In McDowell v. Lopez, 2 CA-CV 2011-0073, 2012 WL 376690 (Ariz. Ct. App. Feb. 7, 2012), the Arizona court affirmed the finding that the the challenged transaction was not a security under the state statute.
Joe Lopez (“Lopez”) promoted Mixed Martial Arts (“MMA”) or cage fighting events. In 2007, through his company Ringside Sports and Entertainment LLC, he organized an MMA event to be held in Sonora, Mexico. Diana McDowell (“McDowell”) invested $20,000 in return for a percentage of the profits. The parties never signed a written agreement and McDowell received very little profit on her $20,000 investment or the $16,737 she paid to the fighters.
In her complaint, McDowell asserted claims of breach of contract, securities fraud, and common law fraud. In addition, she requested a partnership accounting. An arbitrator ruled that the arrangement between McDowell and Lopez was an investment contract and that Lopez had committed securities fraud. Lopez appealed to the superior court and the jury found in his favor on all counts. McDowell’s motions for a judgment as a matter of law and for a new trial were denied.
On appeal, McDowell argued that the trial court erred in “up[holding] a jury verdict in the face of a clearly defined investment contract” and that “Lopez violated Arizona securities law by failing to disclose certain material facts when he solicited the investment from her. The court recognized that before ruling on the alleged fraud, it first had to determine whether the parties’ agreement constituted an investment contract. To do so, the court employed the three-part test developed by the United States Supreme Court in Securities and Exchange Commission v. W. J. Howey Co. According to the test, an investment contract exists when there is “(1) an investment of money, (2) in a common enterprise, (3) with the expectation that profits will be earned solely from the efforts of others.” Given that there was no dispute as to the first two elements, the court focused its analysis on whether McDowell earned profits from the sole efforts of Lopez. S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298 (1946).
Since McDowell and Lopez did not have a signed contract detailing their arrangement, the court “look[ed] to the nature of the parties’ relationship after the investment was made to determine their intent.” Lopez testified that he and McDowell worked together to plan the event. When questioned as to the nature of the deal, McDowell described her relationship with Lopez as a partnership. McDowell also admitted that she knew she was taking a risk when she invested with Lopez and that profits were never guaranteed. The court determined that McDowell was involved in the “essential managerial efforts” of the venture and that she was aware of her risks.
The court held that the jury reasonably could have found that the parties’ agreement was not a security, or that Lopez did not commit fraud under Arizona Revised Statute § 44-1991(A), or both. Therefore, the court affirmed the trial court’s denial of McDowell’s motion for judgment as a matter of law. The court also affirmed denial of McDowell’s motion for a new trial on her claim for securities fraud.
The primary materials for this post may be found on the DU Corporate Governance website.