What Is the Howey Test?

The Howey Test is a test that is used by the U.S. government to determine whether or not an asset is a security. If an asset is a security according to the Howey Test, then it is subject to certain regulations that are related to disclosure and registration. All securities have to be registered with the Securities and Exchange Commission (SEC). The SEC is one of the most prominent U.S. financial regulatory agencies. 

The purpose of the Howey test is to determine if a transaction represents an investment contract for the particular item in question. If so, then it is considered a security and thus must be registered with the SEC. The way that the Howey Test works is that the SEC considers whether or not if when a person invests his or her money in a common enterprise, he or she is led to expect profits solely from the efforts of the promoter or a third party. If the answer is yes, then the item is a security. 

The Howey Test gets its name from the famous 1946 Supreme Court case, SEC v. W.J. Howey Co. In this court case, a citrus farm in Florida was selling investment contracts without registering them as securities with the SEC, claiming that they weren’t actually securities. The SEC won the court case and the Howey Test was set up to determine whether or not financial instruments are investment contracts, and are thus securities. 

Currently, as the cryptocurrency industry grows, the Howey Test is being used more and more to determine whether crypto assets are securities or not. All tokens that are classified as securities through the Howey test have to be registered with the SEC.