The Securities and Exchange Commission says “no.”
My first question is what is a mutual water water company? From my view here in New England water comes from the municipality or your own well. California is big and creating whole new communities.
In this case, the Tesoro Viejo Master Mutual Water Company is being formed to supply water to a new community in Madera County, California that will have over 5,000 residential units and 3 million square feet of commercial and retail space. The Water Company will issue stock to owners of lots in the Water Company service area. The shares are appurtenant to the land and can only be transferred with the land. The shareholders still have to pay for the water they use to the Water Company. The Water Company is responsible for maintaining the water infrastructure in the service area.
The Water Company is organized under California’s General Corporation Law. It is issuing shares of common stock.
Under Section 2(a)(1) of the Securities Act the term “security” means any “note, stock…”
So, it’s clearly a security?
No. The request letter authored by Keith Paul Bishop takes us on a great stroll on the analysis of “what is a security?”
In United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975), the United States Supreme Court found that not all stock is a security. In that case, it looked at shares issued and sold as part of housing coop in New York. The Court came up with five characteristics of a stock:
- Right to receive dividends
- Negotiability
- Ability to be pledged
- Voting rights
- Ability to appreciate in value.
The Court says you should look at the economic realities of the transaction rather than just the mere form.
In the argument for the Water Company, the substance is the sale of real estate, not the sale of securities. The Water Company will not pay dividends and there is will be no market for the shares so there can’t be any appreciation in value separate from the land. The shares can’t transferred without the sale of land and can’t be pledged separately from the land. The ability to vote is also tied to land ownership.
Attorney Bishop then goes on to walk through the “investment contract” analysis under Howey.
There is an investment of money. There is probably exists since there will be aboard governing the Water Company.
But there is no expectation of profit from the Water Company. The purchasers are buying the shares to obtain water services and they still have to pay for the services. There will be no distributions of profits. There may be some increase in value, but no way to realize it. The increase in value can’t be separate from the increase in value of the real estate.
The Securities and Exchange Commission went along with these arguments and granted no-action relief.
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