Has the SEC Already Torpedoed the Howey Test?

The Trump administration has moved quickly in a major policy shift since January 2025 to implement a regulatory regime that appears far friendlier to cryptocurrencies, non-fungible tokens and other digital assets than under the Biden administration.

Nonetheless, the US SEC’s prior enforcement blitz from 2017 to 2024 against digital assets and related decisions from private litigation (collectively, the ‘Digital Cases’) in the Southern District of New York (the ‘Southern District’) appear to pose significant continuing legal risks to digital asset issuers, broker-dealers and markets. The Southern District’s decisions in the Digital Cases—which presumably remain good law—were typically based on a determination that digital assets constituted ‘investment contracts,’ and thus securities under US federal securities law, under the test set forth by the US Supreme Court in SEC v WJ Howey Co in 1946.

In my forthcoming essay in the Fordham Journal of Corporate & Financial Law (draft available on SSRN here), I examine the treatment of the Howey test by the SEC and the Southern District in the Digital Cases. I conclude that the SEC—by effectively eliminating Howey’s ‘common enterprise’ prong and redefining Howey into a weak expansive version expressly rejected by the Second Circuit and previously by the SEC itself—has already torpedoed the Howey test. Whatever the SEC’s current new crypto policies, the impact of this already weakened Howey test remains to be played out in federal and state courts by litigants other than the SEC, including, potentially, with respect to a range of commodities beyond digital assets. The Howey test as reformulated and expanded in the Digital Cases thus raises fundamental public policy questions about the proper scope of US federal securities laws.

Background

The US Supreme Court in Howey in 1946 famously defined the term ‘investment contract’—the catch-all term in the definition of ‘security’ in the Securities Act of 1933—to mean (i) an investment of money, (ii) in a common enterprise, (iii) with an expectation of profits solely from the efforts of others. While the Howey test has endured in federal courts as the standard definition of an investment contract, the Howey Court did not define the term ‘common enterprise,’ and perhaps as a consequence, for more than fifty years Howey’s ‘common enterprise’ prong has eroded. Since the early 1970s, it has split into at least three conflicting versions—‘horizontal’, ‘strict vertical,’ and ‘broad vertical’—that are variously accepted or rejected in different federal circuits. The US Supreme Court has declined to resolve this circuit split.

In 1994, the Second Circuit in the leading case of Revak v. SEC Realty Corp  held that Howey’s ‘common enterprise’ prong required horizontal commonality—generally considered the most rigorous version—which the court defined as the ‘pooling’ of investor funds ‘usually combined with the pro-rata distribution of profits.’ Revak declined to address the question of whether strict vertical commonality gave rise to a common enterprise but expressly rejected broad vertical commonality, on the grounds that broad vertical commonality—which required only a showing that the fortunes of the investors were tied to the efforts of the promoter—effectively merged Howey’s second and third prongs into a single inquiry.

The Howey Test in the Digital Cases

In the Digital Cases, the SEC has effectively ignored Howey’s ‘common enterprise’ prong. Discussion of ‘common enterprise’ was virtually absent from the SEC’s initial DAO Report (2017). In its first crypto enforcement action, In the Matter of Munchee, Inc (2017), the SEC—again without discussing common enterprise—appeared to conclude, regardless of Revak, that investor dependence on promoters’ efforts to develop a blockchain ‘ecosystem’ was sufficient to establish an investment contract under Howey. And in a footnote to its Framework for ‘Investment Contract’ Analysis of Digital Assets (2019), the SEC stated flatly that it ‘does not require vertical or horizontal commonality per se, nor does it view a ‘common enterprise’ as a distinct element of the term “investment contract.”’

In 2019, in Balestra v ATBCoin, LLC, the first Digital Case in the Southern District, the court found that Revak’s pooling requirement was satisfied where investor profits were reliant on the overall success of the promoters’ blockchain, and that Revak’s formalized profit-sharing among investors was simply not required. In direct reliance on the SEC’s position in Munchee, because the value of ATBCoins was dictated by the success of the ATB enterprise as a whole, the Southern District held that the plaintiffs had established horizontal commonality. Subsequent Digital Cases—including SEC v Telegram Group, Inc  (2020) and Friel v Dapper Labs, Inc (2023)—in turn relied upon ATBCoin to arrive at similar holdings with respect to horizontal commonality and digital assets constituting ‘investment contracts’ under Howey. In 2020, in Telegram, the Southern District—in another apparent departure from Revak—also accepted strict vertical commonality.

By 2024, the Revak horizontality standard articulated by the Second Circuit for ‘common enterprise’ was in shambles. In clear contrast to the stricter requirements of Revak, the Southern District appeared ready to find an ‘investment contract’ under Howey wherever there was (i) an investment of money and (ii) investor profits depended on the promoter’s efforts. Broad vertical commonality—which Revak explicitly rejected—had won the day, and Howey’s second and third prongs had indeed been merged into a single inquiry: only whether investors had ‘an expectation of profit from the efforts of others,’ ie, Howey’s third prong. Howey’s ‘common enterprise’ prong had been effectively eliminated.

Before advancing this understanding of Howey in the Digital Cases, it should be noted, the SEC had previously reversed its own historical position. In a brief from 2001, the SEC had stated point blank that the Commission had ‘long taken the position that broad vertical commonality is not an appropriate test because it collapses the second prong of the Howey test (common enterprise) into the third prong (profits to come from the efforts of others).’ In a subsequent brief from 2004, the SEC said simply that ‘the view expressed in those briefs no longer reflects the Commission’s interpretation of investment contract.’ The SEC’s disregard for Howey’s ‘common enterprise’ prong in the Digital Cases should therefore not surprise us.

In my essay I examine potential historical reasons for the instability of Howey’s ‘common enterprise’ prong in the Digital Cases.

Conclusions

Questions were raised prior to 2025, even from within the SEC, as to whether the Digital Cases had expanded Howey to apply not only to digital assets but to a range of commercial transactions—sales of watches, paintings, and collectibles—beyond the reasonable scope of the federal securities laws.

I conclude that there should be public policy limits on what constitutes an investment contract under any test. I also ask whether the SEC, the federal courts, or Congress should determine those limits.

David B. Guenther is a Clinical Professor of Law at the University of Michigan Law School.

A copy of the author’s complete paper can be found here .