Understanding the Howey Test
The Howey Test is a legal test used by the U.S. government to determine whether a particular asset qualifies as a security.
If an asset is classified as a security according to the Howey Test, it is subject to specific regulations, such as disclosure and registration requirements.
All securities must be registered with the Securities and Exchange Commission (SEC), one of the primary financial regulatory agencies in the United States.
Determining Security Classification
The Howey Test aims to assess whether a transaction involves an investment contract.
If it does, the asset is considered a security and must be registered with the SEC.
The test evaluates whether individuals investing their money in a common enterprise are led to expect profits solely from the efforts of the promoter or a third party.
If the answer is yes, the asset is classified as a security.
The Howey Test
The name “Howey Test” originates from the 1946 Supreme Court case, SEC v. W.J. Howey Co.
In this case, a Florida citrus farm sold investment contracts without registering them as securities, arguing that they were not securities in the first place.
However, the SEC prevailed 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.
The Howey Test is increasingly employed in the growing cryptocurrency industry to assess whether crypto assets should be considered securities.
Tokens categorized as securities through the Howey Test must be registered with the SEC.