What’s at Stake: Will the Merge Turn Ether Into a Security?

William John Howey

Let’s review the history and mechanics of Howey to understand Levitin’s argument.

William John Howey was born in southern Illinois in 1876. He eventually moved to Lake County, Florida, where he became a successful real estate developer and politician. He specialized in growing and selling citrus fruits. Howey also sold land sales contracts for citrus groves. Half of his land was for commercial use while the other half was divided into tiny strips and sold to the public.

He founded the Florida town of Howey and became its mayor in 1925 (after which it was renamed Howey-in-the-Hills). He built a couple of hotels and an iconic mansion (now a popular wedding venue). Visitors to the little resort town would stay in Howey’s hotel right next to the citrus groves. Anyone who inquired about the groves became a potential town of Howey-in-the-Hills investor. These prospects were pitched on buying the land from Howey’s companies.

Part of the purchase agreement was to have Howey’s companies develop and service the acquired plot in order to grow and sell citrus fruits for profit. Profits would then be split between Howey’s companies and its investors. Howey died in 1938, but his companies carried on.

A few years later, the SEC accused the companies of selling unregistered securities. The case was eventually brought before the U.S. Supreme Court in May 1946. Writing for the majority, Justice Frank Murphy determined that Howey’s land sales contracts qualified as securities in the form of investment contracts as per the Securities Act of 1933.

The Howey Test

In his opinion, Justice Murphy took it upon himself to craft a definition of the term “investment contract” (the term is used but not defined in the law). An investment contract means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.

The definition has four distinct components, or “prongs”:

1. An investment of money

2. In a common enterprise

3. With an expectation of profits

4. Solely from the efforts of the promoter or a third party

If an asset meets these four criteria it’s deemed an investment contract and thus a security. Even if an asset doesn’t quite meet the criteria, it may still be deemed a security based on economic realities – the totality of circumstances under which a business transaction occurs.

Read more: A ‘Howey Test’ for Blockchain? Why the SEC’s ICO Guidance Isn’t Enough