Fractional interests in loans, where a single loan is divided into multiple pieces and sold to multiple investors, have become increasingly popular through web-based investment platforms. These platforms make it easy for investors to purchase small portions of real estate loans, but regulators often treat these fractional interests as securities rather than simple loan participations. That status triggers three main compliance areas: offering exemptions or registration, broker-dealer rules, and investment adviser rules. Platforms that treat themselves as simple loan sellers but ignore securities compliance risk enforcement.
Growth of Fractional Investing and Alternative Assets
Technology has transformed how private lending reaches capital. Today, online platforms allow investors to purchase fractional interests in loans with a few clicks, giving lenders access to a broader investor base and providing investors with new avenues for participating in real estate debt. While this model offers efficiency and innovation, regulators typically view these offerings as securities transactions. Understanding this classification is critical. Securities treatment brings obligations not only for how the offering is structured, but also for how the platform itself operates. In addition, depending on its activities, the platform may be subject to broker-dealer or investment adviser registration requirements.
The explosion of fractional ownership models, spanning real estate, artwork, luxury goods, and other alternative assets, makes this topic particularly timely. As fractional ownership becomes the new frontier of investing, alternative investment platforms offering fractionalized loans must confront a fundamental legal question: when does innovation cross the line into a securities offering? The rapid growth of these models has outpaced regulatory expectations in many areas, placing increased scrutiny on platforms that divide products into smaller, investable pieces for a broad investor base.
This article reviews the governing federal and California legal standards, applies them to web-based fractionalized note platforms, and highlights compliance strategies that balance innovation with regulation.
Federal Standards for What Counts as a Security
The Investment Contract Test (Howey)
The Howey Test defines an investment contract as an arrangement involving: (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profit, (4) primarily from the efforts of others. The Supreme Court later confirmed that profits include fixed returns, such as interest payments. In practice, when investors use an online platform to purchase fractional loan interests and expect returns generated through the platform’s underwriting and servicing, the elements of Howey are typically satisfied. This makes the fractionalized interests securities, even if the underlying loans are traditional debt instruments.
The Presumption That Notes Are Securities (Reves)
In Reves v. Ernst & Young, the Court held that every note is presumed to be a security unless it closely resembles a type of note already excluded, such as consumer loans or home mortgages. Courts apply the “family resemblance” test, which evaluates: (1) the motivations of buyer and seller, (2) the plan of distribution, (3) the reasonable expectations of the investing public, and (4) whether another regulatory scheme applies.
Fractionalized notes offered broadly on a website, with marketing that emphasizes investment returns, generally fail to resemble excluded categories and lack alternative regulatory oversight. Accordingly, under Reves, such notes are almost always classified as securities.
California’s Broader Approach
California law applies an even broader definition. The Corporate Securities Law of 1968 includes any note or investment contract as a security. In addition, California courts use the risk-capital test, which asks whether investors place their money at substantial risk with the expectation of returns that depend on the promoter’s success. Applied to online platforms, if investors fund loans by purchasing fractional interests and their returns depend on the platform’s ability to service those loans, California law almost certainly treats those interests as securities.
As a result, issuers must either qualify the offering with the Department of Financial Protection and Innovation (“DFPI”) or fit within an exemption. For example, Section 25102(f) permits limited offerings if a notice of transactions is filed within 15 days of the first sale. Platforms that introduce investors to these securities and charge fees may also need to register as broker-dealers. At the same time, all communications are subject to California’s anti-fraud provision, which prohibits false or misleading statements or omissions of material fact.
Compliance Paths If Fractionalized Notes Are Securities
Since fractionalized notes are often considered securities, offerings must be registered or exempt. Common exemptions include those under Regulation D and Regulation A. Rule 506(b) of Regulation D allows sales to accredited investors and up to 35 sophisticated non-accredited investors, provided there is no general solicitation. Rule 506(c) permits general solicitation but requires all investors to be accredited and for issuers to take reasonable steps to verify status. Regulation A, Tier 2, allows offerings of up to $75 million annually to accredited and non-accredited investors, subject to qualification by the United State Securities and Exchange Commission (“SEC”) and ongoing reporting.
Regardless of the exemption used, federal and state anti-fraud provisions apply. These include Section 17(a) of the Securities Act, Rule 10b-5 under the Exchange Act, and California’s anti-fraud statute. Id. at Cal. Corp. Code § 25401.
Broker-Dealer and Investment Adviser Considerations
Securities laws also regulate how platforms themselves operate. Under the Exchange Act, a broker includes anyone engaged in the business of effecting securities transactions for others. A platform that solicits investors, processes subscriptions, or receives transaction-based compensation is likely to be considered a broker-dealer. However, the analysis is more nuanced: even if a platform avoids traditional solicitation or transaction-based compensation, it may still be operating as a broker-dealer if it facilitates the sale of whole loans or fractional interests for other lenders, originators, or brokers, for example, by listing loan opportunities, providing investor-matching functionality, hosting offering materials, transmitting investor funds, or coordinating the closing process.
“Effecting” securities transactions can include providing the marketplace or transactional infrastructure through which investors acquire securities from third parties, even in the absence of direct solicitation. This functional participation aligns with the statutory definitions of “broker” and “dealer” under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934 (15 U.S.C. §§ 78c(a)(4), 78c(a)(5)), which require firms engaged in such activities to register with the SEC under Section 15(a) of the Act (15 U.S.C. § 78o(a)) and, in most cases, become members of a self-regulatory organization such as FINRA. California law imposes similar requirements. Id. at Cal. Corp. Code § 25210.
The Investment Advisers Act defines an investment adviser as any person who, for compensation, provides advice about securities or the advisability of investing in them. If a platform recommends certain notes, curates offerings for investors, or allocates investments automatically, it may be deemed an investment adviser. California imposes comparable rules. Even if exempt from registration, platforms that provide advice are generally held to fiduciary standards.
Conclusion
Online platforms are reshaping how real estate debt is funded, but innovation does not remove compliance obligations. Fractionalized note interest marketed through a website are almost always treated as securities, which means platform sponsors must carefully evaluate registration or exemption requirements. In addition, depending on how the platform operates, broker-dealer or investment adviser rules may apply.
The practical message is straightforward: compliance must be built from the start. Sponsors should assume securities laws apply unless a careful legal analysis demonstrates otherwise, select the correct exemption or registration path, determine whether broker-dealer or adviser registration is required, and ensure all disclosures are accurate. By taking these steps early, private lenders, funds, and real estate managers can innovate with confidence, protect investors, and reduce the risk of costly enforcement actions.
