Exempt Market Update | Fall 2013 | www.emdacanada.com 62
to securities laws involved Sapphire Tower Development Corp.
(Sapphire), a Toronto-based real estate development company.
Sapphire was involved in the development of a hotel-condominium
project in Toronto from 2002 – 2006 and marketed the sale of units in
the building through the use of brochures and other advertising media.
The agreements marketed by Sapphire were similar to those notes
offered by 1 King West Inc. (1 King), an entity which had sought and
received an exemption from certain requirements of the Act and which
involved the same promoter.
Sapphire accepted deposits from prospective purchasers and
entered into conditional agreements of purchase and sale that, like
the arrangements in 1 King, provided investors with the opportunity
to participate in a rental program through which they would receive
a share of the profits earned by the manager of such program.
The OSC contacted Sapphire to advise that an exemption
similar to that obtained by 1 King would be required to continue
its business activities, and ultimately issued a formal Statement
of Allegations noting that Sapphire’s conduct amounted to an
offering of securities. Sapphire ultimately abandoned the project
due to its inability to secure requisite approvals from the City of
Toronto as well as due to certain economic factors.
Sapphire subsequently entered into a settlement agreement
with the OSC in which it admitted to entering into investment
contracts with investors without complying with the registration and
prospectus requirements under the Act. While there were no reported
losses from investors, Sapphire and its lead project manager and
compliance officer, agreed to pay the costs incurred during the
3. W. J. Howey Co.
A landmark U.S. decision involving real estate was Securities
and Exchange Commission v. W. J. Howey Co. (Howey). In Howey,
the defendant marketed tracts of land bearing orange groves and
offered investors the option to: (a) purchase the land outright;
or (b) to lease it back to the defendant under a ‘management
services contract’. Under the latter arrangement, the defendant
contracted to manage and harvest the fruit and other produce
from the investor’s land while making representations to potential
investors of the profits they could expect.
The United States Supreme Court held that the defendants
were ‘offering an opportunity to contribute money and to share
in the profits of a large citrus fruit enterprise’ managed by the
defendant, which were ‘something more than fee simple interests
in land’. The arrangement was found to constitute an investment
contract and the defendants were held to have sold unregistered
securities in violation of applicable U.S. securities law.
Other Examples of Business Arrangements as Investment Contracts
Cases of unexpected deemed distributions of securities are
not limited to the real estate. There are many interesting cases
involving non-real estate business arrangements that have been
subsequently determined to involve a security. Below are a few
examples that will hopefully shed light on this important issue.
1. Investment in Foreign Currency Trading Schemes
Investment contracts may also be found in arrangements
involving investments in companies who advertise expected
profits through the trading of foreign currencies. As discussed
in a 2012 decision of the OSC, Gold-Quest International Corp.
(Gold-Quest) represented to investors that they had developed
asset management and hedging strategies that were capable of
generating extremely high returns. Under its arrangement with
investors, Gold-Quest promised a one-year return of 87.5% and
did not disclose how the invested monies would be used other
than in the trading of foreign currencies.
Applying the test from Pacific Coast, the Gold-Quest
agreements were found to be investment contracts by the OSC
since: (a) investors provided Gold-Quest with money; (b) investors
were led to expect a return of 87.5% per annum on their investment;
and (c) the investor’s role in the arrangement was limited to the
advancement of money, while Gold-Quest maintained managerial
control over the common enterprise. The various parties involved
were subject to sanctions including the disgorgement of profits
earned, administrative penalties and prohibitions on their ability to
trade securities or act for or on behalf of registrants.
2. The Operation of a Chinchilla Breeding Business
Investment contracts have also been found to exist by U.S.
courts in a business relationship involving the breeding and
resale of chinchillas. In Miller v. Central Chinchilla Group, Inc. the
defendants sold a pair of chinchillas to the plaintiffs who agreed
to breed the animals in accordance with directions provided by
the defendants. Under the arrangement, the defendants agreed
to purchase any offspring from the plaintiffs and then resell the
offspring to interested buyers at a profit. The defendants assured
the plaintiffs that raising and breeding the chinchillas would require
minimal effort, and that the defendants would be responsible for
securing buyers under the resale arrangement.
The plaintiff alleged that many of these claims ultimately proved
to be material misrepresentations, and that the ‘defendants were
operating a pyramiding scheme under which profits could be made
by the plaintiffs only if the defendants were successful in encouraging
new victims to buy into the scheme.’ Although it was acknowledged
that the success of this enterprise depended in part on the plaintiff’s
ability to successfully raise chinchillas, the Court found that the
plaintiff’s ability to profit was dependent upon the defendants’ ability
to find other interested buyers, and as a result could be characterized
as an investment contract.
As the examples
above illustrate, many