Howey Test

The Howey test is a legal test used in the U.S. to determine whether certain transactions qualify as investment contracts and, therefore, securities under U.S. federal securities laws. The test derives its name from the 1946 U.S. Supreme Court case, U.S. Securities and Exchange Commission v. W.J. Howey Co. The so-called “Howey test” consists of four elements that must be met for a transaction to be considered an investment contract …

(1) Investment of Money: There must be an investment of money or assets into a common enterprise. This element typically involves the contribution of funds or other valuable assets with the expectation of earning profits.

(2) Common Enterprise: The investors’ money must be pooled together in a common enterprise, where the profits are generated by the efforts of others. The term “common enterprise” refers to an entity or arrangement where multiple investors combine their resources under a single management or entity.

(3) Expectation of Profits: Investors must have a reasonable expectation of earning profits from the investment. The focus is on the potential return on investment, primarily resulting from the efforts of others.

(4) Efforts of Others: Any profit or return on investment must primarily come from the efforts of others. This element is met when the success of the investment depends significantly on the managerial or entrepreneurial efforts of individuals other than the investor.

According to the U.S. Securities and Exchange Commission (“SEC”), “The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales).  Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply.”

If a transaction satisfies all four prongs of the Howey test, it is likely to be classified as an investment contract and, therefore, a security. Securities are subject to various regulations and requirements under U.S. federal securities laws, such as registration with the SEC, and compliance with disclosure and investor protection standards.