Redding v. Montana First Judicial District Court

July 6 2012

OP 11-0558

IN THE SUPREME COURT OF THE STATE OF MONTANA

2012 MT 144A

BILLIE L. REDDING,

Petitioner,
v.

MONTANA FIRST JUDICIAL DISTRICT COURT,
THE HONORABLE DOROTHY McCARTER,
Presiding,

Respondent.

ORIGINAL PROCEEDING: Writ of Supervisory Control
In and For the County of Lewis & Clark, Cause No. ADV 09-649
Honorable Dorothy McCarter, Presiding Judge

COUNSEL OF RECORD:

For Petitioner:

Linda M. Deola (argued), Morrison, Motl & Sherwood, PLLP, Helena,
MT

For Respondent:

P. Brad Condra (argued), G. Patrick HagEstad (argued), Milodragovich,
Dale, Steinbrenner & Nygren, P.C., Missoula, MT

For Amicus:

Jesse Laslovich, Jameson C. Walker, Brett O’Neil, Office of the
Commissioner of Securities and Insurance, Helena, MT

Argued: April 25, 2012
Submitted: April 26, 2012
Decided: July 5, 2012
Amended: July 6, 2012

Filed:

__________________________________________
Clerk
Justice Michael E Wheat delivered the Opinion of the Court.

¶1 Petitioner Billie L. Redding (Redding) asks this Court, pursuant to M. R. App. P.

14, to exercise supervisory control over the First Judicial District Court, Lewis and Clark

County, and to conclude it was error for the District Court to grant partial summary

judgment to Defendants Timothy Janiak; Anderson ZurMuehlen & Co., P.C.; Ray E.

Petersen; and Rick Ahmann (collectively “AZ”).

BACKGROUND

¶2 For the purposes of this Opinion, the facts are not materially disputed. Redding is

a 76 year old widow1 with a high school education. Redding worked the majority of her

adult life on family ranches. In 2004, Redding sold her ranch for approximately 3.3

million dollars. Seeking to avoid tax liability on the sale, and provide income for life for

herself and her son, Redding sought advice from her accountant, Timothy Janiak

(Janiak).

¶3 Janiak, a Certified Public Accountant (CPA), had been Redding’s accountant for

approximately 20 years and was a shareholder at the accounting firm Anderson

ZurMuehlen & Co. (“Anderson”). Janiak assisted Redding in the sale of her ranch, and

Redding sought his advice to invest the proceeds of the sale. To help Redding achieve

her financial goals, Janiak steered Redding to a company called Anderson ZurMuehlen

Real Estate and Business Brokerage, LLC, d/b/a Acquiron.

1
During the events leading up to the lawsuit, Redding was in her late 60s and early 70s.
2
¶4 Acquiron was a subsidiary of Anderson, formed with Rick Ahmann (Ahmann), a

real estate broker. Ray E. Petersen (Petersen), a CPA and former shareholder at

Anderson, was Anderson’s representative in Acquiron. Acquiron sold Tenants-In-

Common investments (TICs) to clients of Anderson. A TIC investment is, generally

speaking, a joint investment in real property, in this case commercial property, where

each owner owns an undivided share of the property. The TICs involved in Redding’s

case were initially owned by DBSI Housing, Inc. (DBSI) or one of its hundreds of

affiliates. 2

¶5 DBSI would acquire title to real property then sell the same property in shares to a

number of investors. DBSI would then require the new owners to execute several

agreements, including a lease agreement with DBSI in which the owners leased the

property back to DBSI as “master tenant,” and a TIC agreement with the other owners.

The owners also assumed a pro rata share of the debt DBSI incurred in acquiring the real

property.

¶6 DBSI, as “master tenant,” would then lease the properties to commercial tenants,

acting as a property manager for the owners. DBSI would pay the expenses of operating

each property. According to the “NNN Plus Lease” summary provided by DBSI to

potential investors, Redding and the other owners did not have to invest “the personal

time and effort involved in operating the property and in dealing with multiple tenants.”

2
In a statement made by DBSI through its bankruptcy attorneys, it acknowledges that it has “hundreds of
companies” as affiliates. For simplicity, we will refer to DBSI only, although several affiliated entities, including
FOR 1031, are involved in this case.
3
Rather, as DBSI advertized, “the management responsibilities of the TICs will simply

consist of dealing with the NNN PLUS Lessee and receiving and depositing a monthly

lease payment from the Lessee.”

¶7 In return for the owners’ investment, DBSI promised a 6% - 7% per year rate of

return on each owner’s investment, with annual increases of approximately 3%. These

promised returns were from the lease payments DBSI collected on the properties. DBSI

would keep any profits above the promised rate of return to investors.

¶8 Ultimately, Redding purchased four DBSI TICs via 1031 exchanges in 2004.3 The

1031 exchanges allowed Redding to avoid tax liability on the sale of her ranch, and, in

theory, the newly purchased properties would provide the income she sought. Redding’s

purchases were brokered by Acquiron. Using the proceeds of the ranch sale and other

assets, Redding paid approximately $4.6 million for the properties, which includes

approximately $2.2 million cash and $2.4 million of assumed debt on the properties.

¶9 DBSI’s scheme collapsed and it stopped making payments to investors in 2008,

and filed for bankruptcy. In response to petitions from the states of Idaho and Montana,

the bankruptcy court appointed an examiner to investigate the finances of DBSI and its

various affiliates. The examiner found that DBSI was running a Ponzi scheme. 4

3
A 1031 exchange is named after § 1031 of the Internal Revenue Code, or 26 U.S.C. § 1031. This section allows,
with some exceptions, an individual to avoid paying taxes on the sale of “property held for productive use in a trade
or business or for investment if such property is exchanged solely for property of like kind which is to be held either
for productive use in a trade or business or for investment.” 26 U.S.C. § 1031(a)(1).
4
We have defined a Ponzi scheme as “a fraudulent investment arrangement in which returns to investors are not
paid from any “profits” of an underlying business venture, but from monies obtained from later investors. The fraud
consists of funneling proceeds received from new investors to previous investors in the guise of profits from the
alleged business venture, thereby cultivating an illusion that a legitimate profit-making business opportunity exists
4
¶10 In a related complaint brought by the bankruptcy trustee against DBSI’s Idaho

attorneys, the trustee alleged that, “[i]n November 2008 . . . [t]ens of thousands of [DBSI]

investors learned that they had lost everything. The docket of the Bankruptcy Court is

crowded with letters from individual investors telling of lost savings accumulated in

some cases through the efforts of generations.”

¶11 After the colossal collapse of DBSI, Redding sued AZ in 20095 alleging: (1)

unlawful sale of securities; (2) negligence; (3) negligent misrepresentation; (4) breach of

fiduciary duty; (5) breach of contract; and (6) tortious breach of the covenant of good

faith and fair dealing. Redding sought damages in the amount of $4,635,485.51, plus

additional amounts for punitive damages, emotional distress, loss of established course of

life, and consequential damages.

¶12 Redding moved for summary judgment on several issues, however the only issue

relevant here is “[w]hether or not the DBSI TICs sold to [Redding] are securities under

the Securities Act of Montana[.]” AZ also moved for summary judgment on the same

issue. After briefing, the District Court found the DBSI TICs were not securities under

Montana law. In an August 9, 2011, order, the District Court found that “Redding did not

engage in a common enterprise,” an essential element of an investment contract (i.e. a

security), because she “did not share the risks of the investment with other investors

and inducing further investment. As a result of the absence of sufficient (or any) assets able to generate funds
necessary to pay the promised returns, the success of such a scheme guarantees its demise because the operator must
attract more and more funds, which thereby creates a greater need for funds to pay previous investors, all of which
ultimately causes the scheme to collapse.” Mosley v. American Express Financial Advisors, Inc., 2010 MT 78, ¶ 3 n.
1, 356 Mont. 27, 230 P.3d 479. DBSI denies it ran a Ponzi scheme.
5
Her complaint was amended three times. These allegations are from the Third Amended Complaint.
5
because she agreed upon a contractually set return on her investment.” The District

Court stated the “keystone” of a common enterprise is “risk and fluctuation with the

return on the investment.” Because Redding “wanted ‘zero risk[,]’ ” the District Court

found the TICs were not securities under Montana law.

¶13 On September 23, 2011, Redding filed her Petition for Writ of Supervisory

Control (“Petition”). AZ moved to stay the proceedings in District Court, pending the

outcome of Redding’s Petition. The District Court granted AZ’s motion over Redding’s

objection. Redding’s Petition presents one issue, we restate as follows:

¶14 Did the District Court err in holding that the TICs at issue are not securities under

the Securities Act of Montana?

DISCUSSION

¶15 Before reaching the merits of Redding’s Petition, we must determine whether the

exercise of supervisory control is appropriate.

A. Is Supervisory Control Appropriate?

¶16 By virtue of Article VII, Section 2(2) of the Montana Constitution, this Court has

“general supervisory control over all other courts.” Stokes v. Montana Thirteenth

Judicial District Court, 2011 MT 182, ¶ 5, 361 Mont. 279, 259 P.3d 754. Supervisory

control is an extraordinary remedy, reserved for extraordinary circumstances. Stokes, ¶ 5.

We consider the propriety of supervisory control on a case-by-case basis. Stokes, ¶ 5.

¶17 Rule 14(3) of the Montana Rules of Appellate Procedure governs petitions for

writs of supervisory control:
6
 The supreme court has supervisory control over all other courts and may,
on a case-by-case basis, supervise another court by way of a writ of
supervisory control. Supervisory control is an extraordinary remedy and is
sometimes justified when urgency or emergency factors exist making the
normal appeal process inadequate, when the case involves purely legal
questions, and when one or more of the following circumstances exist:
(a) The other court is proceeding under a mistake of law and is causing a
gross injustice;
(b) Constitutional issues of state-wide importance are involved;
(c) The other court has granted or denied a motion for substitution of a
judge in a criminal case.

¶18 “This Court will assume supervisory control of a district court to direct the course

of litigation where the district court is proceeding based upon a mistake of law, which if

uncorrected, would cause significant injustice for which an appeal is an inadequate

remedy. Truman v. Montana Eleventh Judicial District Court, 2003 MT 91, ¶ 13, 315

Mont. 165, 68 P.3d 654. Judicial economy and inevitable procedural entanglements are

appropriate reasons to exercise supervisory control where a mistake of law will affect

virtually all aspects of the case: the costs, the course of discovery, settlement

negotiations, and the trial itself. Truman, ¶ 15; Stokes, ¶ 6. In such cases, any verdict

rendered would be “questionable” and would inevitably lead to further costs and

litigation. Truman, ¶ 15.

¶19 Redding argues that supervisory control is appropriate because the District Court’s

order is a clear mistake of law, and is in direct conflict with the precedent of the United

States Supreme Court and the opinions of the Montana Commissioner of Securities and

Insurance, the Securities Exchange Commission (SEC), and the Financial Industry

Regulatory Authority (FINRA) (formerly known as National Association of Securities
7
Dealers (NASD)). If allowed to stand, Redding argues the ruling will create an

“environment ripe for securities fraud” in Montana, and supervisory control is required to

prevent significant injustice to Redding and all citizens of Montana.

¶20 AZ appeared for the District Court, and argues that supervisory control is

inappropriate because the appeal process is an adequate remedy. At oral argument, AZ

also argued that exercising supervisory control in this case will “open the floodgates” of

interlocutory appeals and lead to the granting of innumerable petitions for writs of

supervisory control.

¶21 We first address AZ’s “floodgate” argument. AZ is simply incorrect, as this

Court’s publicly available statistics show. 6 In 2011, 58 petitions for writs of supervisory

control were filed; 7 were granted. The highest number of granted petitions for writs of

supervisory control in recent years was 12 out of 50 in 2009. The lowest number (in the

publicly available statistics) was 1 out of 33 in 2006. The floodgates have simply not

opened. This argument is entirely without merit.

¶22 On the merits of Redding’s petition, we find that exercising supervisory control is

appropriate in this case. There appear to be no facts in dispute that are material to the

contested legal issue—whether the TICs constitute securities under Montana law. Like

Truman, Stokes, and other cases in which we have exercised supervisory control, this is

an issue of law that drives how the case proceeds through trial. Resolution of the issue

6
These statistics are available to all members of the public here: http://courts.mt.gov/clerk/stats/default.mcpx.
Simply click on the heading “Original Proceedings Detail – 2011.” Statistics for the years 2004-2010 are also
available from this page.
8
will avoid the “costs and delay associated with the full re-trial almost certain to result if

the district court’s interpretation of the statute is set aside.” Stokes, ¶ 8. If incorrect, the

District Court’s ruling would deny Redding, and others similarly situated,7 the

protections of the Securities Act of Montana. Redding’s cause of action for unlawful

sale of securities would be forfeited, along with the specific remedies that accompany

such a claim, including rescission and damages allowable under the Act. This in turn

would affect all aspects of Redding’s remaining case. We conclude that the District

Court’s ruling would cause a significant injustice for which an appeal is an inadequate

remedy, and that justice requires this Court to exercise supervisory control.

B. Did the District Court err in holding that the TICs at issue are not

securities under the Securities Act of Montana?

¶23 The Securities Act of Montana, § 30-10-101, MCA, et. seq. (the Act), regulates

the sale of securities to the citizens of Montana. A primary goal of the Act is to “protect

the investor, persons engaged in securities transactions, and the public interest[.]”

Section 30-10-102(1), MCA. The Act is heavily based on its federal counterparts, the

Securities Act of 1933 and the Securities Exchange Act of 1934. The fundamental

purpose of those acts is “to eliminate serious abuses in a largely unregulated securities

market.” United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849 (1975).

¶24 The Act defines “security” quite broadly. Section 30-10-103(22), MCA; State v.

Duncan, 181 Mont. 382, 393, 593 P.2d 1026, 1033 (1979). Such a broad definition is in
7
According to the Montana Commissioner of Securities and Insurance, there are “at least eighty Montana [DBSI]
investors with and [sic] aggregate investment of at least $32 million.”
9
harmony with federal securities law, which recognizes “the virtually limitless scope of

human ingenuity, especially in the creation of ‘countless and variable schemes devised by

those who seek the use of the money of others on the promise of profits[.]’ ” Reves v.

Ernst & Young, 494 U.S. 56, 60-61 (1990). Congress “determined that the best way to

achieve its goal of protecting investors was to define the term ‘security’ in sufficiently

broad and general terms so as to . . . encompass virtually any instrument that might be

sold as an investment.” Reves, 494 U.S. at 61 (internal citations and quotations omitted).

¶25 Under the Act, securities include “investment contract[s].” Section 30-10-

103(22)(xii), MCA. Under Montana law, an “investment contract” is “ ‘an investment in

a common venture premised on a reasonable expectation of profits to be derived from the

entrepreneurial or managerial efforts of others.’ ” Duncan, 181 Mont. at 392-93, 593

P.2d at 1032-33 (quoting Forman, 421 U.S. at 852). In order to be considered an

investment contract (and thereby a security) under the Act, the following elements must

be met:

1) an investment;
2) in a common venture;8
3) with reasonable expectation of profits;
4) derived through the entrepreneurial or managerial efforts of others.

Duncan, 181 Mont. at 392, 593 P.2d at 1032.

¶26 Only two elements are at issue in this case – common venture and entrepreneurial

or managerial efforts of others. The parties do not dispute that Redding has satisfied both

8
This element has also been referred to as “common enterprise.”
10
the investment and reasonable expectation of profits elements. We address each of the

disputed elements in turn.

1. Common Venture

¶27 Commonality can be established several ways. Some courts use the horizontal

commonality approach, while others use a form of vertical commonality. The federal

circuit courts are currently split on which form of commonality is the best approach. We

will discuss each below.

¶28 Horizontal commonality focuses on the relationship between the investors. It is

“the ‘pooling’ of investors’ funds as a result of which the individual investors share all

the risks and benefits of the business enterprise.” SEC v. ETS Payphones, Inc., 300 F.3d

1281, 1284 (11th Cir. 2002), rev’d on other grounds, SEC v. Edwards, 540 U.S. 389

(2004).9 The Third Circuit describes horizontal commonality as “pooling of investors’

contributions and distribution of profits and losses on a pro-rata basis among investors.”

SEC v. Infinity Group Co., 212 F.3d 180, 188 (3rd Cir. 2000). The First Circuit has

“endorsed” the suggestion that “Ponzi schemes typically satisfy the horizontal

commonality standard.” SEC v. SG, Ltd., 265 F.3d 42, 51 (1st Cir. 2001).

¶29 Vertical commonality focuses on the relationship between the investor and the

promoter of the investment. It takes two forms – either broad or narrow. Broad vertical

commonality requires “that the investors are dependent upon the expertise or efforts of

9
Contrary to AZ’s assertion that the Eleventh Circuit has adopted the horizontal commonality approach, the very
next paragraph of its opinion in ETS Payphones states “we are bound by precedent to apply a different test for
commonality, ‘broad vertical commonality.’ ” ETS Payphones, 300 F.3d at 1284.
11
the investment promoter for their returns.” ETS Payphones, 300 F.3d at 1284. Narrow

vertical commonality, as adopted by the Ninth Circuit, requires that “the fortunes of

investors are interwoven with and dependent upon the efforts and success of those

seeking the investment or third parties.” Hector v. Wiens, 533 F.2d 429, 433 (9th Cir.

1976). Under narrow vertical commonality, “where an investor’s avoidance of loss

depends on the promoter’s ‘sound management and continued solvency,’ a common

enterprise exists.” SEC v. Eurobond Exchange, Ltd., 13 F.3d 1334, 1340 (9th Cir. 1994).

¶30 The United States Supreme Court has not settled this split amongst the circuits.

See Mordaunt v. Incomco, 469 U.S. 1115 (1985) (Burger, C.J., and White and Brennan,

J.J., dissenting from denial of certiorari); SG, Ltd., 265 F.3d at 49 (discussing the

“disarray as to the legal rules associated with the ascertainment of a common

enterprise.”).

¶31 Montana has not expressly adopted any of these tests for common venture. We

have found that when income to the investors depends upon the “common enterprise”

selling a final product, a common venture exists. Duncan, 181 Mont. at 391, 593 P.2d at

1032. In other words, the common venture element is met when return on an investment

is dependent on the efforts of the “enterprise” to generate it. Duncan, 181 Mont. at 391,

593 P.2d at 1032. This appears to be broad vertical commonality.

¶32 This case requires us to adopt a method for determining what fulfills the common

venture requirement. In doing so, we keep in mind that one of the foremost purposes of

the Act is to protect the investing public. See Knowles v. State ex rel. Lindeen, 2009 MT
12
415, ¶ 1, 353 Mont. 507, 222 P.3d 595. We also keep in mind the remedial purposes

behind the Act, which require the Act to be broadly construed to effectuate its purpose.

Duncan, 181 Mont. at 393, 593 P.3d at 1033. Finally, we again note the need for

flexibility to address “the virtually limitless scope of human ingenuity” to devise ever

more complex schemes of using others’ money on the promise, many times an illusory

one, of profits. Reves, 494 U.S. at 60-61.

¶33 With these premises in mind, we conclude that for the purposes of the Act, a

common venture can be established by satisfying the elements of any of the above

discussed methods – either horizontal, broad vertical, or narrow vertical commonality.

This approach best satisfies the purposes of the Act and will allow for flexibility to

address any manner of new-fangled schemes.

¶34 We now turn to the District Court’s finding that no common venture existed

“between Redding and DBSI.” It found that “[e]xamining the three different methods of

common enterprise [horizontal, and broad and narrow vertical commonality] reveals that

the keystone is for risk and fluctuation with the return on the investment.” Because

Redding “did not share the risks of the investment with other investors because she

agreed upon a contractually set return on her investment[,]” the District Court found

horizontal commonality was not met. Vertical commonality was not met because the

District Court found “Redding was set to collect a contractually agreed upon return

whether it was a month in which DBSI collected an abundance of rent or a month with

13
very little rent.” In sum, because DBSI promised Redding a certain amount of income,

no common venture existed, and therefore the TICs could not be securities.

¶35 The District Court’s legal conclusions regarding common venture are in conflict

with United States Supreme Court precedent and simply incorrect. In Edwards, the

United States Supreme Court was tasked with deciding “whether a moneymaking scheme

is excluded from the term ‘investment contract’ simply because the scheme offered a

contractual entitlement to a fixed, rather than variable, return.” Edwards, 540 U.S. at

391. The Court unanimously held that “an investment scheme promising a fixed rate of

return can be an ‘investment contract’ and thus a ‘security’ subject to federal securities

laws.” Edwards, 540 U.S. at 397. Any other holding would allow “unscrupulous

marketers of investments [to] evade the securities laws by picking a rate of return to

promise.” Edwards, 540 U.S. at 394-95. The Court also noted that “investments pitched

as low-risk (such as those offering a ‘guaranteed’ fixed return) are particularly attractive

to individuals more vulnerable to investment fraud, including older and less sophisticated

investors.” Edwards, 540 U.S. at 394. The District Court’s reliance on a promised rate

of return as dispositive of common venture (and thus dispositive of security) was error

and must be reversed.

¶36 Contrary to the District Court’s analysis, the “keystone” regarding common

venture is not “risk and fluctuation with the return on the investment.” It is the

relationship between either the investors themselves (horizontal commonality) or the

investors and the promoter or third parties (vertical commonality) that is crucial. For
14
horizontal commonality, a court must consider whether (1) the investors’ assets were

“pooled,” and (2) whether the investors shared in the profits and losses of the enterprise

on a pro-rata basis (i.e. proportionate to each investor’s contribution). SG, Inc., 265 F.3d

at 50-51; Infinity Group, 212 F.3d at 188-89.

¶37 For broad vertical commonality, a court must consider whether the investors’

profits (the return on investment)10 are dependent upon the expertise or efforts of the

promoter. ETS Payphones, 300 F.3d at 1284. The thrust of this test is “that the investors

have no desire to perform the chores necessary for a return[,]” but rather depend upon the

efficacy of the promoter for the return on the investment. SEC v. Unique Financial

Concepts, Inc., 196 F.3d 1195, 1199-1200 (11th Cir. 1999).

¶38 Finally, for narrow vertical commonality, a court must consider whether the

investors’ fortunes are interwoven with and dependent upon the efforts and success of the

promoter or a third party. Brodt v. Bache & Co., 595 F.2d 459, 460 (9th Cir. 1978); SEC

v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n. 7 (9th Cir. 1973) (emphasis

added). Here, more is required than just a link between investor profits and the efforts of

the promoter. Narrow vertical commonality requires the success or failure of the investor

to be linked to the success or failure of the promoter – “there is no common enterprise

unless there is some direct relation between the success or failure of the promoter and

that of his investors.” Mordaunt v. Incomco, 686 F.2d 815 (9th Cir. 1982), cert. denied,

10
In Edwards, the United States Supreme Court made clear that profits under the “investment contract” analysis
mean “the profits that investors seek on their investment, not the profits of the scheme in which they invest.”
Edwards, 540 U.S. at 394.
15
469 U.S. 1115 (1985). Neither vertical commonality approach requires pooling of

investor funds or sharing of profits and losses on a pro-rata basis. Unique Financial

Concepts, 196 F.3d at 1199 n. 4.

¶39 Turning to the present case, we conclude DBSI’s TIC investment scheme was a

common venture under any measure. We first analyze horizontal commonality, and find

that both elements are present. There is no question here that investor funds were pooled.

The resources of several investors, including Redding, were pooled to purchase a given

property, and each investor owned a certain percentage of the property based upon the

amount invested. There is also no question that the investors each shared in the profits

and losses according to their contribution to the investment. If the investment made

money, each investor received a rate of return (6% or 7% per year, plus an annual 3%

increase) on their pro-rata share of the investment. Likewise, each investor stood to lose

some or all of their pro-rata share of the investment should the venture fail. The fact that

Redding was promised a certain percentage return and still owns her interest in some of

the properties does not mean she stood to lose nothing. To conclude otherwise ignores the

reality of what Redding and others who invested with DBSI face – some or all of their

investments are now essentially worthless. These two things – the pooling of assets and

the pro-rata sharing of profit or loss – are all that is required for horizontal commonality.

SG, Inc., 265 F.3d at 50-51; Infinity Group, 212 F.3d at 188-89. DBSI’s scheme meets

both, thus there was a common venture. Additionally, we note that because DBSI was

16
allegedly a Ponzi scheme, that alone may also satisfy horizontal commonality. SG, Ltd.,

265 F.3d at 51.

¶40 We next analyze broad vertical commonality. Again, there is no question that

investors’ returns were dependent upon the expertise or efforts of DBSI. It is clear from

the lease agreement that DBSI was to do all the “chores necessary for a return.” Unique

Financial Concepts, 196 F.3d at 1199-1200. Redding simply purchased her shares in the

property, and indeed was required to lease the property back to DBSI as “master tenant”

and property manager. She did not invest “the personal time and effort involved in

operating the property and in dealing with multiple tenants.” Redding and the other

investors had no responsibility to generate any profit; that was DBSI’s job as “master

tenant.” The investors gave DBSI money, and in return it was DBSI that promised to

generate profit. It was up to DBSI to secure tenants for the property, and it was the rent

generated from these tenants that provided the return to Redding and other investors.

Without DBSI’s effort and expertise renting and managing the property, the investors

would get no return. Thus, broad vertical commonality is satisfied.

¶41 Finally, we analyze narrow vertical commonality. For essentially the same

reasons broad vertical commonality exists, narrow vertical commonality also exists. 11 It

is obvious that there is a direct relation between the success or failure of DBSI and the

success or failure of Redding and the other investors. If DBSI did not rent and manage

11
We also note that once narrow vertical commonality is satisfied, it appears broad vertical commonality would also
be satisfied in virtually every case. However the two are interrelated, one is not dependent on the other and either
can satisfy the common venture element.
17
the property successfully, the investment would fail - the investors’ avoidance of loss was

dependent on DBSI’s sound management and continued solvency. AZ acknowledges as

much, stating “almost every lessee such as Redding is reliant upon the commercial

lessor’s [DBSI’s] ability to manage the property.” While AZ is correct that this alone

does not make the TICs in question securities, it does satisfy narrow vertical

commonality.

¶42 We conclude that the TICs in question were common ventures under any

commonality analysis. Therefore, we proceed to analyze the fourth prong of the Duncan

test - the entrepreneurial or managerial efforts of others.

2. Entrepreneurial or Managerial Efforts of Others

¶43 Duncan requires that the profits expected in prong 3 of the test be “derived

through the entrepreneurial or managerial efforts of others.” Duncan, 181 Mont. at 392,

593 P.2d at 1032. This differs from the United States Supreme Court’s Howey test,

where the profits were to derive “solely from the efforts of the promoter or third party.”

SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). Montana has not required rigid

conformity with the “solely” requirement. Indeed, “solely” was purposefully left out of

our test. Duncan, 181 Mont. at 392, 593 P.2d at 1032 (discussing criticism of the

requirement and the language used by the United States Supreme Court in Forman which

“effectively deletes the strict ‘solely’ requirement from the test.”). The Circuit Courts of

Appeal have also declined to “give literal meaning to the word ‘solely’ in this context[.]”

SG, Ltd., 265 F.3d at 55. Therefore, the requirement that profits be derived from the
18
entrepreneurial or managerial efforts of others is generally satisfied so long as “ ‘the

efforts made by those other than the investor are the undeniably significant ones, those

essential managerial efforts which affect the failure or success of the enterprise.’ ” SG,

Ltd., 265 F.3d at 55 (quoting Turner Enterprises, 474 F.2d at 482.).

¶44 Before we analyze this element, it must be noted that the TICs in question in

Redding’s case are “affiliate TICs” meaning that the investors purchased the property

from DBSI and leased it back to DBSI, or a DBSI affiliate, who served as the “master

tenant.” These differ from “non-affiliate TICs” where investors purchase the property

from a promoter then contract with a property or asset manager who is not the promoter,

nor an affiliate of the promoter to operate the investment. In a non-affiliate TIC

investment, the promoter’s role ends upon the completion of the purchase. The “efforts

of others” analysis for non-affiliate TICs may differ from the analysis here. See David

Rich, Student Author, Betting the Farm: The TIC Turf War and Why TICs Constitute

Investment Contracts Under Federal Securities Laws, 1 Wm. & Mary Bus. L. Rev. 451

(2010). Circuit Courts of Appeal have looked to both pre-purchase efforts (of the

promoter) and post-purchase efforts (of the third party property or asset manager) to

satisfy this prong of the Howey test, reaching differing conclusions. See SEC v. Life

Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996) (pre-purchase efforts alone will not suffice;

absent substantial post-purchase efforts by promoter or a third party, this prong is not

met), compare with SEC v. Mutual Benefits Corp., 408 F.3d 737 (11th Cir. 2005) (efforts

of others may be satisfied by pre- or post-purchase efforts of the promoter or third party).
19
Because DBSI was both the promoter and the property manager, we need not engage in

this analysis.

¶45 The focus in this case is on the amount of control retained by Redding and the

other investors and whether or not that control was illusory. Not surprisingly, the Circuit

Courts of Appeal are split on this issue. The Eleventh and Fifth Circuits look to the

written agreements between the parties. Albanese v. Florida National Bank of Orlando,

823 F.2d 408 (11th Cir. 1987); Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981). The

Eleventh Circuit has found “the crucial inquiry is the amount of control that the investors

retain under their written agreements.” Albanese, 823 F.2d at 410 (citing Williamson,

645 F.2d at 423-24.). “If the investor retains the ability to control the profitability of his

investment, the agreement is no security.” Albanese, 823 F.2d at 410. However, even if

the written agreement offers substantial control to the investor, if that control is illusory,

the “efforts of others” element can still be met. Albanese, 823 F.2d at 412.

¶46 In contrast, the Second Circuit looks to the “reality of the parties’ positions” and

evaluates “whether ‘the reasonable expectation was one of significant investor control.’ ”

United States v. Leonard, 529 F.3d 83, 85 (2d Cir. 2008). If there is a reasonable

expectation of significant investor control, the protection of securities laws is not needed.

Leonard, 529 F.3d at 88. It is for the “passive investor” that the securities laws were

enacted. Leonard, 529 F.3d at 88; SEC v. Aqua-Sonic Products Corp., 687 F.2d 577, 585

(2d Cir. 1982). Thus, despite what the written agreements say on their face, if the

promoter sought out and expected passive investors, this element may be met. Aqua-
20
Sonic, 687 F.2d at 584. Under this approach, “ ‘[w]hat matters more than the form of an

investment scheme is the “economic reality” that it represents. The question is whether an

investor, as a result of the investment agreement itself or the factual circumstances that

surround it, is left unable to exercise meaningful control over his investment.’ ”

Leonard, 529 F.3d at 90 (quoting Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003))

(emphasis in Leonard).

¶47 The District Court did not make any findings on this issue because it concluded

“DBSI providing essential managerial efforts is irrelevant because Redding did not invest

in a common enterprise.” However, the issue was briefed by the parties. Redding argued

that this element was met. AZ argued that Redding could not meet this element because

Redding retained the rights to (1) “terminate DBSI as the master tenant;” (2) “sell the

property;” (3) re-enter “the leased premises for the purpose of making inspections,

repairs, alterations or additions as the Tenant in Common group might deem necessary;”

and (4) a “lien against DBSI for rent damages or other payments.” Further, AZ argued

that Redding was expected to “engage in conference calls, sign documentation and

participate in assessing DBSI’s performance as the Master Tenant.” AZ argued that

Redding exercised this control by participating in at least one conference call, and more

importantly, terminating DBSI as “master tenant” on two properties. Finally, AZ argued

that Redding did not look to DBSI to produce profits, but rather to the property itself.

¶48 We are not persuaded by AZ’s arguments. We agree with the reasoning of the

Second and Fourth Circuits, and we will look to the “economic reality” of the situation
21
and the investor’s ability to meaningfully control the investment. Leonard, 529 F.3d at

89-90; Robinson, 349 F.3d at 170. We will not confine this inquiry to a review of the

organizational documents alone, but rather inquire into the amount of actual control the

investor was expected to exercise in reality. Leonard, 529 F.3d 89-90. This approach

best serves the purposes of the Act, and will allow for the flexibility required to adapt to

the ever evolving schemes “devised by those who seek the use of the money of others on

the promise of profits.” Howey, 328 U.S. at 299. Again, the question is “ ‘whether [the]

investor, as a result of the investment agreement itself or the factual circumstances that

surround it, is left unable to exercise meaningful control over his [or her] investment.’ ”

Leonard, 529 F.3d at 90 (quoting Robinson, 349 F.3d at 170) (emphasis in Leonard).

¶49 In Redding’s case, we conclude that in reality DBSI sought out passive investors

and that Redding, regardless of the rights she retained in the written agreements, was not

expected to exercise any meaningful control over her investment, nor did she expect to

exercise meaningful control over her investment. Indeed, AZ acknowledges that

“Redding did not want to directly manage the day to day affairs of any property she

would purchase.” Nothing better illustrates Redding’s lack of managerial control than

the “NNN Plus Lease” summary, declaring that Redding and the other owners did not

have to invest “the personal time and effort involved in operating the property and in

dealing with multiple tenants.” Rather, as DBSI advertized, “the management

responsibilities of the TICs will simply consist of dealing with the NNN PLUS Lessee

and receiving and depositing a monthly lease payment from the Lessee.” Additionally,
22
that Redding played no role in “shaping the organizational agreements” casts doubt as to

whether she was expected to have significant control over the enterprise. Leonard, 529

F.3d at 90. Moreover, the parties do not dispute that, other than her ranch, Redding had

no experience in owning and managing commercial properties. AZ does not point to any

facts in the record that would suggest Redding’s practical ability to take over and manage

four large commercial properties. Leonard, 529 F.3d at 90. And while Redding and the

other investors terminated DBSI as “master tenant” on two of the properties,12 it can

hardly be said that the investors were expected to do so. The expectations were just the

opposite – DBSI was to directly manage the day to day affairs of the property for

Redding. That was the entire point of the written agreements between Redding and

DBSI. Terminating DBSI once it was in default is not meaningful control of the property

or the investment.

¶50 Even were we to accept AZ’s argument that Redding had the ability to control her

investment via certain rights retained under the written agreements, a review of the

documents themselves shows that any control Redding was granted under the documents

was not meaningful, but was illusory. AZ makes much of the fact that Redding could

terminate DBSI as “master tenant.” However, the process to terminate DBSI was nearly

impossible. Redding alone could not terminate DBSI. A majority vote of all the owners

was required. Then, termination was “effective only when” DBSI was relieved from all

obligations to the property and “indemnified by a majority in percentage ownership . . .

12
AZ acknowledges that Redding lost her interest in two of the properties.
23
against any and all claims, actions, costs, damages, liabilities, deficiencies or expenses”

relating to the property. Additionally, to sell the property or hire a new property

manager, a unanimous vote of all the owners was required. A TIC can have as many as

35 owners,13 none necessarily residing in the same geographic area, and any one owner

could thwart the others’ attempt to sell the property or hire a new property manager. This

does not demonstrate that Redding had meaningful control over her investment. As for

the right of re-entry and the right to a lien against DBSI, these rights do not evidence a

meaningful right to control the profitability of her investment, nor does signing

documents and participating in one conference call.

¶51 We conclude that the efforts made by DBSI are the undeniably significant ones –

the essential managerial efforts which affect the failure or success of the enterprise. SG,

Ltd., 265 F.3d at 55. The written documents themselves indicate that Redding was not

expected to exercise any meaningful control over her investment, nor did AZ present

evidence that she expected to exercise meaningful control over her investment. Because

DBSI’s efforts were the significant ones, Redding was dependent on DBSI’s

entrepreneurial and managerial efforts to generate profit. The final element of the

Duncan test is met.

3. Were the TICs Securities in 2004?

¶52 Finally, we address AZ’s argument that the TICs were not securities in 2004. AZ

argues repeatedly that a security “exists at the time it is sold or not at all,” hence because

13
Rev. Proc. 2002-22, § 6.02, 2002-1 C.B. 733.
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the TICs were not securities in 2004, they cannot be securities now. To support this

argument, AZ states that “guidance from the IRS [Rev. Proc. 2002-22, 2002-1 C.B. 733]

showed that these properties were not securities and there was no guidance from the SEC

on the subject[.]” AZ, however, has not shown that in 2004 the IRS, or anyone else,

believed that TICs were not securities. Rev. Proc. 2002-22 simply provides guidance for

TIC sponsors and owners to avoid having TICs classified as partnerships. It does not say

TICs are not securities.

¶53 In fact, materials which AZ submitted in its Table of Appendices on appeal and

upon which AZ relied for its contention that the TICs here were not securities in 2004,

actually establish that these TICs would have been considered securities in 2004, under

the circumstances presented here. The September 2004 Moffat Thomas opinion letter

directed to FOR 1031 LLC (a DBSI affiliate), addressing the question of whether a TIC

constituted a security under federal law as of 2004, was submitted to the District Court by

AZ when it moved for summary judgment. The letter exhaustively analyzes the case law

as of 2004 on the security question. Repeatedly, the opinion letter states that as long as

the investor in question is experienced and knowledgeable in owning and operating

developed income-producing property – and certain other factors are met – it can be

assumed that the TICs are not securities. Summarizing Williamson v. Tucker, the opinion

letter states:

[T]he [Williamson] court concluded the venture would not involve a
security unless the plaintiffs could show that . . . (2) the partner or venturer
is so inexperienced or unknowledgeable in business affairs that he or she is
25
 incapable of intelligently exercising his or her partnership or venture
powers; or (3) the partner or venturer is so dependent on some unique
entrepreneurial or management ability of the promoter or manager that he
or she cannot replace the manager of the enterprise or otherwise exercise
meaningful partnership or venture powers.” [Emphasis added.]

¶54 It is undisputed that Redding had no experience in or knowledge concerning the

operation of developed income-producing property. Further, she had no meaningful

partnership powers, as we explain in ¶¶ 49-51. Therefore, under the language lifted from

AZ’s tendered authority, it is clear that as of 2004, these circumstances would have

compelled a finding that this transaction qualified as a security transaction. Further

buttressing this conclusion is one of AZ’s own experts, who was employed by “a major

TIC sponsor who sold TICs as a security” in May of 2004, several months prior to the

time Redding purchased her TICs. Given these facts, we do not accept AZ’s argument

that the TICs were not securities in 2004.

¶55 Our holding that the TICs are securities is based on the documents Redding

reviewed and executed in 2004, the contents of which have not changed, and the facts

and circumstances surrounding the transactions. The TICs Redding purchased were

securities in 2004.

CONCLUSION

¶56 Based on the tests and principles of law discussed above, the TICs here are

securities.

¶57 Therefore, IT IS HEREBY ORDERED that Redding’s Petition for Writ of

Supervisory Control is GRANTED.
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¶58 IT IS FURTHER ORDERED that the District Court’s August 9, 2011, Order

granting partial summary judgment to AZ is REVERSED. We remand this case to the

District Court for entry of partial summary judgment in favor of Redding on the question

of whether the TICs sold to Redding are securities under the Securities Act of Montana,

and for further proceedings consistent with this Opinion.

¶59 The Clerk of Court is directed to provide copies of this Opinion to all counsel of

record; The Hon. Dorothy McCarter; and to Monica J. Lindeen, Montana Commissioner

of Securities and Insurance.

/S/ MICHAEL E WHEAT

We Concur:

/S/ MIKE McGRATH
/S/ JAMES C. NELSON
/S/ BRIAN MORRIS
/S/ JIM RICE

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