A promissory note issued by the promoter of a race car venture to a girl friend is a “security” within the meaning of Wisconsin securities law, the Wisconsin Court of Appeals ruled. Therefore, the court affirmed the conviction of the promoter for securities fraud based on his failure to disclose to the investor–with whom he had a “romantic relationship”–a prior larceny conviction and bankruptcy filing.
According to the case opinion, Laura DeLuisa met Kevin McGuire in January 2001. He told her he was involved in a NASCAR related venture and showed her pictures of several race cars he said he owned. DeLuisa mentioned to McGuire that she was awaiting a personal injury settlement.
McGuire asked DeLuisa to loan him money for his NASCAR related expenses. After receiving her settlement, DeLuisa wrote checks to people associated with McGuire’s NASCAR venture. DeLuisa made the checks, eventually reaching $140,000, payable to various vendors but not McGuire. McGuire told her the money was for establishing his NASCAR venture and that it would be a good investment. McGuire said he would repay DeLuisa and she would realize a profit. During this period, the court said, DeLuisa and McGuire’s “acquaintance evolved into a romantic relationship.”
On July 1, 2001, McGuire signed a promissory note to DeLuisa at her lawyer’s office agreeing to repay her $140,000 plus 10 percent interest on the unpaid balance amortized over four years. The note provided that in the event of untimely payments or default, all interest and any amount still owed would become immediately due and payable.
McGuire soon stopped making payments and DeLuisa filed a complaint with Wisconsin securities regulators. A securities examiner learned McGuire had filed for bankruptcy in 1998 and had a felony conviction for larceny for which he had served time in prison. McGuire apparently never told DeLuisa about the bankruptcy, the conviction or the prison term.
A trial court eventually found McGuire guilty of securities fraud based on his silence concerning his felony conviction and bankruptcy. The trial court sentenced McGuire to seven years’ probation with one year of conditional jail time, and ordered him to pay DeLuisa restitution. McGuire apealled claiming the note was not a “security”, thus he could not be guilty of securities fraud.
The court analyzed the definition of a security under both WIsconsin and Federal law, applying the “family resemblance test” as determined in the U.S. Supreme Court case of Reves v. Ernst & Young, 494 U.S. 56 (1990). Applying the Reeves test, the court looked at various factors:
The first concerns the intent of the parties: Is the seller’s purpose to raise money for the general use of a business enterprise rather than to finance substantial investments. Is the buyer interested primarily in the profit expected to be generated. If so, the instrument is likely to be a “security,” the court explained. In this case, “the bottom line is McGuire’s motivation was to raise money for his NASCAR venture and DeLuisa’s motive was to make a profit.”
The second factor of the family resemblance test examines whether the instrument was one for which there was common trading for speculation or investment. The narrow plan of distribution for this instrument “weighs in favor of a ‘nonsecurity’ determination,” the court said.
The next factor is an objective one: would a reasonable investor have considered the transaction to be an investment? “The relevant facts bearing on this factor are the same ones we considered on the first factor, motivation. Here, McGuire convinced DeLuisa that since NASCAR was ‘up and coming,’ his venture had a promising future and she would realize a return significantly better than likely could have been achieved at a local bank. A reasonable investor would have considered the transaction with its higher-than-commercial interest rate to be an investment,” the court said.
Finally, the court said, the last factor examines whether another regulatory scheme exists which, without resort to securities law, adequately protects the public from the risk the instrument poses. The court found no such regulatory scheme existed to protect DeLuisa.
Thus, the court said, on balance, only the second factor weighs in favor of a finding of a “nonsecurity.” The factors are considered as a whole, however, and failure to satisfy one of the factors is not dispositive and thus concluded that McGuire’s note qualifies as a “security”.
The moral of this story seems to be: Before you convince a girl friend to loan you money for a venture, don’t forget to tell her you have comitted a crime, gone to jail and declared bankruptcy.
Shepherd Smith and Edwards represents investors nationwide who have been victims of investment fraud. If you have questions concerning whether you may be a victim of “securities fraud”, call for a free consultation at 1-800-259-9010 or contact Shepherd Smith and Edwards online.