Case(s): Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946)
W.J. Howey Co. sold small units of land in a citrus grove to buyers, the majority of whom who also signed a service contract with Howey for the cultivation and harvesting of the citrus crops, and that required the buyers to split the resulting profits with Howey. Purchasers of the land had the option of making other service arrangements, but Howey, in its advertising materials, stressed the superiority of Howey-in-the-Hills’s service. Howey marketed the land through a resort hotel it owned in the area and promised significant profits in the sales pitch it provided to those who expressed interest in the groves. The purchasers, for the most part, are nonresidents of Florida. They are predominantly business and professional people who lack the knowledge, skill, and equipment necessary for the care and cultivation of citrus trees. They are attracted by the expectation of substantial profits.
District Court and Fifth Circuit Decisions
The Securities and Exchange Commission (“SEC”) filed suit against Howey, arguing that it had not filed a registration statement, and yet, was using interstate commerce to offer and sell securities in violation of § 5(a) of the Securities Act of 1933. In furtherance of its suit, the SEC sought injunctive relief to bar Howey from using “the mails and instrumentalities of interstate commerce in the offer and the sale of unregistered and nonexempt securities.” The U.S. District Court for the Southern District of Florida denied the injunction, and the U.S. Court of Appeals for the Fifth Circuit affirmed.
The SEC sought Supreme Court intervention, arguing that the ruling of the Circuit Court of Appeals conflicted with other federal and state decisions and that it introduced a novel and unwarranted test under the statute which the Commission regarded as administratively impractical. The Supreme Court granted certiorari and decided the case on May 27, 1946.
Supreme Court Opinion
Writing for the majority, Justice Frank Murphy identified the critical question in this case as whether or not the contracts that Howey was selling constituted an “investment contract” within the meaning of § 2(a)(1) of the Securities Act of 1933. Murphy reasoned that while “investment contract” was left undefined by the Securities Act, it was “common in many state ‘blue sky’ laws in existence prior to the adoption of the federal statute, and, although the term was also undefined by the state laws, it had been broadly construed by state courts so as to afford the investing public a full measure of protection.”
According to the court, “By including an investment contract within the scope of § 2(1) of the Securities Act, Congress was using a term the meaning of which had been crystalized by this prior judicial interpretation. It is therefore reasonable to attach that meaning to the term as used by Congress, especially since such a definition is consistent with the statutory aims. In other words, an investment contract, for purposes of the Securities Act, means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.”
With the foregoing in mind, the court established the now-famous “Howey Test” to determine whether a transaction qualifies as an investment contract. The test consists of three elements:
(1) Investment of Money: There must be an investment of money or other valuable consideration.
(2) Common Enterprise: The investment must be in a common enterprise, meaning that the fortunes of the investor are linked to the efforts of others; and
(3) Expectation of Profits: Investors must have a reasonable expectation of obtaining profits primarily from the efforts of others, typically the promoters or managers of the investment.
If a transaction meets these three criteria, it is considered an investment contract and therefore falls under the definition of a security subject to U.S. federal securities laws. The Howey Test has been widely applied in legal cases involving various types of investment schemes, including those involving real estate, business ventures, and financial instruments. As such, the case and the test have had a significant impact on the regulation of securities and investments in the United States and continue to be referenced in legal discussions and court cases related to securities law.