A "TIC"ING TIME BOMB: RULE 506 MEETS SECTION 1031

Fordham Journal of Corporate & Financial Law, 2007 by Whitman, Elizabeth Ayres

For finding the real estate opportunity, providing due diligence services, and negotiating the loan, sponsors typically receive compensation upon sale of the TIC interest through fees variously characterized as "acquisition fees," "loan fees," and sometimes simply "sponsor compensation."39 Therefore, investors typically purchase their TIC interests at a price that exceeds their pro-rata share of the appraised value of the real estate.40 While the investors own their TIC interests (the "hold period"), sponsors typically receive additional compensation either through an asset management fee (in the case of the management agreement structure), or through a spread between the lease payments under the master lease and the actual net revenue from operation of the real estate (in the case of the master lease structure).41 Typically, sponsors are also entitled to a disposition fee when the investors sell the real estate at the end of the hold period.42 Therefore, between the continuing sponsor obligations under the master lease or management agreement and lender prohibitions upon cancellation of those sponsor relationships, the sponsors are nearly inextricably tied to the property and to the investors during their hold period.

III. TICs ARE SECURITIES SUBJECT TO REGULATION UNDER THE SECURITIES EXCHANGE ACT OF 1933

Since most TIC investors depend upon the efforts of the TIC sponsor for the profitability of their investments, TICs are generally considered "investment contracts" and therefore classified as securities under Section 2(1)43 of the Securities Act of 1933 (the "1933 Act").44 In Sec v. WJ. Howey & Co., ("Howey"),45 the Supreme Court considered whether the sale of real estate to investors constituted an investment contract when the seller managed the real estate after purchase by the investors.46 In Howey, the management agreement was optional, although most investors selected that option.47 The Supreme Court found that the arrangement in Howey constituted a security and established the classic definition of an "investment contract" under the 1933 Act: investors investing "money in a common enterprise with the expectation that they would earn a profit solely through the efforts of the promoter or of some one other than themselves."48 Unlike the situation in Howey, TIC investors do not have the option of attempting to manage the real estate themselves; they must enter into either a management agreement or master lease with the sponsor.49 There is little debate that the traditional TIC structures involve investment of money in a common enterprise with an expectation of profit from the efforts of the sponsor, and that those TIC investments are securities.50 Indeed, in 2000 the SEC Division of Corporation Finance declined to issue a no-action letter for TICs utilizing a master lease to a sponsor-entity unless the TICs were either registered or subject to an exemption from registration under the 1933 Act.51 In doing so, the SEC implicitly determined that TICs are securities.