Concept of the test
The Howey test is a legal tool used in the United States to determine whether a deal is an investment contract subject to federal securities legislation's jurisdiction.
The U.S. Supreme Court developed this test in 1946 in SEC v. W.J. Howey Co. It was accepted to evaluate various financial proposals.
Under the test, a transaction will be considered an investment contract if money is deposited in a group venture with the anticipation of returns from the management company or a third party.
In this case, the deal is subject to securities rules.
The Howey test plays a key role in identifying the legal status of financial tools and transactions in the USA.
It helps courts and regulators determine whether additional registration and regulation are required for these deals under the legislation.
Criteria for the test
The Howey test includes three main criteria necessary to evaluate whether a deal is a security:
Financial investment: the parties of the transaction must invest their money with the risk of losing it.
Joint venture: investors must pool their resources, and their success must be connected.
Anticipation of benefits from the efforts of others: investors must rely on the work of other people to get returns from their investments in a group or management organization.
Usage of the test for cryptocurrencies
The Howey test has been actively applied in digital assets because it provides a basis to understand if a particular crypto product or tool is a security under U.S. law.
If a digital asset meets the criteria of the test, it can be considered a security and becomes a subject of federal regulation.
It is important for crypto companies and investors, as violations of federal securities rules can lead to serious negative effects.
Crypto startups should scrutinize the Howey test to be sure that their proposals comply with securities legislation.
Consequences of the test
Utility tokens that do not pass the requirements of the Howey test are tokens that provide investors access to future products and services or can be redeemed for a reduced fee.
They are not considered securities, but the infrastructure for such tokens does not mean that the project will be exempt from classification as a security.
The use of the Howey test for digital assets will depend on how regulators apply the test in practice and how crypto startups present their products and tools to comply with securities requirements.
Digital asset businesses must be familiar with the federal securities laws in the United States to provide compliance.
Securities rules apply to cryptocurrencies: Some kind of digital assets may be recognized as securities by the Securities and Exchange Commission. Therefore, companies must follow its requirements, including registration and mandatory disclosure.
Securities laws apply to token offering: If a crypto startup sells tokens to the public in exchange for fiat or different assets, it could be considered an offering of securities. It means that businesses must follow securities regulations.
Disclosure of financial information: To comply with U.S. securities legislation, crypto startups must disclose their financial targets and inform investors about how funds raised are used.
Securities laws apply to trading platforms: If a cryptocurrency trading platform is a securities exchange, it must also register with the SEC and comply with securities rules.
High fines for non-compliance: Violations of the rules can lead to severe consequences for crypto corporations in the form of fines and lawsuits if they violate securities requirements.
Digital startups, offering tokens or other crypto assets, must be aware of and comply with securities regulations in the United States. Failure to follow these laws can lead to legal consequences, such as fines, restitution, and even criminal prosecution.
Companies must understand whether their tokens are verified as securities by the U.S. SEC.
If the tokens issued by a crypto startup are considered securities according to the SEC requirements, the company must register with the SEC and follow the disclosure requirements that apply to securities.