When a Real Estate Deal Becomes an Unregistered Securities Offering Subject to SEC Scrutiny

Dmitriy Smirnov

May 30, 2025

Firm News

Offering frauds are among the most common types of enforcement actions brought by the U.S. Securities and Exchange Commission (SEC). Most of these follow a familiar path: someone raises money from investors, promising profits, only for the SEC to later allege the offering involved misstatements—or worse, outright fraud. But before the SEC can even allege fraud, it must first establish that what was sold qualifies as a security. That threshold question—whether a real estate deal, a crypto token, or even a management agreement is a security—frequently turns on the four-part test set out in SEC v. W.J. Howey Co..

In this post, we focus not just on the definition of a security, but on the nuanced and evolving standards courts apply to determine when an offering—particularly in real estate or crypto—is an investment contract. We unpack the concepts of vertical and horizontal commonality, explore how courts assess pooling and promoter efforts, and explain how even real estate transactions marketed as passive income investments can meet the federal definition of a security.

First, What Is an Offering Fraud Under the Securities Laws?

An offering fraud occurs when a person or entity raises money from investors through misrepresentations or omissions in connection with a securities offering. These actions are typically brought under:

• Section 17(a) of the Securities Act of 1933,
• Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5.

In every case, a threshold issue is whether the offering involves a “security.”

What Is a Security? The Howey Test and Federal Definition

Under Section 2(a)(1) of the Securities Act (15 U.S.C. § 77b(a)(1)), a “security” includes a long list of instruments—among them, “stocks,” “bonds,” and critically, “investment contracts.”

The term investment contract is defined by the Supreme Court’s landmark decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). According to the Howey test, a transaction is an investment contract if it involves:

1. An investment of money,
2. In a common enterprise,
3. With a reasonable expectation of profits,
4. Derived from the efforts of others.

This four-part test is the backbone of modern securities law enforcement—and the subject of frequent litigation.

Fittingly, Howey itself involved what appeared to be a real estate deal: citrus grove parcels sold to investors who had no intention of farming the land but expected profits from the promoter’s management. That historical parallel underscores how real estate-based offerings can qualify as securities when structured around passive income and third-party efforts.

Case Study: SEC v. Fonseca and de Bastos – Real Estate Deal or Securities Fraud?

Recently, in SEC v. Fonseca et al., the U.S. District Court for the Southern District of Florida issued an order denying a motion to dismiss addressing two elements of the Howey test. In Fonseca, the SEC brought an enforcement action against two individuals accused of raising over $40 million from investors in connection with real estate investments in Detroit. The SEC alleged that the defendants promised to renovate properties and generate rental income, while in reality, many of the properties were never renovated—or even owned.

In their motion to dismiss, the defendants argued:

• The offering was not a security, because there was no common enterprise, and
• There was no expectation of profits solely from the efforts of others.

The court rejected both arguments, allowing the SEC’s case to proceed.

Why the Real Estate Investments Qualified as Investment Contracts

Judge Singhal ruled that the SEC sufficiently pled the existence of an investment contract under Howey.

• Expectation of Profits: The investors had no role in managing the real estate. Most lived in France and relied entirely on the defendants to generate returns. Courts have made clear that total passivity is not required. The question is whether profits depend on someone else’s efforts. As the Eleventh Circuit stated in SEC v. Merchant Capital, LLC, even “nominal involvement” by the investor doesn’t remove the transaction from the scope of the securities laws.
• Efforts of Others: The investors’ returns were to come from the defendants’ promises to renovate and manage the properties—clearly managerial or entrepreneurial efforts.

Pooling of Funds and the “Common Enterprise” Element

The defendants also argued that there was no common enterprise because investor funds were not pooled, and profits were not shared. But the court applied the doctrine of vertical commonality, where each investor’s success is tied to the promoter’s efforts.

Judge Singhal cited Eleventh Circuit precedent—SEC v. Unique Financial Concepts, Inc., 196 F.3d 1195 (11th Cir. 1999)—which expressly adopted vertical commonality, stating that a common enterprise exists “where the fortunes of the investor are interwoven with and dependent on the efforts and success of those seeking the investment or of third parties.” In Unique Financial Concepts, the Eleventh Circuit explained that vertical commonality is “a more flexible standard than horizontal commonality, as it ‘does not require investor funds to be pooled nor does it require profits to be shared on a pro rata basis.’” 

Horizontal vs. Vertical Commonality: Key Distinctions

The Supreme Court has never defined what constitutes a “common enterprise.” Courts have developed two main approaches:

• Horizontal Commonality: Investors’ funds are pooled, and profits and losses are shared pro rata among all participants. This standard is used in the Second, Third, Sixth, and Seventh Circuits.
• Vertical Commonality: Investors’ fortunes are tied to the success of the promoter. Some circuits (like the Fifth and Ninth) accept this broader formulation, while others require a stricter tie between investor and promoter outcomes.

Critically, the Second Circuit rejected broad vertical commonality in Revak v. SEC Realty Corp., warning that it risks collapsing Howey’s second and third prongs into a single inquiry.

The Eleventh Circuit, by contrast, has continued to apply vertical commonality as sufficient, particularly where the investors’ fortunes hinge on the promoter’s performance—even if not all investor funds are pooled or shared. In Unique Financial Concepts, for example, the court observed that “the thrust of the common enterprise test is that the investors have no desire to perform the chores necessary for a return.” This language, drawn from Eberhardt v. Waters, 901 F.2d 1578, 1580–81 (11th Cir. 1990), focuses more on investor passivity and reliance on others—concepts more traditionally associated with the fourth prong of Howey. This formulation has been criticized for potentially collapsing two distinct inquiries. By emphasizing investor reliance on the promoter’s success, vertical commonality risks overlapping entirely with the “efforts of others” requirement. As the Second Circuit noted in Revak v. SEC Realty Corp., 18 F.3d 81 (2d Cir. 1994), too broad a view of vertical commonality “would render the second prong of Howey superfluous.”

Nonetheless, courts in the Eleventh Circuit and others embracing vertical commonality view the economic link between promoter and investor as sufficient to meet the common enterprise element—at least at the pleading stage.

Horizontal Commonality in Cryptocurrency Cases: A More Nuanced Standard

While the traditional understanding of horizontal commonality focuses on the pooling of investor funds and pro rata profit sharing, courts analyzing cryptocurrency and digital asset offerings have recognized a more flexible approach within this paradigm. In these cases, horizontal commonality may be found where the proceeds of a token sale or NFT offering are reinvested into the platform or ecosystem that supports the value of the digital asset—regardless of whether investors’ returns are formally shared.

In Dufoe v. DraftKings Inc., 2024 U.S. Dist. LEXIS 116412 (D. Mass. July 2, 2024), the court reaffirmed this emerging standard. It held that pooling may be sufficiently alleged where the promoter uses proceeds from digital asset sales to develop the ecosystem, promote the platform, or support demand for the asset in question. As the court explained:

“Pooling occurs when the funds received by the promoter through an offering are, essentially, reinvested by the promoter into the business. In turn, such reinvestment increases the value of the instrument offered.” (quoting Dapper Labs, 657 F. Supp. 3d at 436)

The court noted that DraftKings allegedly used revenue from NFT sales to build out and promote its Marketplace platform. Even though each NFT was non-fungible (and thus unique), the value of all NFTs depended on the success and continued operation of the DraftKings platform. This interdependence among purchasers, the platform, and the secondary market tied the investors’ fortunes together—satisfying horizontal commonality at the pleading stage.

This same approach has been applied in several other recent cryptocurrency cases:

• In SEC v. Ripple Labs, 682 F. Supp. 3d 308, 2023 WL 4507900, the court found horizontal commonality where proceeds from XRP sales were deposited in a network of bank accounts controlled by Ripple and used to develop use cases for XRP and maintain the trading market.
• In SEC v. Terraform Labs, 684 F. Supp. 3d 170, 2023 WL 4858299, horizontal commonality existed where investor funds were deposited into a pool and used to build the blockchain infrastructure supporting the tokens.
• In SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020), the court concluded that the pooling of investor proceeds to fund the Kik ecosystem was sufficient to establish horizontal commonality, even where individual investors bought or sold tokens independently.

Why This Matters

These decisions reflect a shift away from a narrow, formalistic view of pooling and toward an “economic realities” approach. In the digital asset space, where value depends on network effects, platform utility, and ongoing development, courts recognize that reinvesting proceeds into the ecosystem can serve the same economic function as traditional pooling.

This more flexible view aligns with Howey’s underlying purpose: preventing fraud in the offer and sale of investment-like products. When token buyers rely on a promoter to sustain the platform that gives their asset value, courts are increasingly willing to treat that relationship as satisfying the common enterprise requirement—even if the asset is non-fungible or individually managed.

As is often the case, the substance—not the form—of an offering matters. Even if a transaction is structured as a real estate purchase with a management agreement, it can still be a security if investors expect profits from the promoter’s efforts. That distinction has serious implications. If it’s a security, the offering must comply with federal securities laws, including registration or a valid exemption—and misrepresentations may trigger regulatory enforcement or criminal charges.

Facing SEC Scrutiny Over an Investment Offering?

If you’re under SEC investigation or facing allegations related to an offering fraud, you need experienced legal counsel. At Fridman Fels & Soto, we have decades of experience handling complex white-collar criminal and SEC enforcement matters, including those involving real estate, private offerings, and digital assets.

We help clients navigate every stage of the process—from responding to subpoenas to negotiating settlements and litigating in federal court. If you’ve received a Wells notice, subpoena, or inquiry from the SEC, contact us today to discuss your case in confidence.