Legal Research

Housing Cooperatives: What UHF v. Forman Means for Securities Regulation and Real Estate Investors

When it comes to real estate, although significantly different from owning a condo or renting an apartment, individuals may consider investing in a housing cooperative[1] (often referred to as “co-op”). In considering whether to do so, purchasers should determine whether the purpose of the co-op investment is not for profit and thus not considered a security or for-profit and thus considered a security. United Housing Found. v. Forman[2] is an important case in which the United States Supreme Court determined that The Securities Act of 1933 and of the Securities Exchange Act of 1934 (Securities Acts) do not recognize commercial contracts in stock as securities where the transaction’s purpose is not an investment for profit.

In United Housing Found. v. Forman, United Housing Foundation, Inc. (UHF), a nonprofit organization, developed Co-op City, a low-cost housing cooperative.[3] UHF formed Riverbay, a separate entity, to own and operate Co-op City.[4] In order for a potential tenant to acquire an apartment, the tenant had to purchase eighteen shares of stock for each requested room; the entire purpose of the share purchase was to move into Co-Op City.[5] The shares were not transferrable, came with no voting rights, and, upon moving out, the tenant had to sell the shares back at the original purchase price.[6] Originally, UHF wanted to attract occupants in order to cover a portion of the construction costs, but when costs were higher than anticipated, UHF raised the monthly rental charges to cover overrun.[7] Fifty-seven residents claimed that the initial offer stated that residents would not be required to cover construction cost increases and filed suit against UHF and Riverbay.[8] The citizens of Co-op City stated that the alleged distortions were in violation of federal securities laws.[9] UHF countered that the contracts did not involve securities and the district court judge granted a motion to dismiss.[10] The court of appeals reversed, and UHF appealed.[11]

The issue for the Supreme Court in United Housing Found. v. Forman was whether shares of stock entitling a purchaser to lease an apartment in Co-op City, a state-subsidized and supervised nonprofit housing cooperative, are “securities”  within the purview of the Securities Act of 1933 and the Securities Exchange Act of 1934.[12]  The Securities Act of 1933 and the Securities Exchange Act of 1934 define what is and is not a security. Both acts contain similar definitions. The 1933 Securities Act uses the following language:

[T]he term “security” means any note, stock, treasury stock, bond, debenture, security, future, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement . . ., pre-organization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security . . . or warrant or right to subscribe to or purchase, any of the foregoing.[13]

The plaintiffs contended that these shares were covered by the securities laws either because: (1) shares of “stock” were issued, and the federal securities laws explicitly include “stock” in the definition of security; or (2) the shares represented investment contracts under the test articulated in SEC v. WJ Howey Co..[14] With regard to the argument that the cooperative membership interests were “stock,” and therefore within the literal terms of the federal securities laws, the Court found that “Congress intended the application of these statutes to turn on the economic realities underlying a transaction, and not on the name appended thereto.”[15]  After noting that the primary congressional purpose behind the federal securities laws was to protect the integrity of the capital markets, the Court contrasted the sale of securities for the purpose of raising capital by promising profits to the investors with purchases motivated by a desire for personal use.[16] The Court opined that:

Common sense suggests that people who intend to acquire only a residential apartment in a state-subsidized cooperative, for their personal use, are not likely to believe that in reality, they are purchasing investment securities simply because the transaction is evidenced by something called a share of stock.[17]

Examining the economic realities of the transaction, the Court concluded that the cooperative shares possessed none of the characteristics typical of corporate stock.[18] The shares lacked: (1) the right to receive dividends contingent upon an apportionment of profits, (2) negotiability, (3) the ability to be pledged or hypothecated, (4) voting rights in proportion to the number of shares owned, and (5) the possibility of appreciation in value.[19] With regard to the plaintiffs’ alternate basis for invoking the protection of the federal securities laws, the Court similarly declined to find that the cooperative shares were “investment contracts” under the Howey test.[20] Howey requires: (1) an investment, (2) in a common enterprise, (3) with the expectation of profits, (4) solely from the efforts of others.[21] A cooperative is clearly a common enterprise, but the Supreme Court concluded that the shares at issue in Forman were not investment contracts because they did not involve any investments;[22] there was no “expectation of profits”;[23] and any possible economic benefits would not result from the managerial efforts of others.[24]

In sum, owning a portion of a co-op means owning shares in a company; co-op owners do not own real estate directly. The company owns the property and “owners” are shareholders who hold the right to live in the property by virtue of ownership of shares in the company. Forman teaches that the formation or investment in a co-op does not, in itself, constitute a securities transaction regulated by the Securities and Exchange Commission. A co-op that meets the same not for profit criteria as outlined in Forman avoids such securities regulation. Investors considering investing in co-op property, especially for profit, should review the financials and the co-op policies to decide whether the transaction involves regulated securities and whether additional filings, disclosures, and other compliance are necessary to execute the transaction in full compliance of the law.

[1]A housing cooperative or “co-op” is a corporation whereby the owners don’t own their units outright; instead, each member of the cooperative purchase a share of the corporation that corresponds to a particular property, and which gives them the right to live there. The ownership is of the share in the cooperative corporation, not of the property itself. [2]United Hous. Found., Inc. v. Forman, 421 U.S. 837  (1975). [3] Id. at 841. [4] Id. at 842. [5] Id. [6] Id. [7]United Hous. Found., Inc. v. Forman, 421 U.S. at 843. [8] Id. [9] Id. at 845 [10] Id. [11] United Hous. Found., Inc. v. Forman, 421 U.S. at 846. [12] Id. at 840. [13] See Section 2(a)(1) of the Securities Act of 1933, 15 U.S.C. § 77b(1). [14] Securities & Exch. Comm’n v. W.J. Howey Co., 328 U.S. 293, 298- 99 (1946). [15] United Hous. Found., Inc. v. Forman, 421 U.S. at 849. [16] Id. at 849-50. [17] Id. at 851. The Court noted that in the case before it, “the inducement to purchase was solely to acquire subsidized low-cost living space; it was not to invest for profit.” Id. [18] See Id. at 851. [19] See Id. [20] See Id. at 852. [21] See Securities & Exch. Comm’n v. Howey Co., 328 U.S. 293, 301 (1946). [22] See Forman, 421 U.S. at 857 (observing that the purchases of cooperative shares were not intended as an investment but were intended to provide essential services for the residents of the cooperative). [23] Id. at 852. The Court recognized some potential economic benefits that might accrue to purchasers of the cooperative shares, but determined that, on the facts before it, the possibility of such income was “far too speculative and insubstantial” to bring the transaction within the securities laws. See id. at 856.  [24] See Id. at 847-52. The Howey requirement that profits arise solely through the efforts of others would not normally be satisfied in the case of cooperatives for three reasons: (1) because there are no profits paid on capital, the benefits of cooperative membership can arise only through use of the cooperative by the member (through direct patronage); (2) the economic savings to cooperative members arise primarily as a consequence of the nonprofit relation between the co-op and its members, rather than through the managerial efforts of others; and (3) where, as is often the case, cooperative members retain control over important decisions and participate in its business affairs, the „solely through the efforts of others‟ test could not be met. See id. at 848-51.

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