- What Do You Mean Securities Registration? It's Just a Golf Club Membership
- September 18, 2008 | Author: Michelle Fisher Tanzer
- Law Firm: Holland & Knight LLP - Fort Lauderdale Office
"What do you mean securities registration?" Resort and mixed-used developers have asked this question more times than one can imagine. While counterintuitive to many, securities laws and registration issues play a significant role in establishing a successful and legal membership program offering. Whether a golf club, yacht marina club or a private residence club, failure to ask the right questions and address the answers properly at the right time will leave you facing more trouble than reconstructive knee surgery before a U.S. Open championship.
How Do Securities Law Even Come Into Play? The Definition of Security.
SEC. 2.  (a) of the Securities Act of 1933 provides as follows (with emphasis added):
(1) The term ‘‘security’’ means any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
What Does All This Have to Do With Club Memberships?
The courts have certainly addressed the definition of a security, but guidance in the context of club membership offerings comes from the Securities and Exchange Commission (SEC), through its promulgation of No-Action Letters (NALs). The NALs contain the SEC’s current position on whether the SEC will take enforcement action against a particular person or entity making an offering under a particular set of facts, and will only be issued in response to a specific request concerning that specific set of facts. The developer or club provides the SEC with the facts and circumstances of its proposed membership offering and requests that the SEC respond with its current position as to whether the SEC will take enforcement action under the stated set of facts. If the SEC determines that it would not take enforcement action under those particular facts, the SEC may, but is not required to, issue an NAL to the party requesting it. Each NAL is fact-specific and may only be relied upon for that particular offering. However, the SEC has issued many NALs involving the offering of club memberships which clearly frame the SEC’s prevailing position as to which club membership offerings fall within the definition of a security. When analyzing whether a club membership offering is a security in light of these NALs, one can conclude that a club membership squarely falls within the definition of security if any one of a number of elements exist in the membership offering. These elements include capital, investment contract, or profit motive outside of acceptable parameters.
Why Do I Need to Escrow Membership Proceeds? The Risk Capital Test.
The NALs provide that if a club member pays money for the club membership prior to completion of all of the advertised club facilities, the money paid may be at risk. The risk to the member is that the club facilities may never be completed and the funds may not be available for a refund. Thus, if the developer receives money from club members prior to the completion of the promised club facilities, and the money is at risk, the offering would fail the “risk capital test.” If a membership offering fails the risk capital test – a critical element of a security – the offering may require registration. Generally speaking, this result can be avoided by depositing all membership proceeds in a properly maintained escrow account until the club facilities are completed. There are exceptions and alternatives to the escrow requirement, however, such exceptions and alternatives are narrowly construed and are often misunderstood. In difficult lending times such as these, the escrow limitation on the use of such funds could, in effect, render the development of the club impractical, so the temptation to ignore this requirement is significant. However, while resisting the temptation is essential, proper advice on escrow and the available alternatives is equally essential.
What About Founder’s Programs? The Howey Test.
There are two main types of Founder’s Programs. The first type is the Founder Membership which is virtually identical to all of the other memberships being offered, but the Founder Members have special recognition and added benefits of membership, such as preferred tee times, special lockers, and invitations to special membership activities or tournaments. These special benefits do not, by themselves, cause the membership to be a security. The second type of Founder Membership is a membership in which the Founder Membership offering is used by the developer as capitalization for the development of the club. In these cases, the Founder Member is typically offered specific financial incentives associated with the acquisition of the membership, such as a promise that the Founder Member will receive the amount paid for the membership earlier than generally provided to other members, along with a return on the money paid, in exchange for the developer’s use of the Founder Membership contribution to construct the club facilities. This second type of Founder Membership program is a classic danger zone as it likely constitutes an investment contact. While Founder Memberships cannot be offered as investment contracts, the famed Sec v. W.J. Howey Co., 328 U.S. 293, rehearing denied, 329 U.S. 819 (1946) defined the “economic realities” of a transaction to establish the existence of an investment contract. The offering is an investment contract if the three following criteria are present: (1) an investment of money; (2) in a common enterprise; and (3) the expectation of profit from the efforts of the promoter or a third party. The presence of these three elements, now known as the “Howey” test, disregards the form of the transaction and evaluates the true economic basis of the transaction. While the phrase “from the efforts of the promoter or a third party” has been interpreted in various ways, the concept is that the investment is passive. Simply put, when the member makes an investment of money (frequently called the “membership contribution”), in the common enterprise (the club membership program), with the expectation of profit (with only a passive involvement in the business of the club), the Howey test has been met. As such, this type of membership generally requires, at the very least, a Regulation D filing (the “Reg. D”). The Reg. D is a significantly less cumbersome and less expensive way to comply with the SEC’s registration requirements; however, much like the alternative for escrow, this alternative has many specific requirements. For example, there can be no general advertising under the Reg. D, and all Founder Members need to be “high net worth” individuals, also narrowly defined by the SEC.
All Categories of Membership Must Pass the Howey Test.
However, memberships in typical non-equity membership deposit programs do not include an expectation of profit, as the return on the membership is generally limited to the amount paid for the membership programs. With respect to other forms of membership offerings, including equity membership programs, numerous NALs carve out a special exemption for golf club memberships. These NALs provide that the third prong of the Howey test, the expectation of profit, will not be met if the return on the golf membership is limited or unlikely. This exemption allows the member to receive a return on the membership only if the value of the membership has increased beyond a specified amount, which deems the expectation of profit immaterial in making the decision to acquire the membership. More specifically, the NAL provide that the maximum amount of return the membership can receive is 80 percent of the then current price of the membership. Thus, the membership would have to appreciate more than 25 percent before the member can realize any profit. Prior to offering any type of type of membership program, including, but not limited to a Founder Membership program, the Howey test must be considered unless a securities registration is planned.
Can We Have a Rental Program? The Intrawest Guidelines.
As club membership programs have evolved, they have expanded far beyond the traditional golf club membership. In addition to golf club memberships, there are yacht marina memberships, private residence club memberships, vacation club memberships, as well as membership interests in yachts, airplanes and virtually every other type of amenity or service imaginable. Regardless of the type of amenity, if the membership program combines usage of the amenity with participation in a rental management program, a security may have been created. For example, when a yacht marina membership is offered, it typically provides for the exclusive usage of a yacht slip within the club’s marina for a period of time. The member also has the opportunity to enroll the yacht slip in a rental management program in which the member shares in the rental revenue. Depending on how the membership and rental program are presented, offered and operated, the membership may be a security requiring registration.
In the Intrawest NAL (November 8, 2002), the SEC formulated guidelines for rental program offerings in the context of condominiums and condo-hotels. Even though club memberships are not an interest in real estate in virtually all cases, the securities law issues, as well as the rationale and guidelines, of Intrawest are applicable to club memberships when combined with a rental program offering. The Intrawest guidelines are lengthy and a detailed discussion is well beyond the scope of this article, however, the content can be briefly summarized as follows:
- the only statement that a sales representative may make is “Acquisition of a membership in the club may include the opportunity to place your membership in a rental program”; any statement made beyond this by a membership sales representative (in contrast to a rental program representative) would violate the guidelines; if the prospective member asks for further information, the sales representative must refer the prospect to a rental management company representative, either with the affiliated management company or with an unaffiliated manager or the prospects choice
- the sale of the membership must be completely separate and distinct from the decision to participate in any rental program; no rental management agreement may be executed prior to execution of the agreement to acquire the membership and the rental management agreement must be contingent upon the acquisition of the membership
- no statements whatsoever may be made with respect to the economic or tax benefits that may result from the rental program, and no rental history or other financial information regarding the program may be given by sales representatives; rental company representatives may give limited information, but only upon specific request from the prospective member
- the rental program must be voluntary and the member must be free to participate in the program or not, or utilize the services of an unaffiliated rental management company
- the rental income will not be pooled, and each rental program participant will receive a share of the income only from the rental of his or her personal membership amenity
- the member will not be limited in the use of the membership amenity, unless applicable zoning or law imposes the limitation The Intrawest guidelines can be overwhelming, but with a yacht marina membership program, as with any other membership program, proper guidance allows navigation of trouble-filled waters and arrival at the safe harbor unscathed.
There is no doubt that a club membership offering can be classified as a security if the offering includes risk capital, is an investment contract, or offers a profit motive beyond established limits. Other elements and characteristics of a security must similarly be avoided or a security registration will be required. A securities registration is expensive, both in time and money. Failure to register a security, i.e., offering an unregistered security, will subject the sponsor and possibly operators, agents and affiliates to severe consequences including litigation and significant penalties.