Securities Law: What is the Howey Test?

Securities are governed by complex state and federal regulations—including the Securities Act of 1933 and the Securities Exchange Act of 1934. Of course, in some cases, the line between a commercial transaction and an investment contract can be blurry. To resolve this issue, the United States Supreme Court created the Howey Test, which can be applied to a commercial transaction to determine if it qualifies as an investment contract.

The Howey Test: Understanding the Basics

The Howey Test was created in the 1940s Supreme Court case of Securities and Exchange Commission (SEC) v. Howey. The commercial transaction being reviewed by the court in that case was a complex real estate leaseback agreement. Although the specific details of that transaction are no longer important, the test that came out of this case remains quite meaningful.

In the most simple terms, the nation’s highest court decided that a commercial transaction qualifies as an investment contract—and thus, is governed by securities law—if one party to the transaction puts forth material assets and then relies, primarily, on the work of the other party to gain value. Put another way, the Howey Test states a commercial transaction qualifies as an investment contract if:

  • One party puts money or other financial assets into a common enterprise; and
  • Their expected profits will be derived based on the work of another party.

One of the key things to understand about the Howey Test is it emphasizes substance over form. Whether a commercial transaction is labelled as a “stock” or a “bond” is largely irrelevant for the purposes of federal securities law. Instead, it is the substance of the transaction that matters. If a commercial opportunity is available to many people and those people will have little or no control over the success of the business enterprise, then the transaction likely involves a security.

Compliance with Securities Law is a Must

For companies both small and large, strict compliance with state and federal securities regulations is a must. If you sell securities without following applicable securities law, it could expose your company to substantial legal liability. The bottom line: Make sure you know whether your firm is offering securities. Companies that are offering securities must follow certain registration and disclosure requirements. If you have any specific questions or concerns about the Howey Test, contact an Illinois business law attorney who has experience advising companies on matters of securities law.

Get Help from Our Chicago, IL Securities Law Attorneys Right Away

At North Suburban Legal Services LLC, our Illinois business lawyers have the skills and experience to handle complex securities law issues. We will protect the rights and interests of your company. To set up a free, confidential initial consultation, please contact our law firm by calling (312) 909-6089 or reach out to us directly online. From our office in Chicago, we serve companies throughout Cook County, including in Des Plaines, Orland Park, Prospect Heights and Cicero.

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