Howey test
Definition.
Evaluation test used by the Security and Exchange Commission (SEC) in order to establish whether or not a certain activity is referable to the offering of financial products (i.e. investment contracts) and is therefore subject to US Securities Law.
On the basis of these principles, a concrete case falls within the definition of an 'investment contract' in consideration of a criterion of prevalence of the substantial aspect over the formal one, i.e. when, regardless of the type of contract agreed upon between the parties through the agreement, there is an 'investment of money in an enterprise with the reasonable expectation of profits from the managerial or entrepreneurial efforts of others'. The three elements of the test are therefore:
1) the investment of money;
2) the expectation of profit;
3) the fact that such profit is derived from the labour of others.
The origin: SEC v. W.J. Howey Co.
The case concerned two corporations, the W. J. Howey Company and Howey-in-the-Hills Service Inc., which were Florida corporations under direct common control and management. The Howey Company, which owned large tracts of citrus acreage in Lake County, Florida, used to plant about 500 acres annually, while the Howey-in-the-Hills Service Inc., was a service company engaged in cultivating and developing many of these groves. The case arose because the company owning the land had offered contracts on the basis of which it undertook to cultivate the land with citrus fruits and the investors would be paid a portion of the harvest resulting from the cultivation as remuneration for the capital invested. Upon the facts of that case, the US Supreme Court ruled that an offering of units of a citrus grove development, coupled with a contract for cultivating, marketing, and remitting the net proceeds to the investor, was an offering of an "investment contract" within the meaning of that term as used in the provision of § 2(1) of the Securities Act of 1933 defining "security" as including any "investment contract," and was therefore subject to the registration requirements of the Act. The test of whether there is an "investment contract" under the Securities Act is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or non speculative, or whether there is a sale of property with or without intrinsic value.
TheDAO case.
A popular example of the application of the Howey test to a DAO concerned the TheDAO case, in which the SEC qualified the initial offering of TheDAO tokens as investment contracts on the basis of the following considerations:
- the investment does not have to be 'monetary' in nature, but can be made by other means of contribution of value. In the present case, the value was Ether (with which a monetary value was associated) contributed to the project in exchange for DAO Tokens;
- the investors' participation was motivated by an expectation of profit. TheDAO's promotional materials, in fact, clearly emphasized the goal of creating an entity that would finance projects and provide investors with a return on their investment;
- profit for investors depended on the management efforts of others. In fact, decisions within TheDao on which projects to submit for funding evaluation were made by a small group of individuals. Founders and curators monitored the activities, safeguarded the interests of investors, and selected projects to be nominated for potential investment.
As a result, TheDAO was held to be subject to the Securities Law with the consequent obligations for the issuing entity to register the offers and sales of the securities (an obligation not complied with by the organizers of TheDAO in violation of Section 5 of the aforementioned law); to inform potential investors; and with related obligations to register as a "national securities exchange" for the entities that allowed through their exchange platforms the trading of the aforementioned tokens.
References and Websites.
A. Dhanani e B. J. Hausman, Decentralized Autonomous Organizations, in Intellectual Property and Technology Law Journal, 2022, vol. 34, n. 5, p. 1 ss.;
M. Nicotra, Il regime giuridico delle ICOs. Analisi comparata e prospettive regolatorie italiane, in dirittobancario.it, 18 aprile 2019.
US Supreme Court, SEC v. W.J. Howey Co., 328 U.S. 293, May 27, 1946, is available here.
