Howey test

The Howey test is a legal standard established by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine whether a transaction qualifies as an "investment contract" and is therefore subject to federal securities laws.

Under Section 2(a)(1) of the Securities Act of 1933 , a "security" includes a list of financial instruments . However, the term "investment contract" is also listed, though undefined, leading to significant legal debate over its interpretation. The Howey test provides a framework for assessing whether a transaction constitutes an investment contract based on its economic reality rather than its label.

The test requires four elements to be satisfied:

  1. There must be an investment of money by the investor,
  2. The investment must be made in a common enterprise where the fortunes of the investor are tied to others,
  3. There must be a reasonable expectation of profits, and
  4. Those profits must be derived primarily from the efforts of others, such as the promoter or a third party.

If these criteria are met, the transaction is deemed a security and falls under the regulatory oversight of the Securities and Exchange Commission (SEC) .

The Howey test is often used to evaluate unconventional financial arrangements, such as cryptocurrencies . However, its applicability varies across federal circuits and remains a subject of ongoing debate as cases advance through the courts and as federal and state legislation evolves.

For more information, see : SEC Resources on the Howey test.

[Written in December of 2024 by the Cornell Law School Securities Law Clinic ]

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