The Question of Whether LLC Interests are Securities

California has a somewhat confusing answer to the question of whether LLC interests are considered securities in our state. In some situations they are, and in others, they are not. Here we explain when they are and when they are not. If an LLC interest is considered a security it can have significant regulatory implications, particularly when the interest transferred or offered for sale. There are ways around these regulations, but the process can require additional work and filings and is not a sure thing.

When LLC Interests are Considered Securities

California’s first LLC law was called the Beverly-Killea Act. When it became law the legislature amended the corporations code. This amendment provided that a security includes an interest in a limited liability company. So this is the default position. However, this is not the end of the discussion. The legislature also carved out some substantial exceptions to this general rule.

When LLC Interests are Not Considered Securities

The exception to the rule says a membership interest is not a security if “the person claiming [the] exception can prove that all of the members are actively engaged in the management of the limited liability company.”

The exception is also not the only statute that prevents an LLC interests from being considered a security. Section 8103(c) of the Commercial Code also says that a limited liability company is not a security unless one of three requirements is met. These three requirements are:

  1. It is dealt in or traded on securities exchanges or in securities markets, or
  2. Its terms expressly provide that it is a security governed by Division 8 of the Commercial Code; or
  3. It is an investment company security.

What is a Security?

In very basic terms a security is a tradable financial asset, but every jurisdiction has more precise definitions depending on the relevant regulatory regime. In California the Commercial Code regulates the transfer and registration of securities. One requirement is if securities are offered for sale in California the sale must be qualified.

So What if an Interest in an LLC is a Security?

If an LLC interest is considered a security, then this has implications for the transfer of that interest. If an LLC interest that is considered a security is offered or sold in California under the California Corporate Securities Law then it must be “qualified” unless an exemption is available. Getting an exemption can require a filing with the California Department of Corporations. Qualification of a security is governed by Sections 25111, 25112, and 25113 of the Corporations Code. This process can make the transfer of an interest in an LLC substantially more complicated that one may initially assume it would be. This is why it is important to communicate with a business law attorney before participating in a transfer of one of these interests, to be sure you are complying with any and all regulatory requirements.