Free tool · Business Law
Is It a Security? The Howey Test
Under the Securities Act, an investment contract is a security if it involves an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others (SEC v W.J. Howey Co.). Stock, bonds and notes are securities by name. If an offering is a security, it must be registered with the SEC or fit an exemption, and the antifraud rules apply. Courts look at the economic reality of the deal, not at what it is called. Tick the facts to see which prongs are met.
Tool · Is It a Security? The Howey Test
An investment contract, and therefore a security, under the Howey test.
An investment of money: The investor puts in money or something of value, with an investment, as opposed to a gift or a purchase for use.
In a common enterprise: The investors’ fortunes are pooled and rise and fall together (horizontal commonality), or are tied to the promoter’s fortunes (vertical commonality, which some courts accept).
With an expectation of profits: The buyer is motivated by profit (appreciation or a share of earnings). If the buyer is motivated to consume or use the item, such as a home, it is not an investment (United Housing Foundation v Forman).
To come from the efforts of others: The profits depend on the essential managerial or entrepreneurial efforts of the promoter or a third party, not on the investor’s own efforts (SEC v W.J. Howey Co.; SEC v Glenn W. Turner Enterprises).
- The offer and sale must be registered with the SEC, unless an exemption applies (private placements under Regulation D, Regulation A, crowdfunding and others), and state ‘blue sky’ laws apply.
- The antifraud rules apply, including Section 10(b) and Rule 10b-5, and Section 12(a)(2) for public offerings, whether or not registered.
- Promoters, brokers and platforms may need to register and meet disclosure obligations.
An investment contract is a security if it involves an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others (SEC v W.J. Howey Co.). The checker tests the four prongs and lists what follows if it is a security. Courts look at economic reality, not labels. Simplified; applying the test to new kinds of assets is contested. A teaching aid, not a prediction and not legal advice. Runs in your browser; nothing is stored or sent.
How to use it
- Say whether the buyer invests money.
- Say whether the investors’ fortunes are pooled or tied to the promoter’s.
- Say whether the buyer expects a profit, and whether it depends on the efforts of others.
- Read the result and the consequences.
Common questions
What are the four parts of the Howey test?
An investment of money, in a common enterprise, with an expectation of profits, derived from the efforts of others.
Does calling something a ‘token’ or a ‘membership’ avoid securities law?
No. Courts look at the substance of the transaction, not the label.
What happens if an offering is a security and is not registered?
Buyers may be able to rescind, and the issuer and promoters face SEC enforcement and liability, unless an exemption applied.
Learn the law behind the tool
This tool is part of our Business Law course, with lectures, concept maps, flashcards, interactive exercises and a capstone case. Business Law: M&A and Securities.
More free law tools
General information, simplified, mainly on American law, not legal advice. States and countries differ, and real cases turn on facts that a tool cannot capture.