Howey Test

Understanding the Howey Test

The evaluation known as the Howey Test is a critical process conducted by the U.S. government to determine whether an asset should be classified as a security. If an asset is deemed a security based on the Howey Test, it becomes subject to specific regulations regarding disclosure and registration. All securities must be registered with the Securities and Exchange Commission (SEC), which is one of the leading financial regulatory agencies in the United States. 

The primary purpose of the Howey test is to establish whether a transaction represents an investment contract for a particular item. If it does, the item is considered a security and must be registered with the SEC. The Howey Test operates by evaluating whether an individual, upon investing their money in a common enterprise, expects to solely derive profits from the efforts of the promoter or a third party. If the answer is yes, the item is classified as a security. 

The Howey Test gets its name from the well-known 1946 Supreme Court case, SEC v. W.J. Howey Co. In this case, a citrus farm in Florida sold investment contracts without registering them as securities with the SEC, arguing that they did not meet the criteria of securities. However, the SEC emerged victorious in the court case, leading to the establishment of the Howey Test as a means to determine whether financial instruments qualify as investment contracts and, consequently, securities. 

Due to the rapid growth of the cryptocurrency industry, the Howey Test is increasingly utilized to determine the classification of crypto assets as securities. Any tokens identified as securities through the Howey test must be registered with the SEC.