Howey test

The Howey test is a legal standard established by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine whether a transaction qualifies as an "investment contract" and is therefore subject to federal securities laws. 

Under Section 2(a)(1) of the Securities Act of 1933, a "security" includes a list of financial instruments. However, the term "investment contract" is also listed, though undefined, leading to significant legal debate over its interpretation. The Howey test provides a framework for assessing whether a transaction constitutes an investment contract based on its economic reality rather than its label.

The test requires four elements to be satisfied: 

  1. There must be an investment of money by the investor, 
  2. The investment must be made in a common enterprise where the fortunes of the investor are tied to others, 
  3. There must be a reasonable expectation of profits, and 
  4. Those profits must be derived primarily from the efforts of others, such as the promoter or a third party. 

If these criteria are met, the transaction is deemed a security and falls under the regulatory oversight of the Securities and Exchange Commission (SEC).

The Howey test is often used to evaluate unconventional financial arrangements, such as cryptocurrencies. However, its applicability varies across federal circuits and remains a subject of ongoing debate as cases advance through the courts and as federal and state legislation evolves.

For more information, see: SEC Resources on the Howey test.

[Written in December of 2024 by the Cornell Law School Securities Law Clinic]

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