Company Name: Shelby Land and Cattle Co.
Public Availability Date: 01-16-1984
INQUIRY LETTERBERRY, MOORMAN, KING, COOK & HUDSON
2600 COMERICA BUILDING
DETROIT, MICHIGAN 48226
TELEPHONE(313) 961-2314 November 11, 1983 1033 Act/Sec 2(3) Office of Chief Counsel
Division of Corporate Finance
Securities and Exchange Commission
450 5th Street, North West
Washington, D.C. 20549 Re: Request for No-Action Letter Dear Sir/Madam: We are counsel for Shelby Land and Cattle Company ("Shelby"), a Texas
corporation that is engaged in the business of breeding, raising and selling
crossbred cattle. On behalf of Shelby we hereby request that the staff of the
Securities and Exchange Commission (the "Commission") advise us that it will not
recommend that the Commission take any action if Shelby engages in the course of
conduct described herein without registration under the Securities Act of 1933,
as amended. FACTS In the process of building its own breeding herd, Shelby has utilized the latest
techniques for cattle embryo transplantation and has developed both the
facilities for, and a recognized reputation in, the breeding of crossbred cattle
produced by embryo transplants. The technique of embryo transplantation
generally involves the selection of a donor cow (the "Donor") which exhibits
superior genetic characteristics and fertility. At the appropriate point in the
estrous cycle of the Donor, the Donor is injected with hormones in order to
induce super ovulation and is then artificially inseminated with the semen from
a bull that has also been carefully selected for its genetic traits. After
insemination, several fertilized eggs are surgically removed or "washed" from
the Donor and evaluated by Shelby. Viable embryos are then either stored in
liquid nitrogen for future use or placed in the uterus of a lower grade female
cow (the "Recipient") who is at the appropriate point in its estrous cycle, and
the pregnant Recipient is then brought to term and gives birth to the Donor's
offspring. In this manner, many more offspring from a selected high grade Donor
can be obtained because the pregnant Donors are not required to take their
calves to term. Shelby has been so successful in its embryo transplantation methods that it is
currently producing far more embryos than it has the financial resources to use
in developing its own herd. To take advantage of this circumstance, Shelby
proposes to sell a portion of its excess embryo production to interested third
parties. In return for a flat embryo transplant fee, Shelby would supply the
purchaser with a designated Recipient cow that has been implanted two months
previously with an embryo from a selected Donor. It is generally accepted in the
cattle breeding industry that a Recipient that has been implanted with another
cow's embryo for two months and has not yet aborted will have a reasonable
probability of successfully calving. Shelby does not guarantee that the
Recipient will give birth to a healthy calf and the payment of the fee for each
transplant is contingent only upon a positive pregnancy test two months after
transplant. The purchaser would then have the option of (1) taking possession of
the Recipient and maintaining it until it gives birth and the calf is weaned;
(2) taking possession of the Recipient and transferring it to a farm or ranch
where it can be maintained at the purchaser's expense; or (3) entering into a
maintenance contract with Shelby (the "Maintenance Contract") whereby Shelby
will provide appropriate maintenance services until the birth of the calf,
weaning of the calf or the calf is ready for sale or breeding, depending upon
the sole discretion of the purchaser. Shelby is not in the business of raising
cattle for third parties and would only offer Maintenance Contracts as a service
to purchasers of its surplus embryos. The Maintenance Contract would require the
purchaser to pay, on a month-to-month basis, for all normal costs of maintaining
the purchaser's embryo or calf. Any extraordinary expenses (e.g. veterinary
surgery) incurred in connection with the purchaser's embryo or calf would be
billed separately. Payment under the Maintenance Contract would be made on the
first of each month for the services to be performed in that month. A purchaser
would be allowed to terminate the Maintenance Contract at any point and, upon
termination, would forfeit only that portion of the monthly payment not yet
used. Purchasers could also authorize Shelby to sell their calves for a
commission in its regular program of sales from its own breeding herd. The
maintenance services that Shelby would supply to the Recipients and their
offspring would be the normal feed, shelter and veterinary care provided by
experienced cattle breeders, as Recipients do not require any more care than
other pregnant cows bringing their own pregnancies to term. Shelby proposes to sell its embryos to other cattle breeders who are interested
in improving the genetic stock of their own herds and to individuals who
anticipate both making a profit upon the sale of the new cross breeds of cattle
and utilizing the tax benefits obtainable in raising and selling cattle or
building their own breeding herds. Shelby expects that the purchasers of embryos
will largely come from business and personal acquaintances of Shelby and its
affiliates but that the majority would not be purchasing the embryos to improve
existing breeding herds. It is also anticipated that a majority of purchasers
would not exercise their options to take possession of the Recipients and calves
and would enter the Maintenance Contract and then utilize Shelby to raise and/or
sell their cows. DISCUSSION It is our view that the activities of Shelby will not involve the offer and sale
of a "security" as defined in Section 2(1) of the Securities Act of 1933 (the
"1933 Act") because those activities will not constitute the offer and sale of
an "investment contract" as that term is defined in SEC v. W.J. Howey Co. 328 US
293 (1946) and its progeny. In Howey, the United States Supreme Court defined an
investment contract as "a contract, transaction or scheme whereby a person (1)
invests his money (2) in a common enterprise and (3) is led to expect profits
solely from the efforts of the promoter or a third party". 328 US 293, 298-99
(1946). Under the third prong of the Howey definition, the focus is on the
dependency of the investor on the entrepreneurial or managerial skills of a
promoter or third party. Gordon v. Terry, CCH Fed. Sec. L. Rep. 1982 Decisions
Par. 98, 787 (11th Cir. 1982). Several Courts have stated that the "solely"
requirement in the third prong of the Howey definition of an investment contract
is not to be read strictly. Rather, when the functions the "investor" performs
are not significant managerial ones, but mere administrative ones, the schemes
will not be excluded from the coverage of the act merely because the profits are
not derived, in some strict sense, solely from the efforts of others. SEC v.
Glenn W. Turner Enterprises, 474 F2d 476 (9th Cir. 1973) cert denied 414 US 821
(1973); SEC v. Koscot Interplanetary, Inc., 497 F2d 473 (9th Cir. 1974); Odom v.
Slavik, CCH Fed. Sec. L. Rep. 1982-83 Decisions Par. 99, 130 (6th Cir. 1983). We believe that the activities of Shelby do not constitute the offer and sale of
an investment contract because (1) there is no common enterprise and (2) the
purchasers are not dependent upon Shelby for those essential managerial efforts
which affect the failure or success of the enterprise. There is no common
enterprise because each purchaser of an embryo from Shelby stands apart from any
other purchaser and has the option either to take delivery of the pregnant
Recipient and care for it themselves until the calf is born and weaned or to
leave the pregnant Recipient with Shelby and enter into the Maintenance
Contract. This independence continues even for those purchasers who choose to
enter into the Maintenance Contract, since each purchaser's embryo or calf will
be separately identified and the services provided by Shelby to each purchaser
are separate and not dependent upon those provided to any other purchaser.
Furthermore, each purchaser who initially elect to enter into the Maintenance
Contract has the option to terminate the Maintenance Contract at the end of any
month without penalty and without any effect on any other purchaser. Each
purchaser will bear the risk of loss with respect to its own embryo or calf and,
if the purchaser elects to have Shelby raise its calf until the calf is sold,
any profit from that sale will belong entirely to that purchaser and will not be
commingled with the profits of any other persons who have entered into similar
Maintenance Contracts with Shelby. Nor will the success or failure of the
purchaser's efforts be dependent on the financial resources or efforts of
Shelby. The purchasers of the embryos from Shelby are not dependent upon Shelby for the
essential managerial efforts which affect the failure or success of their
enterprise. Those purchasers reserve the ultimate control over their enterprise
by having the option whether they wish to enter into the Maintenance Contract
with Shelby and, if they do decide to enter into that contract, by having the
option at any stage in their calf's development at which they can elect to
terminate the Maintenance Contract without penalty and take possession of their
calf and either raise and/or sell it themselves or contract with someone else to
raise and/or sell it. Their position is similar to that of a landowner who does
not wish to manage a property himself and, pursuant to a terminable management
contract, delegates the responsibility for managing the property to an agent.
See Schultz v. Dain Corp, 568 F2d 612 (8th Cir. 1978) and Fargo Partners v. Dain
Corp, 540 F2d 912 (8th Cir. 1976). Even though it is expected that a number of the purchasers will elect to have
Shelby take care of the pregnant Recipient, raise their calf and sell their calf
when appropriate, that is not enough to cause Shelby's activities to constitute
the offer and sale of a security. A number of courts have dealt with a variety
of situations in which investors retained substantial control over their
investment but in fact remained passive and, insofar as the power retained by
the investors was a real one which they were in fact capable of exercising, the
courts have uniformly refused to find securities in such cases. See Mr. Steak,
Inc. v. River City Steak, Inc., 460 F2d 666 (10th Cir. 1972). Ballad & Cordell
Corporation v. Zoiler & Dannenberg Exploration, Ltd. 544 F2d 1059 (10th Cir.
1976) cert. denied, 431 US 965 (1977), Fargo Partners v. Dain Corp., 540 F2d 912
(8th Cir 1976) and Schultz v. Dain Corp., 568 F2d 612 (8th Cir. 1978). The
United States Court of Appeals for the Fifth Circuit summarized those cases by
stating that "(t)hese cases from the Tenth and Eighth Circuits... are consistent
in their treatment of latent investor control. In each case the actual control
exercised by the investor is irrelevant. So long as the investor has the right
to control the asset he has purchased, he is not dependent on the promoter or a
third party for `those essential managerial efforts which affect the failure or
success of the enterprise'". Williamson v. Tucker, 645 F2d 404, 421 (5th Cir,
1980). In Williamson, the Fifth Circuit had to decide if the joint venture
interest in question could be designated as a security and went on to say that
"a complication is added where the investment asset is not owned directly, but
is held instead through a joint venture or general partnership. While the
partnership per se may have full ownership powers over the asset, each
individual partner has only his proportionate vote in the partnership." 645 F2d
at 421. Although in Williamson v. Tucker the Fifth Circuit was dealing with a
case having the added complication that the investment asset was owned through a
joint venture rather than directly, the Eleventh Circuit has stated that
Williamson v. Tucker articulates a narrow exception to the general rule that
"(a)n investor who has the ability to control the profitability of his
investment, either by his own efforts or by majority vote in group ventures, is
not dependent upon the managerial skills of others." Gordon v. Terry, CCH Fed.
Sec. L. Rep. 1982 Decisions Par. 98, 787 (11 Cir. 1982). The Fifth Circuit's
reasoning in Williamson v. Tucker can therefore be applied by analogy to
situations where the asset is owned directly by the investor and managed by the
promoter pursuant to a management agreement. According to the Fifth Circuit, a general partnership or joint venture interest can be designated a security if
the investor can establish, for example, that (1) an agreement among the parties
leaves so little power in the hands of the partner or venturer that the
arrangement in fact distributes power as would a limited partnership; or (2) the
partner or venturer is so inexperienced and unknowledgeable in business affairs
that he is incapable of intelligently exercising his partnership or venture
powers; or (3) the partner or venturer is so dependent on some unique
entrepreneurial or managerial ability of the promoter or manager that he cannot
replace the manager of the enterprise or otherwise exercise meaningful
partnership or venture powers. 645 F2d at 424. None of these features is present in the arrangement between Shelby and the
purchasers of its embryos. First of all, the purchasers of the embryos are not
required by a contractual obligation to enter into the Maintenance Contract and
some of the Commission's own rulings and releases indicate that a management
contract must be a condition of the sale before a security exists. Schultz v.
Dain Corporation, 568 F2d 612 (8th Cir. 1978). furthermore, even if the
purchasers do enter into the Maintenance Contract, they have many opportunities
to terminate it without penalty. In that respect, this situation is unlike the
ones presented to the staff of the Commission in American Dairy Leasing
Corporation CCH Fed. Sec. L. Rep. `71-`72 Decisions Par. 98,584 (December 3,
1971) and Modern Dairy Farms, No. I, Inc. CCH Fed. Sec. L. Rep. `76-`77
Decisions Par. 80,992 (June 24, 1976) in which the promoters were offering
investors a program consisting of a dairy herd purchase agreement a rental
agreement and a management agreement and the Division of Corporate Finance was
unable to concur with the promoter's opinion that their plans did not involve
the offer and sale of an investment contract within the meaning of Section 2(1)
of the 1933 Act. In those cases it appears that the investors were required to
enter into the management agreement as a condition of their purchase of the cows
and the investor's right to terminate the management agreement was diminished by
the fact that they would be penalized if they sought to do so (if the investors
in American Dairy Leasing Corporation terminated the management agreement within
the first five years they would still have the continuing obligation to pay the
same fee to the promoter). Therefore, the arrangement between Shelby and the
purchasers cannot be said to leave so little power in the hands of the investor
that it in fact distributes power as would a limited partnership. Secondly, Shelby expects to sell its embryos to business and personal
acquaintances of Shelby and its affiliates and does not intend to sell its
embryos to any person who is so inexperienced and unknowledgeable in business
affairs that he is in capable of intelligently exercising his powers with
respect to the Maintenance Contract. However, since that determination depends
upon an evaluation of each purchaser which you are unable to make, we request
that in giving us your position you condition it upon the assumption that the
persons that purchase the embryos from Shelby will be experienced and
knowledgeable in business affairs. Lastly, the purchasers of the embryos will not be so dependent upon some unique
entrepreneurial or managerial ability of Shelby that they could not replace
Shelby or otherwise exercise their powers with respect to their embryos or
calves. The purchasers are really purchasing a two month old embryo and the use
of the Recipient until the calf is born and weaned with an option to enter into
the Maintenance Contract. Since the services to be performed by Shelby pursuant
to the Maintenance Contract are not unique and could be performed by many other
persons who are experienced in the care of pregnant cattle and the birthing,
raising and sale of the calves, the purchasers of embryos from Shelby could
elect not to enter into the Maintenance Contract and then find another qualified
person to perform those services if they did not wish to perform them
themselves. Based upon the foregoing, we respectfully request your interpretative view that
the activities of Shelby will not involve the offer and sale of a security
within the meaning of Section 2(1) of the 1933 Act. If you need any additional
information regarding these matters to help you in preparing your response
please feel free to contact the undersigned. Very truly yours, Robert A. Hudson RAH:mmn STAFF REPLY LETTERDecember 16, 1983 RESPONSE OF THE OFFICE OF CHIEF COUNSEL
DIVISION OF CORPORATION FINANCE Re: Shelby Land and Cattle Company
Incoming letter dated November 11, 1983 On the basis of the facts presented, this Division is unable to assure you that
it would not recommend enforcement action to the Commission if the cattle
breeding arrangements described in your letter are offered and sold without
compliance with the registration requirements of the Securities Act of 1933. The
existence of the maintenance and sales services suggests the possibility of
investment contract arrangement. Accordingly, the cattle breeding arrangements
would appear to be subject registration under the 1933 Act, absent an available
exemption. Sincerely, Barry T. Mehlman
Attorney Adviser
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