According to the SEC, for an asset to qualify as a security, the sale of that asset must pass the Howey test.
The Howey test finds its origins in the 1946 Supreme Court case SEC v. W.J. Howey Co. Back in the ’40s, the Howey Company was selling tracts of citrus groves to Florida residents, getting access back via lease, and selling fruit grown on the property for profit — which it then shared with the landowners.
Clearly, this leaseback arrangement involved an investing contract. But Howey failed to register the transactions with the SEC. The SEC established the Howey test to help future businesses avoid this mistake.
According to the Howey test, a transaction qualifies as an “investment contract” (and thus the asset exchanged is qualified as a security) if it includes three factors:
- An investment of money
- A common enterprise (i.e. shared goals between investors and those selling the asset)
- Reasonable expectation of profits derived from the efforts of others
The SEC has used the Howey test to classify certain ICOs (initial coin offerings a.k.a. IPOs for cryptos) as investment contracts, thus qualifying the underlying crypto as regulatable security.