Howey Test - YouTube

I am attorney Laura Anthony founding partner of Legal & Compliance, a full service corporate,

securities, and business transactions law firm.

Today is the continuation in a series of LawCasts discussing What Is a Security?

Today, I will begin talking about the definition of a security as an investment contract and

the landmark US Supreme Court of SEC vs WJ Howey company, the result of which has become

commonly known as the Howey Test.

Under the Howey Test whether an investment instrument is a security requires a substance

over form analysis.

Clearly, a stock or bond is the security, but an investment contract can take many different

forms and its underlying character may not be as easily recognizable.

The Howey Test defines an investment contract as follows: An investment contract for purposes

of the Securities Act means a contract, transaction or scheme whereby a person invests his money

in a common enterprise and is led to expect profits solely from the efforts of the promoter

or a third party.

Such a definition permits the fulfillment of the statutory purpose of compelling full

and fair disclosure relative to the issuance of the many types of instruments that, in

our commercial world, fall within the ordinary concept of a security.

It embodies a flexible rather than a static principle, one that is capable of adaptation

to meet the countless and variable schemes devised by those who seek the use the money

of others on the promise of profits.

To further break down the analysis, Howey established a four-part test.

In particular: The first factor requires an investment of money and has been expanded

by subsequent cases to include any form of consideration with value.

The second factor is In a common enterprise.

The majority of federal courts define a common enterprise as having a horizontal commonality

which involves the pooling of money or assets from multiple investors with the sharing in

the profits and risk in some proportion.

Another group of federal courts define a common enterprise as involving vertical commonality,

which focuses on the relationship of the parties and whether one is relying on the efforts

of the other.

If a commonality of enterprise is found regardless of the form it has taken, this factor in the

test will be satisfied.

The third factor is with an expectation of profits: Profits can either be in the form

of capital appreciation, cash return on investment, or other earnings, including dividends or

interest.

Profits for purposes of the Howey Test refers, particularly, to a return to the investor

and not necessarily the success of the enterprise as a whole.

A Ponzi scheme clearly involves a security, even though the enterprise itself is designed

to be a failure.

The analysis turns on a finding that the investor is motivated by a return on his investment.

The fourth factor is the requirement that the potential profit be derived solely from

the efforts of the promoter or third parties or in other words that it be a passive investment

for the investor.

I am securities attorney Laura Anthony, founding partner of Legal & Compliance, and producer

of LawCast.

Should you have any questions about today’s topic, please visit SecuritiesLawBlog.com

and LawCast.com, or contact me directly.

Inquiries of a technical nature are always encouraged.