Howey Test
| The Howey Test is a test used to determine whether an asset is a security. The test is named after the Supreme Court case Securities and Exchange Commission v. W. J. Howey Co. The Howey Test has three prongs: 1) an investment of money, 2) in a common enterprise, 3) with the expectation of profits derived from the efforts of others. The first prong of the Howey Test, investment of money, is pretty straightforward. In order for an asset to be a security, there must be an investment of money. This can be in the form of cash, assets, or even services. The second prong of the Howey Test, common enterprise, means that there must be a common enterprise between the investor and the issuer. A common enterprise can be either horizontal or vertical. A horizontal common enterprise exists when there is a pooling of funds and each investor shares in the profits and losses of the enterprise. A vertical common enterprise exists when there is a common enterprise between the investor and the issuer, but the investor does not share in the profits and losses of the enterprise. The third and final prong of the Howey Test, expectation of profits derived from the efforts of others, is probably the most important part of the test. In order for an asset to be a security, there must be an expectation of profits derived from the efforts of others. This means that the investor is relying on the efforts of others to make a profit. So, in order for an asset to be a security, it must pass all three prongs of the Howey Test. If it fails any one of the prongs, it is not a security. |
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