Ninth Circuit Rejects Securities Fraud Claim By Purchasers of Hard Rock Hotel Condominiums

The case is captioned Salameh v. Tarsadia Hotel. It is an investment contract case, where the plaintiff alleges that certain contracts he signed were really securities and that the securities should have been registered under the Federal Securities laws.

The facts, from the plaintiffs' complaint, were as follows:

Forty plaintiffs signed contracts to purchase condominium units in a Hard Rock Hotel then under construction. Plaintiffs alleged that they were obligated also to sign Rental Management Agreements with Defendant Tarsadia in which Tarsadia would be the exclusive management agent for the hotel.

Plaintiffs alleged that they were not given keys to the units purchased and could not occupy the units for more than 28 days each year. Therefore, according to plaintiffs, the purchase should be viewed as an investment contract, not a purchase of real estate.

Plaintiffs alleged that Defendants did not comply with the Securities Act of 1933, Sections 12 (a) and Section 10 B of the Securities  Exchange act of 1934, the California Securities Law and were guilty of common law fraud.   

The District Court held that the defendants did not sell securities. It reasoned that the contract to purchase the condominium and the contract under which the hotel was to be managed were two separate contracts signed 15 months apart.

The 9th Circuit affirmed.

The 9th Circuit acknowledged that the both the Securities Act of 1933 and the Securities Exchange Act of 1934 defines the term security to include the  term “investment  contract” . The Court also noted that the term “investment contract” has been interpreted to include novel, uncommon devices.” The investment contract concept embodies a flexible rather than a static principle, one that is capable of adaptation to meet countless and variable schemes  by those who seek the use of the money of others  on the promise of profits. SEC v. Howey 328 U.S.281. The Court went on to say whether a real estate transaction is a security, substance governs, not label, or form. However, the Court held that the Condo Purchase and Management Agreements were not offered  as a package.

The material delivered to plaintiffs do not allege that management agreement forthcoming.  The Court said that there was a significant time gap between the execution of the Condo Purchase Agreement and the Management Agreement The Court said that the two transactions were distinct. The Court went on to say that there was no reason why there could not be a market for ownership of a condo as a short term vacation home.

The Court said that taking all nonconclusionary allegations as true, Plaintiffs did not sufficiently allege claims under federal or state securities laws. The Court also went on to reject the common law fraud claims.

Although the Court made passing reference to  the amicus brief of the SEC,  it was not persuaded. The well-written and thoughtful brief of the SEC stated in part :

“The Commission believes that the district court, in determining that the hotel-room sales did not  sales of investment contracts, failed to give effect to the economic realities of the transaction as required by Supreme Court and Ninth Circuit precedents.

The Commission is concerned that the district court’s holding on the investment contract issue, unless reversed, would seriously erode the investor protection of the securities laws. It would impermissibly allow a promoter to avoid the coverage of these laws by (1) artificially dividing a single investment into ostensibly separate parts and (2) including a written disclaimer that falsely state that there is no investment exception.”

The brief also stated that (1) the sales agreements left the plaintiffs with so little use or control that it was obvious from the beginning that the defendants would exercise exclusive control to rent and operate the rooms; the reality of the defendant’s plan made if obvious from the outset that these  rooms would be necessary to serve as the hotels guest rooms; and  the hotel was under construction during the entire period, making the time gap between the room sales  and rental program inconsequential.

The Ninth Circuit rejected the arguments of the SEC:


"Plaintiffs' strongest argument that the two contracts, signed about a year apart, form a single transaction is their assertion that the "economic reality" shows that the two transactions are part and parcel of one scheme. They contend that the Purchase Contract, combined with external factors, such as the zoning ordinance, gave them no choice but to sign the Rental Management Agreement when it was later presented. This argument has some force. See Hocking, 885 F.2d at 1461; see also Tcherepnin v. Knight, 389 U.S. 332, 336 (1967). But to accept this argument, we not only would have to ignore the large time gap between the two transactions that were executed with different entities, but also the fact that Plaintiffs' complaint is void of any allegation that they were induced to buy the condominiums by the Rental Management Agreement. The economic reality as we see it is that these two transactions were distinct. Moreover, Plaintiffs' economic-reality argument rests on the implicit assumption that the only viable use for the condominiums was as an investment property, but there is no plausible reason why there cannot be a viable market for owner-occupied hotel-condominiums for use as short-term vacation homes. See Brief of Amici Real Estate Roundtable & National Association of Realtors 3-6. This conclusion undercuts Plaintiffs' economic assumptions. See Forman, 421 U.S. at 858 (holding that a security does not exist "where [a consumer] purchases a commodity for personal consumption or living quarters for personal use")."

In my opinion, this is an unfortunate result that is not consistent with precedent Doubtless there were substantial losses suffered by the investors.

Edward X. Clinton, Sr.