Great Lakes Chemical Corp. v. Monsanto Co.

OPINION

This is a securities case. Plaintiff Great Lakes Chemical Corporation is a Delaware corporation with its principal place of business in Indianapolis, Indiana. Defendants Monsanto Company and its wholly owned subsidiary, Sweet Technologies, Inc. *377 (“STI”), are Delaware corporations with their principal places of business in St. Louis, Missouri.

On May 3, 1999, Great Lakes purchased NSC Technologies Company, LLC (“NSC”), from Monsanto and STI. NSC is a Delaware limited liability company with its principal place of business in Mount Prospect, Illinois.

On January 4, 2000, Great Lakes filed the complaint in this action, alleging that Monsanto and STI violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, by failing to disclose material information in conjunction with the sale of NSC. Great Lakes also alleges that defendants are liable for violating Indiana securities law, engaging in common law fraud, and breaching the sale contract, and that defendants must indemnify Great Lakes for all costs arising from the breaches of their representations and warranties in the purchase agreement, Great Lakes is seeking compensatory damages, punitive damages, indemnification, costs, fees, and rescission of the purchase agreement. With respect to a subsidiary agreement, Great Lakes is seeking a declaratory judgment that Monsanto is in breach of the agreement, and an order for specific performance of Monsanto’s duties arising thereunder, or an award of consequential damages.

On March 9, 2000, Monsanto and STI moved to dismiss the complaint pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6), for failure to plead fraud with specificity and for failure to state a claim upon which relief may be granted. Among their assertions, Monsanto and STI argue that the interests sold to Great Lakes were not “securities,” as defined by § 2(a)(1) of the Securities Act of 1933,15 U.S.C. § 77b(a)(1), and that Great Lakes has failed to plead adequate facts in support of its claim for securities fraud.

The parties have completed briefing on defendants’ motion. On May 2, 2000, the court heard oral argument on the motion. This is the court’s decision on defendants’ motion to dismiss.

I. FACTUAL AND PROCEDURAL BACKGROUND

The court draws the following facts from the complaint and the documents attached to the complaint that have been incorporated by reference therein. For the purposes of a motion' to dismiss, the court accepts all allegations in the complaint as true and draws all reasonable inferences in favor of Great Lakes. See Rocks v. Philadelphia, 868 F.2d 644, 645 (3d Cir.1989).

A. The Formation of NSC

1.. Creation of the NSC Unit within Monsanto

Monsanto is the world’s largest manufacturer and distributor of L-phenylalanine (“L-phe”), an amino- acid that is a principal ingredient in the sweetener aspartame. Monsanto manufactures and sells aspartame as the product NutraSweet. L-phe is also useful in the production of numerous pharmaceutical products.

In approximately 1985, Monsanto created the NSC Unit within its NutraSweet division to develop specialized pharmaceutical intermediates and pharmaceutical active compounds derived from L-phe. In 1995, Monsanto reorganized its NutraSweet division and established the NSC Unit as a separate reporting division of Monsanto Growth Enterprises. Monsanto retained the commercial rights to manufacture and sell L-phe and aspartame to the sweetener market. Monsanto restricted the NSC Unit’s sales of L-phe to the pharmaceutical market and to a single customer in the sweetener market, Enzymologa, a Mexican manufacturer of aspartame. By 1998, the NSC Unit’s principal business was based on the development and sale of L-phe and Tic-D, a pharmaceutical intermediate derived from L-phe.

*378 2. Creation of NSC as a Limited Liar bility Company

On September 25, 1998, Monsanto entered into an agreement (the “LLC Agreement”) with STI to establish the NSC Unit as a limited liability company called NSC Technologies Company, LLC (“NSC”), pursuant to the Delaware Limited Liability Company Act, 6 Del.C. § 18-101 et seq. The following terms of the LLC Agreement are relevant to the present dispute.

a. Members and Interests

The LLC Agreement names Monsanto and STI as the Members of NSC, and provides that each Member shall have an Interest in NSC. The LLC Agreement defines “Interest” as “[a] Member’s Percentage Interest, right to distributions under Section 4.1 of this Agreement, and any other rights which such Member has in the Company.” A Member’s Percentage Interest is determined according to the Member’s capital contributions to NSC. Pursuant to the LLC Agreement, Monsanto contributed assets to NSC totaling $162.9 million, and STI contributed assets totaling $37.1 million, giving the firms an 81.5% and 18.5% Percentage Interest, respectively, in NSC. The LLC Agreement establishes procedures for Members to adjust their Percentage Interest in NSC.

b. Net Cash Flow and other distributions

The Members are entitled to receive distributions of Net Cash Flow and allocations of profits and losses. Net Cash Flow is defined, essentially, as all cash receipts of NSC, excluding members’ capital contributions, less all cash expenditures, accrued expenses, and loan payments due. Section 4.1 of the LLC Agreement establishes the allocation mechanism by which Members receive distributions of Net Cash Flow, as follows:

Net Cash Flow shall be determined at such times and in such amounts as the Board, in its sole discretion, shall determine. Any Net Cash Flow so distributed shall be distributed to the Members in the following order: (i) first, the preferred return on any Optional Capital Contributions, pro rata in accordance with the relative amounts thereof; (ii) second, any Optional Capital Contributions not previously returned, pro rata in accordance with the relative amounts thereof; (iii) third, any Additional Capital Contributions not previously returned, pro rata in accordance with the relative amounts thereof; (iv) fourth, any Capital Contributions to the extent not previously returned, pro rata in accordance with the relative amounts thereof; and (v) fifth, to the Members, pro rata in accordance with their respective Percentage Interests.

The LLC Agreement also provides that NSC’s income, profits, gains, losses, deductions, and credits shall be allocated to the Members pro rata in accordance with their respective Percentage Interests.

c.Board of Managers

The LLC Agreement provides that the business and affairs of NSC shall be managed by a Board of Managers. As noted above, the Board, in its sole discretion, shall determine the Net Cash Flow of NSC, and shall distribute the Net Cash Flow to the Members on a pro rata basis. Except as otherwise provided for in the LLC Agreement, the Board of Managers has exclusive authority to bind NSC, and to manage and control NSC’s business and affairs. The LLC Agreement states:

Except as otherwise expressly set forth in this Agreement, the Members shall not have any authority, right, or power to bind the Company, or to manage or control, or to participate in the management or control of, the business and affairs of the Company in any manner whatsoever. Such management shall in every respect be the full and complete responsibility of the Board alone as provided in this Agreement.

The Members of NSC may remove the Managers with or without cause.

*379 d. Members’voting rights

The Members of NSC are entitled to vote on certain matters, including on all incurrences of indebtedness or guarantees thereof. The LLC Agreement specifies that a Majority in Interest, which is defined as 51% of the Percentage Interests owned by the Members, is required to constitute a quorum, or to amend the LLC Agreement.

e. Transfer of Interests

The LLC Agreement restricts the ability of Members to transfer or otherwise dispose of their Interests in 'NSC absent consent of the Board. Moreover, Members are prohibited from disposing of their Interests in NSC when the disposition would cause NSC to be taxable as a corporation, would violate federal or state securities laws, or would violate other laws or commitments binding on NSC. In full, § 6.1(a) of the LLC Agreement provides:

No Member may sell, assign, transfer or otherwise dispose of, or pledge, hypothe-cate or otherwise encumber his Interest without the prior consent of the Board, and any such act in violation hereof shall be of no effect and shall not be binding on the Company. Anything contained herein to the contrary notwithstanding, no Member may sell, assign, transfer, encumber or otherwise dispose of his Interest if such disposition would (i) cause the Company to be treated as an association taxable as a corporation (rather than a partnership) for federal income tax purposes; (ii) violate the provisions of any federal or state securities laws; or (iii) violate the terms of (or result in a default or acceleration under) any law, rule, regulation, agreement or commitment binding on the Company.

The LLC Agreement establishes procedures for assigning the whole or any portion of a Member’s Interest -to a Substituted Member.

B. The Sale of NSC

1. Solicitation of Great Lakes

.. In October 1998, BancBoston Robertson Stephens, an investment bank, prepared a Confidential Descriptive Memorandum (the “Offering Memorandum”) on behalf of Monsanto and STI to promote the sale of NSC. The Offering Memorandum provides an overview of NSC’s business, identifies potential growth opportunities and strategies for NSC, and reports NSC’s financial performance. The Offering Memorandum recites that NSC’s sales increased from $8.3 million in 1995 to $34.5 million in 1997, and projects that NSC’s sales would increase to $93.2 million in 1999 and $192.2 million by 2002.

On November 10, 1998, Monsanto and STI presented the Offering Memorandum to Great Lakes, together with a letter from BancBoston Robertson Stephens proposing that final bids be submitted by year end. On November 12, 1998, Great Lakes responded to the solicitation with a letter indicating its interest in submitting a bid.

On December 11, 1998, Ian Wolpert, a VicerPresident of Monsanto. and the authorized representative of defendants, met with representatives from another interested bidder. Wolpert allegedly told the bidder’s representatives that he stood behind the defendants’ recently issued sales projections. After Wolpert made these remarks, Fred Beyerlein, the Co-Chief Operating Officer of NSC, allegedly spoke to Wolpert outside the meeting, taking exception to Wolpert’s remarks, and voicing concern about the sales projections. Wolpert allegedly became angry, and advised Bey-erlein that it was his job to be an active and, enthusiastic participant in the sale process.

2. Changes in the Market for L-phe and Tic-D

In early 1999, as negotiations over the sale of NSC continued, a number of events were occurring that may have impacted the business prospects of NSC. *380 Monsanto and other competing producers of L-phe, in particular the Korean firm Daesang, began discounting the sale price of L-phe in the sweetener market. As the price of L-phe dropped, NSC allegedly began experiencing diminished' sales of L-phe, particularly to NSC’s sole customer in the sweetener market, Enzymologa. Moreover, an Italian firm, Archimica, was producing Tic-D, a pharmaceutical intermediate derived from L-phe, by a manufacturing process that allegedly infringed the claims of a United States patent assigned to NSC. Archimica was allegedly selling Tic-D products to NSC’s customers.

3. Great Lakes’ Offer to Purchase NSC, and Monsanto’s Revision of NSC’s Financial Projections

On January 15, 1999, Wolpert provided representatives of Great Lakes with revised sales projections for NSC, reducing the forecast of $93.2 million originally stated in the Offering Memorandum to $78 million.

The following week, Great Lakes offered to acquire defendants’ Interests in NSC for approximately $130 million.

During the months of January through April 1999, Great Lakes conducted due diligence concerning NSC’s business, intellectual property, its product markets, and its actual and projected sales. During these months, defendants allegedly instructed NSC’s management not to speak directly to Great Lakes regarding sales, sales forecasts, customer orders and other information, telling NSC management, instead, that all such inquiries should be channeled to defendants’ representatives who would respond to Great Lakes.

In February 1999, defendants allegedly informed NSC’s management that defendants were considering ending negotiations with Great Lakes and seeking a new buyer. NSC’s management allegedly told defendants that, in light of reduced sales in 1999, seeking a new buyer would necessitate a complete revision of the Offering Memorandum. Allegedly as a result of these communications, defendants continued negotiations with Great Lakes.

On March 15, 1999, during a teleconference call with Wolpert, representatives from Great Lakes raised concerns about defendants’ sales projections for NSC. Wolpert allegedly replied that the reduced sales in 1999 were the result of temporary reductions in orders and the accelerated posting of 1999 sales in 1998, and that the shortfall in sales in the first quarter of 1999 would benefit Great Lakes because those deferred sales would be realized after Great Lakes acquired NSC.

On March 16, 1999, Monsanto and STI provided Great Lakes with revised financial projections, stating that NSC could realize total sales of approximately $68.2 million in 1999. Defendants allegedly assured Great Lakes that NSC’s total sales would increase to $124.1 million in 2000, $149.9 million in 2001, and $184 million in 2002. At a meeting the same week between defendants and Great Lakes, Wol-pert allegedly stated to Great Lakes’ representative that defendants “stood by” these sales projections. After the meeting, Beyerlein allegedly told Wolpert that he, Beyerlein, did not stand behind the projections. Defendants allegedly prohibited Beyerlein from advising Great Lakes of his opinions.

In early April 1999, the parties adjusted the purchase price for NSC from $130 million to $125 million. On April 8, 1999, the parties entered into an Ownership Interest Purchase Agreement (the “Purchase Agreement”). On April 12, 1999, Wolpert executed the Purchase Agreement on behalf of defendants, and on April 14, Great Lakes executed the Purchase Agreement. The parties closed the transaction on May 3,1999.

4. The Purchase Agreement

a. Characterization of Interests as “equity securities”

In setting forth the sellers’ representations and warranties, the Purchase Agree *381 ment refers to the Ownership Interests in NSC being transferred as “equity securities.” In full, § 4.1(a) states:

Monsanto owns 31.6 percent of the Ownership Interests and STI owns 68.4 percent of the Ownership Interests, free and clear of any and all liens, encumbrances, restrictions and rights of any nature held by other persons. The Ownership Interests represent 100% of the issued and outstanding equity securities of the Company, all of which are owned by the Sellers and all of which have been duly authorized, are validly issued, fully paid, and nonassessable, and are held of record by the Sellers. There are no outstanding or authorized options, warrants, purchase rights, subscription rights, conversion rights, exchange rights or other contracts or commitments that obligate the Company to issue, sell, or otherwise cause to become outstanding any of its equity securities. There are no outstanding or authorized equity appreciation, phantom equity, or similar rights with respect to the Company. There are no voting trusts, proxies, or other agreements or understandings with respect to the voting of the equity securities of the Company.

b. Representation and warranty of NSC’s financial position

In § 4.6 of the Purchase Agreement, Monsanto and STI make the representation and warranty that, except as otherwise provided, the financial statements provided by defendants to Great Lakes “reflect all material items and present fairly in all material respects the financial position of the Company as of the dates thereof and the results of operations for the periods described therein.”

c. Representation and warranty as to lack of adverse-changes'

In § 4.7(a) of the Purchase Agreement, Monsanto and STI make, the representation and warranty that, since December 31, 1998, “there has been no- change in the business of the Company,” which would have a “negative effect or negative change on the operations, results of operations or condition (financial or otherwise) in an amount equal to $6(500,000 or more.”

d. Responsibility of Great Lakes to evaluate NSC

The Purchase Agreement includes a disclaimer which states that Great Lakes is to take full responsibility for evaluating the accuracy of all estimates and projections furnished to it by Monsanto and STI. Section 6.10 of the Purchase Agreement, in part, states:

In connection with the Buyer’s investigation of the Company, the Buyer may have received from or on behalf of the Sellers certain projections, including projected statements of operating revenues and income from operations of the Company. The Buyer acknowledges that there are uncertainties inherent in attempting to make such estimates, projections and other forecasts and plans, that the Buyer is familiar with such .uncertainties,' that the Buyer is taking full responsibility, for making its own evaluation of the adequacy and accuracy of all estimates, projections and other forecasts and plans so furnished to it (including the reasonableness of the assumptions underlying such estimates, projections and forecasts), and that the Buyer has received no representation or warranty from either Seller with respect to such estimates, projections and other forecasts and plans (including the reasonableness of the assumptions underlying such estimates, projections and forecasts).

e. Transaction Agreements

The Purchase Agreement provides that the parties shall enter into a number of Transaction Agreements prior to the closing of the Purchase Agreement, including a Supply Agreement under which Monsanto would agree to continue to manufacture certain L-phe products for sale to NSC. Section 9 of the Supply Agreement, which was entered into on May 1, 1999, *382 provides in pertinent part that Monsanto shall set aside on consignment “Safety-Stock,” which is defined as a quantity of identified L-phe products equal to one-sixth of the products shipped from Monsanto to NSC during the previous year.

f. Indemnification'

Section 11.1 of the Purchase Agreement states that, except as otherwise provided, Monsanto and STI “will indemnify and reimburse the Buyer for any and all claims, losses, liabilities, damages, penalties, fines, costs and expenses ... incurred by the Buyer and its Affiliates” as a result of, among other things, any breach or inaccuracy of any representation or warranty made by Monsanto or STI as set forth in the Purchase Agreement.

C. The Dissolution of NSC

On October 5, 1999, Great Lakes filed a Certificate of Cancellation with the State of Delaware, dissolving NSC as a separate entity. NSC’s actual sales for 1999 were approximately $33 million, less than 50% of the projections provided by Monsanto and STI to Great Lakes in March 1999.

D. The Lawsuit

1. Great Lakes’ Complaint

On January 20, 2000, Great Lakes filed an eight count complaint in this court. Count I asserts that Monsanto and STI violated § 10(b) of the Securities Exchange Act of 1934,15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, by making material misrepresentations and by failing to disclose material facts in connection with the sale of securities. Count II asserts that Monsanto and STI violated Indiana securities law, § 23-2-1-1 et seq., by making material misrepresentations and by failing to disclose material facts in conjunction with the sale of securities. Count III asserts that Monsanto and STI engaged in common law fraud by knowingly or recklessly making material misrepresentations and failing to disclose material facts in conjunction with the sale of NSC. Count IV asserts that Monsanto and STI fraudulently induced Great Lakes to purchase NSC. Count V asserts that Monsanto and STI breached their warranties and representations given in § 4.7 of the Purchase Agreement, as NSC had sustained adverse changes to its business in excess of $6.5 million between December 31, 1998 and April 30, 1999. Count VI asserts that Monsanto and STI breached the Supply Agreement by failing to supply NSC with a quantity of Safety Stock of certain L-phe products. Count VII asserts that Monsanto and STI breached their representations and warranties that the financial statements of NSC fairly represented NSC’s financial position. Count VIII asserts that Great Lakes is entitled to indemnification for all damages and claims arising out of the breach or inaccuracy of any representation or warranty of the defendants as set forth in the Purchase Agreement.

As to Counts I and III, Great Lakes seeks compensatory damages in excess of $58 million, plus costs, fees, and prejudgment interest. As to Counts II and IV, Great Lakes seeks to rescind the Purchase Agreement and to recover $125 million as the full amount paid by Great Lakes for the Interest in NSC, plus costs, fees, and prejudgment interest, or to recover compensatory damages in excess of $58 million plus costs, fees, and prejudgment interest. As to Count VI, Great Lakes seeks a declaratory judgment that Monsanto is in breach of the Supply Agreement and an order for specific performance under the Supply Agreement, or an award of consequential damages. As to Count VII, Great Lakes seeks an award of compensatory damages in excess of $680,000, plus costs, fees, and prejudgment interest. As to Counts V and VIII, Great Lakes seeks an award of indemnified damages in the aggregate sum of $13 million for its attorneys’ fees and costs of suit. As to Counts III, IV, and V, Great Lakes seeks an award of punitive damages and fees.

Great Lakes asserts that this court has subject matter jurisdiction over its federal *383 securities law claim, pursuant to 28 U.S.C. § 1331, and pendent jurisdiction over its state law and common law claims.

2. Defendants’ Motion to Dismiss

On March 9, 2000, Monsanto and STI moved to dismiss the complaint pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6) for failure to plead fraud with specificity and for failure to state a claim upon which relief may be granted. Monsanto and STI assert that Great Lakes’ federal and state securities claims fail as a matter of law because the Interests in NSC transferred pursuant to the Purchase Agreement do not constitute “securities” under federal or state law, and because plaintiffs fail to adequately plead fraud. Monsanto and STI argue that if plaintiffs federal securities claim is dismissed, plaintiffs state law claims should be dismissed for lack of supplemental jurisdiction. Monsanto and STI argue, moreover, that all plaintiffs’ state law claims, with the exception of Count VII, also fail as a matter of law.

II. DISCUSSION

A. What Is an LLC?

In Delaware, LLCs are formed pursuant to the Delaware Limited Liability Company Act, 6 Del.C. § 18-101 et seq. LLCs are hybrid entities that combine desirable characteristics' of corporations, limited partnerships, and general partnerships. LLCs are entitled to partnership status for federal income tax purposes under certain circumstances, which permits LLC members to avoid double taxation, i.e., taxation of the entity as well as taxation of the members’ incomes. See Treas.Reg. § 301.7701-1 et seq. Moreover, LLCs members, unlike partners in general partnerships, may have limited liability, such that LLC members who are involved in managing the LLC may avoid becoming personally liable for its debts and obligations. See 6 Del.C. § 18-303. In addition, LLCs have greater flexibility than corporations in terms of organizational structure. The Delaware Limited Liability Company Act, for example, establishes the default rule that management of an LLC shall be vested in its members, but permits members to establish other forms of governance in their LLC agreements. See 6 DeLC. § 18-402.

The following law review articles provide additional commentary on the characteristics of LLCs: Michael J. Garrison & Terry W. Kneopfle, Limited Liability Company Interests as Securities: A Proposed Framework for Analysis,, 33 Am.Bus.L.J. 577 (1996); Park McGinty, The Limited Liability Company: Opportunity for Selective Securities Law Deregulation, 64 U.Cin.L.Rev. 369 (1996); Carol R. Goforth, Why Limited Liability Company Membership Interests Should Not Be Treated as Securities and Possible Steps to Encourage This Result, 45 Hastings L.J. 1223 (1994); and Mark A. Sargent, Are Limited Liability Company Interests Securities?, 19 Pepp.L.Rev. 1069 (1992).

B. Are the Interests in NSC That Were Transferred Pursuant to the Purchase Agreement “Securities” Under Federal Law?

To prevail in its claim that defenengaged in securities fraud under § 10(b) of the Securities Exchange Act of 1984, Great Lakes must demonstrate that: (i) defendants made a misstatement or omission; (ii) of a material fact; (iii) with' scienter; (iv) in connection with the purchase or sale of securities; (v) upon which plaintiffs relied; and (vi) that rebanee proximately caused plaintiffs’ losses. See In re Westinghouse Securities Litigation, 90 F.3d 696, 710 (3d Cir.1996). A threshold question in this matter is whether defendants’ alleged misconduct involved a purchase or sale of securities. Defendants contend that plaintiffs claim fails ‘ as a matter of law because the Interests' in NSC do not constitute securities.

Section 2(a)(1) of the Securities Act of 1933 lists financial instruments that qualify as securities, as follows:

The term “security” means any note, stock, treasury stock, bond, debenture, *384 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 certificaté 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.

15 U.S.C. § 77b(a)(1). Among the securities enumerated in § 2(a)(1) of the Securities Act, Great Lakes contends that the Interests in NSC constitute either “stock,” an “investment contract,” or “any interest or instrument commonly known as a ‘security.’ ”

1. Key Cases Governing the Characterization of Novel Instruments

It is helpful, before determining whether the Interests in NSC constitute “stock,” an “investment contract,” or “any interest or instrument commonly known, as a security,” to review a series of cases that provide guidance as to how to characterize novel financial instruments. ,

a. SEC v. W.J. Howey

The Supreme Court defined the parameters of an “investment contract” for the purposes of federal securities law in the case of SEC v. W.J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). Howey concerned a Florida corporation, the Howey Company, that sold small tracts of land in a citrus grove to forty-two purchasers, many of whom were patrons of a -resort hotel. See id. at 296, 66 S.Ct. 1100. For the most part, the purchasers lacked the knowledge, skill, and equipment necessary for the care and cultivation of citrus trees. They invested in the enterprise for profit. The purchasers were free to contract with a number of companies to service the tracts, but the sales contract stressed the superiority of Howey-in-the-Hills Service, Inc., which the purchasers chose to service 85% of the acreage sold. The service contracts granted Howey-in-the-Hills full and complete possession of the acreage, and the individual purchasers had no right of entry to market the crop. Purchasers of tracts shared in the profits of the enterprise, which amounted to - 20% in the 1943-44 growing season. The Howey Company did not register the interests in the enterprise as securities.

The" Securities and Exchange Commission (“SEC”) brought an action pursuant to § 5(a) of the Securities Act, 15 U.S.C. § 77e(a), seeking to enjoin the Howey Company from using interstate mail to offer and sell interests in the enterprise. Because the interests at issue did not constitute any of the traditional kinds of securities enumerated in § 2(a)(1) of the Securities Act, the SEC argued that the interests were “investment contracts.” Noting that the term “investment contract” was not defined by Congress, but that the term was widely .used in state securities laws, the Court largely adopted the definition used at the time by state courts. The Court stated that “an investment contract for purposes of the Securities Act means 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.” Howey, 328 U.S. at 298-99, 66 S.Ct. 1100. Thus, the three requirements for establishing an investment contract are: (1) “an investment of money,” (2) “in a common enterprise,” (3) “with profits to come solely from the efforts of others,” Id. at 301, 66 S.Ct. 1100. In articulating this test, the Supreme Court stated that this definition *385 “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” Id. at 299, 66 S.Ct. 1100.

b. United Housing Foundation, Inc. v. Forman

The Supreme Court established guidelines for whether non-traditional instruments labeled “stock” constitute securities in United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). Forman concerned a nonprofit housing cooperative that sold shares of “stock” to prospective tenants. The sole purpose of acquiring the shares was to enable the purchaser to occupy an apartment in the cooperative. The shares essentially represented a recoverable deposit on the apartment. The shares were explicitly tied to the apartment, as they could not be transferred to a non-tenant. Nor could they be pledged or encumbered. No voting rights attached to the shares.

After the housing cooperative raised rental charges, the residents sued the cooperative under § 17(a) of the Securities Act, 15 U.S.C. § 77q(a), asserting that the cooperative falsely represented that it would bear all subsequent cost, increases due to factors such as inflation. The Supreme Court held that the “stock” issued by the cooperative did not constitute a security. The shares, the Court found, lacked the five most common features of stock: (1) the right to receive dividends contingent upon an apportionment of profits; (2) negotiability; (3) the ability to be pledged or hypothecated; (4) voting rights in proportion to the number of shares owned; and (5) the ability to appreciate in value. Id. at 851, 95 S.Ct. 2051. Finding that the purchasers obtained the shares in order to acquire subsidized low-cost living space, not to invest for profit, the Court ruled that the “stock” issued by the coop[erative was not a security. See id. at 852, 95 S.Ct. 2051.

c. Landreth Timber Co. v. Landreth

Following the issuance of Forman, a number of lower courts began to apply the Howey test to distinguish between investment transactions, which were covered by the securities laws, and commercial transactions, which were not. See, e.g., Landreth Timber Co. v. Landreth, 731 F.2d 1348, 1352 (9th Cir.1984) (citing cases). In Landreth, the Ninth Circuit addressed whether a single individual who purchased 100% of the stock in a lumber corporation, and who had the power to actively manage the acquired business, could state a claim under the securities laws for alleged fraud in the sale of the business. The Ninth Circuit found that the purchaser bought full control of the corporation, and that the economic reality of the transaction was the purchase of a business, and not an investment in a security. See id. at 1353. The court held that the sale of 100% of the stock of a closely held Corporation was not a transaction involving a “security.”

Reversing the Ninth Circuit, the Supreme Court reasoned that it would be burdensome to apply the Howey test to transactions involving traditional stock. See Landreth Timber Co. v. Landreth, 471 U.S. 681, 686-88, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985). The Court held that, insofar as a transaction involves the sale of an instrument called “stock,” and the stock bears the. five common attributes of stock enumerated in Forman, the transaction is governed by the securities laws. The Court noted that stock is specifically enumerated in § 2(a)(1) of the Securities Act as a security, and that stock is so “quintessentially a security” that it is unnecessary to apply the Howey test to determine if it is a security. Id. at 693, 105 S.Ct. 2297. The financial instrument involved in the case, the Court reasoned, “is traditional stock, plainly within the statutory definition.” Id. at 690, 105 S.Ct. 2297. “There is no need here,” the Court continued, “to look beyond the characteristics of the instrument to determine whether the [Securities] Acts apply.” Id. The Court stated *386 that the Howey test should only- be applied to determine whether an instrument is an “investment contract,” and should not be applied in the context of other instruments enumerated in § 2(a)(1) of the Securities Act. See id. at 691-92, 105 S.Ct. 2297.

d. Penturelli v. Spector, Cohen, Gordon & Rosen-

In Penturelli v. Spector, Cohen, Gadon & Rosen, 779 F.2d 160 (3d Cir.1985), the Third Circuit reaffirmed that the Howey test should not .be used to determine whether instruments that are enumerated in the Securities Act constitute securities. In Penturelli, an individual, Bernardo Pen-turelli, purchased 28 fractional undivided working interests in a coal mining operation. Penturelli relied on the advice of his accountant that purchasing the interests would result in significant tax benefits. The accountants and other parties connected with the mining operations allegedly diverted Penturelli’s funds to mine worthless land, and the tax benefits never materialized. Penturejli brought suit under 15 U.S.C. § 10(b).

The district court found that Penturelli exercised managerial control over the mining operations, and dismissed the complaint because Penturelli was not a sufficiently passive investor under the Howey test. The Third Circuit reversed. Noting that fractional undivided interests in mining operations are listed as securities in § 2(a)(1) of the Securities Act, the court reasoned that under Landreth, it was unnecessary to apply the Howey test. See id. at 164-65.

2. Prior Cases Concerning Whether Interests in LLCs are Securities

The present case raises novel issues regarding the regulation of transactions involving interests in LLCs. The court has identified three cases in which other courts have determined whether interests in LLCs constitute securities.

a. Keith v. Black Diamond Advisors, Inc.

In Keith v. Black Diamond Advisors, Inc., 48 F.Supp.2d 326 (S.D.N.Y.1999), the plaintiff, Keith, founded a sub-prime mortgage lending firm, Eagle Corp., and brought it to profitability. Milton was an