The Transformative Power of the Howey Test
The Howey Test consists of four essential criteria that an asset must meet to be categorized as an “investment contract.” To qualify, the asset must consist of an investment of money in a common enterprise, with a reasonable expectation of profits derived from the efforts of others. Assets that meet these criteria are considered securities and are therefore subject to strict disclosure and registration requirements under U.S. laws.
The Howey Test is crucial in evaluating blockchain and digital currency projects, particularly during fundraising stages. Certain cryptocurrencies and initial coin offerings (ICOs) may fall under the Howey definition of an “investment contract.”
Key Insights:
- Defining Investment Contracts: The Howey Test determines the criteria that qualify an asset as an
Related Terms: Securities Act of 1933, Securities Exchange Act of 1934, initial coin offering (ICO), investment of money, common enterprise, expectation of profit, derived from the efforts of others.
References
- U.S. Securities and Exchange Commission. “Framework for ‘Investment Contract’ Analysis of Digital Assets”.
- Mendelson, Michael. “From Initial Coin Offerings to Security Tokens: A U.S. Federal Securities Law Analysis”. *Stanford Technology Law Review,*vol. 22, no. 1, Winter 2019, pp. 66.
- Library of Congress. “Securities & Exchange Commission v. W. J. Howey Co. et. al.”, Pages 298-299.
- Fisher Hudson Shallat. “Decentralized Cryptocurrencies Typically Fail the Howey Test”.
- U.S. District Court, Southern District of New York. “Securities and Exchange Commission vs. Ripple Labs, Inc., et. al”.
- U.S. Securities and Exchange Commission. “SEC Charges Ripple and Two Executives With Conducting $1.3 Billion Unregistered Securities Offering”.
- Norton Rose Fulbright. “U.S. Federal Court Issues Mixed Ruling in Watershed SEC Action on Ripple’s XRP”.
- U.S. Securities and Exchange Commission. “SEC Charges North Carolina Resident for Conducting Fraudulent and Unregistered Offerings of Crypto Asset Securities”.
- U.S. Securities and Exchange Commission. “SEC Charges Digital World SPAC for Material Misrepresentations to Investors”.
- U.S. Securities and Exchange Commission. “SEC Charges Celsius Network Limited and Founder Alex Mashinsky With Fraud and Unregistered Offer and Sale of Securities”.
- CNBC. “SEC Chief Says Agency Won’t Change Securities Laws to Cater to Cryptocurrencies”.
- Justia. U.S. Supreme Court. “SEC v. W.J. Howey Co., 328 U.S. 293 (1946)”.
Get ready to put your knowledge to the test with this intriguing quiz!
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## What is the primary purpose of the Howey Test?
- [ ] Determine tax liability on investments
- [ ] Set interest rates for securities
- [x] Determine whether a transaction qualifies as an investment contract
- [ ] Define trading regulations for foreign exchange
## Which body uses the Howey Test to classify securities?
- [ ] Financial Industry Regulatory Authority (FINRA)
- [x] Securities and Exchange Commission (SEC)
- [ ] Commodity Futures Trading Commission (CFTC)
- [ ] Internal Revenue Service (IRS)
## Which of the following criteria is NOT part of the Howey Test?
- [ ] An investment of money
- [ ] A common enterprise
- [x] A guaranteed profit
- [ ] An expectation of profits from the efforts of others
## The Howey Test originated from a U.S. Supreme Court case involving which type of investment?
- [ ] Stocks
- [ ] Bonds
- [ ] Derivatives
- [x] Citrus groves
## For a transaction to be considered an investment contract under the Howey Test, what must profits be derived from?
- [ ] The efforts of the investor themselves
- [x] The efforts of a promoter or third party
- [ ] Interest accrued over time
- [ ] Fixed income securities
## Which element is required for the Howey Test to apply regarding the source of profits?
- [ ] Profits depend entirely on market conditions
- [x] Profits depend on the efforts of others
- [ ] Profits are results of individual research and decisions
- [ ] Profits are fixed and pre-determined
## Which feature would make a cryptocurrency fall under the classification of a security per the Howey Test?
- [ ] It is mined using computer algorithms
- [ ] It is traded on multiple exchanges
- [ ] It has a fixed supply
- [x] It profits primarily from the work of a development team
## What best describes a "common enterprise" in the context of the Howey Test?
- [x] An investment scheme pooling resources to share profits
- [ ] A sole proprietorship
- [ ] An individual financial advisory service
- [ ] A privately held company with limited partners
## If a transaction does NOT meet all criteria of the Howey Test, what can be inferred?
- [ ] It automatically qualifies as a traditional security
- [ ] It necessitates further regulatory investigation
- [x] It does not qualify as an investment contract
- [ ] It is exempt from all financial regulations
## When was the Howey Test established by the U.S. Supreme Court?
- [ ] 1971
- [x] 1946
- [ ] 1952
- [ ] 1930
