The Howey Test is a test developed by the US Supreme Court to determine if certain transactions qualify as an “investment contract.” If the test is positive, these transactions are subject to the Securities Act of 1933 and the Securities Exchange Act of 1934, are considered securities and must comply with certain disclosure and registration requirements..
Howie’s test is often referred to by American regulators when, in the absence of a clear regulatory framework, they want to prove that a particular cryptographic token is a security.
What is a security
The Securities Act of 1933 and the Securities Exchange Act of 1934 contain broad definitions of the term “security”. These include, for example, credit cards, stocks, bonds, investment contracts, etc..
The assignment of a certain investment to securities is of great importance, since the requirements for such an investment depend on it. As a general rule, all securities distributed in the United States must be registered with the Securities and Exchange Commission, although there are exceptions. A company offering non-exempt securities must register them. This process involves the disclosure of certain information, including:
- Description of the company’s property objects;
- Description of the offered security;
- Information about the company’s management;
- The financial position of the company certified by independent accountants.
Howie’s test background
In 1946, the US Supreme Court held a hearing in the case of the Securities and Exchange Commission v. Howie, the participants of which examined the question of whether a leaseback agreement is an investment contract (one of the types of investments that is a security under law). Howey Co., two Florida businessmen, negotiated contracts for the sale of citrus land. They also offered buyers the opportunity to lease back the land they had bought to harvest and sell their crops. Since most of the buyers were not farmers and had no experience in growing crops, they were happy to lease the land back..
The SEC filed charges over these transactions, claiming that the defendants violated the law by not applying to register the security. The Supreme Court, in order to understand whether the leaseback agreements of the defendants were securities, developed a test that allows you to determine whether a particular transaction falls within the definition of an investment contract (and therefore requires registration as a security).
According to Howie’s test, a transaction is a security if:
- It is done for the purpose of investing money;
- The investment is made in anticipation of making a profit;
- The investment is in a joint venture;
- Any profit is the result of the activities of the person offering the contract or a third party.
Although Howie’s test uses the concept of “money,” later variations include investing in non-monetary assets. The term “joint venture” in this case is not clearly defined, so the courts use different interpretations. Most federal courts understand joint ventures as so-called horizontal enterprises, that is, enterprises in which a pool of investors invests their money.
The final factor that determines the result of the Howie test is profit-making that does not depend on the actions of the investor. If such a profit is obtained, this may be the basis for recognizing the investment as a security. If the final result largely depends on the actions of the investor himself, such an investment is probably not a security.
Prioritize content over form
In Howey Co. The Supreme Court has created a test to consider the nature of an investment, rather than its form, as the most accurate way to determine its status. Even if the investment is not called a “security” or “bond,” it can be considered a security by law, which means that it will be subject to appropriate registration and disclosure requirements. After the creation of the Howie test, some issuers tried to hide the real status of their securities in order to avoid registration requirements (for example, naming their securities as equity participation in an unlimited partnership). To bring the issuer to clean water, the courts assess the economic factors associated with the investment scheme, omitting its name or form, when classifying it as a security.
If an investment opportunity is offered to many people, if investors have little or no control or management of the money or assets invested, such an investment can be considered a security. On the other hand, if only a few people get the opportunity to invest, if the investors have significant control over the invested money, then it is likely that such an investment is not a security..
Howie’s test is not the only test courts use to determine investment status. For example, in 1990 the Supreme Court created a “family similarity test”. The test allows a security issuer to show that his security is not valuable by demonstrating a “family resemblance” to other securities that are not recognized as securities.
Individual states have their own rules for registering securities, often referred to as “blue sky laws.” In some states, such as California, a venture capital test is used, which first checks the reasons for encouraging investors to invest their money and the associated risks..
Based on materials from FindLaw
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