Howey Test
2 min read
Courts use the Howey test from 1946 to assess which offerings qualify as securities. In SEC v. W.J. Howey Co., the court held that the sale of land within a common enterprise was an investment contract, which is subject to the Securities Act of 1933 and other Securities and Exchange Commission (SEC) regulations. A common enterprise is a business in which external investors contribute to the same pool of funds as the party offering the investment.
Today, courts use the Howey test to disambiguate whether a particular transaction or offering meets the requirements to be an investment contract. When one party invests with the reasonable expectation that the investment will yield some return, an investment contract has been formed. In other words, the test seeks to establish detrimental reliance or promissory estoppel to protect the investor.
Most recently, the Howey test was used in the SEC’s action against Ripple Labs, Inc., where the court found that XRP offerings constituted an investment contract. Although it raised capital to finance the company’s business, Ripple did not register with the SEC. The subsequent SEC investigation revealed that Ripple failed to comply with SEC requirements for broad public offerings, highlighting the importance of investor protection when issuing a new virtual currency.