## Facts

- Quiznos experienced steep business decline from 2007 to 2011, losing about 3,000 franchise locations and falling out of compliance with loan covenants.
- To avoid default-related consequences, Quiznos restructured its debt and formed a manager-managed LLC to operate the business.
- Investment funds led by Avenue and affiliated Fortress entities acquired equity interests in the LLC through the restructuring.
- Avenue held about 70% and Fortress about 10% of the LLC, giving them roughly 80% combined ownership.
- The LLC agreement gave Avenue and Fortress extensive governance and information rights, including the ability to appoint and remove managers (including the board chair), obtain financial information, and amend the LLC agreement.
- Quiznos’s finances continued to deteriorate after the restructuring.
- The investors sued former Quiznos managers and officers, alleging fraudulent misrepresentations about Quiznos’s financial condition in connection with the transaction, and pleaded federal securities-fraud claims under Exchange Act § 10(b) and Rule 10b-5.

## Issues

1. Whether the investors’ LLC interests qualified as “securities” under the Securities Exchange Act of 1934, specifically as “investment contracts” under the Howey test.
2. Whether the investors could treat the interests as “stock” or as “instruments commonly known as securities” on appeal.
3. Whether dismissal under Rule 12(b)(6) was proper where plaintiffs failed to allege the purchase or sale of a covered “security.”

## Decision

- The Tenth Circuit affirmed the Rule 12(b)(6) dismissal of the federal securities-fraud claims.
- The court held the LLC interests were not “investment contracts” because the investors had substantial contractual control over profitability and were not relying primarily on the managerial efforts of others.
- The court declined to consider arguments that the interests were “stock” or “instruments commonly known as securities,” holding those theories were forfeited because they were not adequately raised in the district court.

## Legal Principles

- Under Howey, an “investment contract” requires an expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
- Significant ownership, governance powers (including manager appointment/removal), amendment authority, and access to company financial information can show investors are not passive and therefore are not relying on others’ efforts for profits.
- Federal securities-fraud claims under § 10(b) and Rule 10b-5 require a purchase or sale of a “security” as defined by the Exchange Act.
- Arguments characterizing an instrument as a statutory “security” category must be preserved in the district court; new theories first raised on appeal may be treated as forfeited.

## Conclusion

Because the investors’ extensive control and information rights meant their expected profits were not primarily dependent on others’ managerial efforts, their LLC interests were not Howey investment contracts, and their alternative “security” theories were forfeited; the dismissal of the federal securities-fraud claims was affirmed.


Avenue Cap. Mgmt. II, L.P. v. Schaden, 843 F.3d 876 (10th Cir. 2016)