Update: SEC Charges Real Estate Executives with Investment Fraud But Fails to State a Claim

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The Securities and Exchange Commission brought charges against Cay Clubs Resorts and Marinas and several of its executives for defrauding investors. The case originally caught my eye because it involved real estate and would likely play a role in my continuing quest to figure out what’s a security.

The first ruling came out and it was bad for the SEC. A Florida court said the SEC failed to prove its case.  (SEC v. Graham, Case No. 13-10011 (S.D. Fla. Ruling issued July 10, 2013).

In order for the SEC to bring a claim against Defendants for violation of the Securities Act, the SEC must allege enough facts to establish that the subject transactions are investment contracts. Under the Eleventh Circuit’s interpretation of the three-prong test set forth by the U.S. Supreme Court in SEC v. W.J. Howey Co. (328 U.S. 293 (1946)), the Plaintiff must show that there was an investment, that it was a common enterprise, and that the buyer lacked control over profitability of the investment. See Alumni v. Development Resources Group, LLC, 445 Fed. Appx. 288 (1 1th Cir. 201 1); see also Bamert v. Pulte Home Corp. , 445 Fed. Appx. 256 (11th Cir. 201 ).

The court ruled that the purchase agreement is at the heart of the control analysis. The SEC didn’t file a copy of the purchase agreement on the record and did not include adequate factual allegations concerning the contents of the purchase agreement.

The case was dismissed without prejudice. So if the SEC can dig up a copy of the purchase agreement, the SEC can try again.

The SEC’s complaint stated that the defendants “offered investors the opportunity to purchase undervalued condominium units and obtain an immediate 15 percent return through a two-year leaseback agreement with Cay Clubs.”

Investors were also told that their units would appreciate after being renovated by Cay Clubs. Cay Clubs even managed to find lenders who would provide 100% mortgage financing.

During the leaseback, purchasers were restricted from using their units. They could only use the units for 14 days per year. Cay Clubs owned the common areas and controlled access to the units. Cay Clubs had a right of first refusal on the sale of a unit. Cay Clubs controlled the renovation of the resorts and the units. Under the master leasing program, Cay Clubs would rent out the units, with 65% going to the unit owner.