Definition of a Security & The Howey Test
Explains what constitutes a security under USA Section 401(l), the Supreme Court Howey four-pronged test, and products that are statutorily excluded.
- Howey Test: (1) Investment of money, (2) Common enterprise, (3) Profit expectation, (4) Derived primarily or solely from the efforts of others.
- Non-securities: Fixed annuities, whole life insurance, endowment policies, commodities, precious metals, collectibles, and currencies.
- Variable annuities and variable life insurance ARE securities because the policyholder assumes investment risk in underlying market subaccounts.
Section 401(l) of the Uniform Securities Act contains a comprehensive list of instruments deemed securities, including notes, stocks, treasury stocks, bonds, debentures, investment contracts, and voting trust certificates.
The defining legal standard for an investment contract was established in SEC v. W.J. Howey Co. (1946). Under the Howey test, an instrument is a security if there is: (1) an investment of money, (2) in a common enterprise, (3) with a reasonable expectation of profits, (4) to be derived primarily or solely from the managerial efforts of others.
The statute explicitly excludes certain products from the definition of a security: (1) fixed annuities, (2) whole life, term life, or universal life insurance contracts, (3) endowment policies, (4) commodities or futures contracts, (5) physical currencies and collectibles, and (6) retirement plan vehicles. In sharp contrast, variable annuities and variable life insurance ARE securities because returns fluctuate with market subaccounts.
- Do not classify fixed annuities as securities; fixed products carry insurance guarantees and are strictly excluded from state securities law.
- Retirement accounts (IRAs, 401ks) are tax structures, not securities themselves (though securities may be held within them).
Under Section 401(l) of the Uniform Securities Act and the Supreme Court landmark decision SEC v. W.J. Howey Co., which of the following describes the four essential criteria that establish the existence of an investment contract (and thus a security)?