What Is the Howey Test?

The Howey Test, established by the SEC in 1946, determines whether a transaction is subject to federal securities laws based on the investment of money, common enterprise, and expectation of profit.

Nov 08, 2024 at 08:57 am

What Is the Howey Test?

1. Overview

The Howey Test is a legal test used by the Securities and Exchange Commission (SEC) to determine whether a transaction qualifies as an "investment contract" and is therefore subject to federal securities laws.

2. Elements of the Howey Test

The test was established in the 1946 Supreme Court case SEC v. W.J. Howey Co. and considers the following elements:

• Investment of Money: Is there an investment of money?
• Common Enterprise: Is the investment made with the expectation of profits from the efforts of others?
• Expectation of Profit: Is there a reasonable expectation of profits resulting from the investment?

3. Application of the Test

If all three elements are met, the transaction is considered an investment contract and is subject to federal securities laws. This means that the issuer must register the securities with the SEC and comply with other disclosure and reporting requirements.

4. Exemptions

There are some exemptions to the Howey Test, such as:

• Bank Deposits: Deposits in banks are generally not considered investment contracts.
• Insurance Contracts: Insurance policies are not typically investment contracts.
• Real Estate: Purchases of real estate for personal use or rental are not usually investment contracts.

5. Importance of the Howey Test

The Howey Test is important because it helps the SEC determine which transactions are subject to federal securities laws and which are not. This helps to protect investors by ensuring that they have access to adequate information about investments and that they are not defrauded.

6. Examples

• Examples of Investments Considered Securities under the Howey Test:

  • Stock offerings
  • Bonds
  • Mutual funds
  • Hedge funds

• Examples of Investments Not Considered Securities under the Howey Test:

  • Purchases of a house for personal use
  • Purchases of art or antiques for collection purposes
  • Simple loans with fixed interest