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What Is Howey Test? What Is The Purpose Of Howey Test?

With the increasing use of cryptocurrencies, the number of regulations has also increased.

Table of Content

Relevant regulations are used by authorities that seek to control the use and trading of cryptocurrencies under a certain amount of law. These authorities can be regulatory bodies such as governments.

The SEC (U.S. Securities and Exchange Commission) has recognized the growing interest in cryptocurrencies and has taken several regulatory initiatives itself. Recently, the SEC has explicitly declared that ICOs (Initial Coin Offering) are a form of securities and in fact fall under its regulatory purview.

The SEC uses the Howey test to determine whether an asset is a security. As a result of this Howey test, the SEC decides whether the asset is a security or not. After the decision stage, if the asset is deemed to be a security, necessary regulations are made accordingly. If the asset is not considered a security, no regulation is applied.

Although the SEC has been subjected to objections and opposing views on cryptocurrencies, it has not changed its stance on this issue and continues to evaluate cryptocurrencies according to the Howey test.

William John Howey, the inventor of the Howey test, was a man who owned extensive orange groves in Florida. Howey set aside half of these orange groves for his own use. He used the other half of the orange groves to finance his future investments. He parceled out these remaining orange groves in square meters. He then put each parcel up for sale through real estate contracts. People bought these parcels from Howey for a certain price.

Buyers would receive a share of the profits from the harvested oranges when harvest time came.

Howey marketed this land full of orange groves. He also used a hotel he owned in the area for this marketing. Howey promised anyone interested in the orange groves that they could make a substantial profit.

The buyers of these orange groves that Howey put up for sale were not Florida residents or farmers. Rather, most of the investors were professional investors and businessmen with no experience in agriculture and no skills or equipment to take care of the orange groves on their own.

Howey's company was sued by the SEC for failing to report any of these transactions to the SEC. The SEC then took this lawsuit against Howey all the way to the United States Supreme Court. In 1946, the Supreme Court of the United States announced its final decision on this case between Howey and the SEC. The Supreme Court found that Howey's agreement for the orange groves was "an investment contract". This decision in the case between Howey and the SEC later became a precedent. The Howey test was created to determine whether an asset is a security. The 4 main criteria of the Howey test were determined after this case.

What Are the Criteria of the Howey Test?

The Howey test has 4 main criteria. These criteria are as follows:

  • Was the asset acquired for money?
  • Is it planned to make a profit from the investment in the asset?
  • Has the investment in the asset been made in a company or venture?
  • Is the profit from the asset the result of the efforts of any third party or entrepreneurs?

The Howey test evaluates all of the above criteria. The result of the evaluation determines whether the asset in question is a security or not.

The SEC has applied this Howey test for years. In line with the results of this test, the SEC filed various lawsuits against many different companies, just like Howey. In the cryptocurrency world, in September 2019, the SEC accused Block.One, the founder of EOS, of selling securities without legal registration due to an ICO in 2017. Block.One founders paid a fine of 24 million dollars, an amount that was not even 1% of the funds they raised with great cunning in the face of this incident, and the case was closed. In the same year, the KIK crypto platform was sued by the SEC for similar reasons. When the KIK Platform paid a fine of 5 million dollars, the case was closed. Later, a lawsuit was also filed by the SEC against John McAfee regarding fake ICOs. In December 2020, the SEC sued Ripple, which is very popular in the crypto world. In this case, the SEC accused Ripple of selling $1.3 billion worth of unregistered securities in the form of XRP over the last 8 years.

The SEC also took action against BitConnect fraudsters and initiated legal proceedings.
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