The Howey test is a legal interpretation by the U.S. Supreme Court, which is used to determine whether or not a transaction constitutes an "investment contract." If a transaction is determined to be an investment contract, it is considered a security and is subject to securities regulations, including those under the Securities Act of 1933 and the Securities Exchange Act of 1934.
The Howey test defines an investment contract to mean "an investment of money in a common enterprise with profits to come solely from the efforts of others." Embodied in this definition are four criteria, each of which must be met for something to be considered an investment contract and, thus, a security.
- Investment of Money: There must be an investment of money or some other form of capital.
- Common Enterprise: The investment is in a common enterprise.
- Expectation of Profits: The investor has an expectation of profits from the investment. This means that the investor is expecting to gain a return on their investment.
- Efforts of a Promoter or Third Party: The expectation of profits is derived predominantly from the efforts of others, typically the efforts of the promoter or a third party.
The Howey test has, in recent years, become more prominent in the world of startups, largely because of the uncertain regulatory state for cryptocurrencies, tokens, and initial coin offerings.