II. LLP and LLC Interests as "Securities"
The federal and state securities laws do not apply to an ownership interest unless the interest is a security. The relevant federal and South Carolina statutes define "security" by listing interests that constitute securities as a matter of law.9 Jurisprudence concerning the definition of "security" has largely developed in the federal courts.
A. Federal Law
LLC memberships and LLP partnerships are not on the list of interests that are specifically identified under the Securities Act as securities.10
The leading cases use the Howey "investment contract" test11 to evaluate partnership interests as securities, so Howey will apply to LLPs.12 Investments in LLCs as securities have also been widely determined by the courts according to Howey.13
The virtue of the Howey test in this context is its case-by-case focus on the economic realities of the investment, often phrased in terms of whether the investors, under the circumstances, need the protections of the securities laws.14 Where economic realities are the key, labels will not control.
In Howey, the United States Supreme Court defined an investment contract as "a contract, transaction or scheme whereby 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."15 Subsequent opinions have interpreted "solely from the efforts of [others]" to require that the investor's expectation of profit be based not entirely, but chiefly or perhaps even substantially, on the entrepreneurial or managerial efforts of others.16
In most cases, an investor in an LLC or LLP will be investing money in a common enterprise in the expectation of profit. This makes such investments look very much like investment contracts and therefore securities, leaving open only the last Howey element, the question whether the anticipation of profit is based substantially on the efforts of others.17
In light of Howey and its progeny, the courts incline to this question in terms of investor rights of management and control of operations balanced against the investor's reliance on third parties for the success of the enterprise. This raises the issue of who has the right to control those operations that are intended to generate profits.
LLPs, being general partnerships, convey to their owners as a matter of statute and common law substantial rights of management and control. Nevertheless, by agreement these rights can be waived, or these rights may be unavailable as a practical matter. In this way, LLP interests can pass the final prong of Howey and become securities.
In the case of an LLC, management can be fixed at any point along a continuum from absolute member management to absolute member passivity based on professional management. Each South Carolina LLC must elect whether to be member-managed or manager-managed.18 The members of a member-managed LLC each have the apparent authority to bind the LLC in the ordinary course of its business (like partners in a general partnership), while a manager-managed LLC can be bound only by its designated management (like a business corporation).19 In the case of an LLC designed for absolute member passivity and professional management, there can be little argument that the Howey test is met, with the result that a membership will be a security. All other arrangements are in doubt.20
The closest analog to the LLC securities issue lies with partnerships, where "efforts of others" is also the determining Howey issue; here, LLP and LLC analysis coincides. In this area of the law, the defining difference has generally been between general partnerships and limited partnerships. General partnership interests - roughly analogous to member-managed LLC memberships - are presumed not to be securities. Limited partnership interests - roughly analogous to manager-managed LLC memberships - are presumed to be securities. In both cases, however, the presumption can be overcome on the basis of right to control.21
In the Fourth Circuit's view as expressed by retired Justice Powell in Rivanna Trawlers Unlimited v. Thompson Trawlers, Inc.,22 when a partnership agreement allocates to the partners "specific and unambiguous" powers giving them "ultimate control, as a majority" over the business of the partnership, then "the presumption that the general partnership is not a security can only be rebutted by evidence that it is not possible for the partners to exercise those powers."23 This approach, focusing on state law and the partnership agreement, is referred to by commentators as a "modified per se" test. In Rivanna Trawlers, the partners delegated control to external managers but, because the partners were empowered to replace these managers and in fact had done so twice, the court held that they were "not dependent upon the irreplaceable skills of others" so as to make necessary the protection of the federal securities laws.24
Notably, Rivanna Trawlers identifies the tipping point of analysis to be the partners' powers as a group to control management...
