The Howey test is an artifact of U.S. securities law that dates from 1946. It is used to test whether a financial instrument or investment scheme constitutes a security. It is also used to analyze whether cryptocurrencies, initial coin offerings, digital assets, etc. constitute a security - and is hence a "security token" - for legal and regulatory purposes under U.S law.
The Howey test derives from the application of several findings by the U.S. Supreme Court regarding a case involving a land investment scheme (an orange orchard) in Florida in 1946. In U.S. Securities and Exchange Commission ("SEC") versus W.J. Howey Co. the court found that the Howey Company had violated the U.S. Securities Act of 1933 by not registering as securities the investment contracts that it was offering to members of the public. In his opinion for the majority Judge Frank Murphy, among other things, formulated the test, writing, "The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others."
The SEC and the DAO
The DAO was a venture capital fund established in 2016 in Germany to make investments in entities designing technologies that exploit smart contract technologies on the Ethereum platform. About $50 million in Ether tokens were stolen from the fund shortly after it was established. A year later, on July 17, 2017, the U.S. Securities and Exchange Commission published an investigative report because participation in the DAO's schemes had been offered and sold to U.S. residents. The report provides a comprehensive description of the establishment and organization of the DAO and notes that by doing business with U.S. residents the DAO likely violated the federal securities laws in a number of ways. According to the agency, DAO tokens would have been securities under the Howey test and they should have been registered and offered pursuant to the Commission's regulations. In addition, the Commission indicated that platforms where the DAO tokens were traded probably should have been registered as securities exchanges or other regulated facilities unless there were relevant exemptions available.
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