
Part V cautions practitioners that they cannot rely on rules of thumb or presumptions that apply to other forms of business entities, such as general partnerships. The characteristics and organizational structure of each LLP will determine whether the interest at issue is a security. Each offering must be analyzed on a case-by-case basis, focusing on substance, not form. …