Wednesday Word: the Howey Test

By: Caitlyn Scofield , Spring 2019 IAC Student Intern

Have you ever looked at your bank account and wondered where your money went? As an investor, you ask yourself the same question “what am I putting my money into”? There are many investment opportunities out there. The government has put into place certain regulations for investments. These ensure that certain information about specific investments are provided honestly and accurately to the investor. This is done through the Securities act of 1933 and the Securities Exchange act of 1934.  Yet not all investments are covered under these acts, only those that are determined to be securities are regulated in this way.

“How do I know if my investment is a security” you might ask?  In 1946, the Supreme Court answered that question by developing “the Howey Test”.

This test is used to determine if an investment contract fell under the title and therefore regulation requirements of a security. In the little citrus grove case of the SEC v. Howey (now you know where they got the name) the court provided four factors in determining whether a transaction is a security.

  1. It is an investment of money.
  2. There is an expectation of profits from the investment.
  3. The investment of money or assets is in a common enterprise
  4. Any profit comes from the efforts of promoter or third party

If your transaction falls within these factors, then it may be subject to the disclosure and registration requirements of the Acts. This is a substantive test and focuses more on the economic realities of the investment rather than the what a promoter might pose the investment to be to avoid registration requirements. Many investment instruments fall into the category of a security, including stocks, bonds and investment contracts. In general, this means that all these types of transactions must be registered with the SEC, a state, or subject to an exemption, investors must be provided with financial and other significant information and all misrepresentation and other fraud is prohibited. While there are other tests which have since been developed by the court and states often have their own securities registration requirements, the “Howey Test” is the original. Investors can use it as a tool to look at the economic reality of their investment and determine whether it qualifies as a security and is therefore subject to the regulations of the Securities Acts. Furthermore, investors can be assured that the courts will undergo the same analysis and protect their rights to be informed investors.