What Is The Howey Test & How Does It Affect Securities?
The body of law that regulates securities in the United States has been steadily built up since the creation of the Securities & Exchange Commission (SEC) in 1934. One of the most foundational aspects of securities law comes from a U.S. Supreme Court case, SEC v. W.J. Howey & Co, decided in 1946. Howey answered the question of which instruments constitute ‘investment contracts’ – and in turn, helped to cement all investment contracts as securities, able to be traded on the newly developing securities market. Even today, an instrument must pass the Howey test in order to qualify.
What Constitutes An Investment Contract?
In the case, the defendants were selling real estate contracts for portions of Florida citrus groves. The purchasers were gently encouraged to lease their land (with the citrus groves) back to a corporation controlled by the defendants so that it could be tended and the produce harvested – but without any kind of rights specified for the purchasers as to the produce or even a right of entry. The SEC filed suit against the Howey corporation, arguing that the contracts qualified as unregistered securities.
The Securities Act of 1933 does not define an ‘investment contract,’ but the Supreme Court held that Congress had intended it to be interpreted in the same manner as past common law. The majority opinion clarified the term’s history in past jurisprudence, stating four criteria that a document had to meet in order to qualify as an ‘investment contract.’ They were:
- A financial investment must have been made – in other words, the participants’ own money must have been risked;
- A common enterprise – that is, both parties’ financial success is linked somehow;
- An expectation of profits must exist; and
- Those profits must be “solely derived” from the efforts of others (either a promoters’ efforts or another party’s), rather than one’s own.
Relevance Today
The Howey test is still used today to identify what constitutes an investment contract – but the more important caveat in today’s jurisprudence is that an investment contract, under this definition, generally qualifies as a security. Failure to properly identify a financial instrument as a security can open a broker/dealer or an investor to serious penalties; in some cases, jail time may even be on the proverbial table.
This is particularly relevant given the (as of this writing) ongoing fight between the SEC and the U.S. cryptocurrency industry. Crypto exchanges and dealers have persistently argued that most cryptocurrencies do not qualify as securities, but rather, utility tokens or ‘token’ offerings, but the SEC has continually argued the opposite. If the Howey test applies to a particular cryptocurrency, U.S. courts have shown increasing willingness to regulate that cryptocurrency as a security.
Contact A Seminole, FL Securities Law Attorney
If you are looking to invest in the securities market, but are unsure as to whether a certain currency qualifies as a security, contacting a Florida securities law attorney from the Hunt Law Group may help to get your questions answered. Contact our office today at (727) 471-0444 to schedule a consultation.
