Howey Test Doesn’t Fit Crypto, SEC's Hester Peirce Says

US Securities and Exchange Commission member Hester Peirce said on the latest episode of Decrypt’s gm! podcast the so-called Howey test, used by the Securities and Exchange Commission to determine whether a digital asset should be classified as a security, has some limitations.

The Howey test stems from the 1946 Supreme Court case that established the criteria under which a financial agreement is an “investment contract” and therefore subject to federal securities law.

“There's been a lot of emphasis on the Howey test in the crypto world because [...] a lot of these things were sold as tokens plus a promise that we're going to build a network,” she said.

The court case that led to the creation of the Howey test centered on the sale of units in a Florida-based citrus grove development, where investors could share in the profits of efforts to cultivate produce. 

It determined an “investment contract” is "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."

In August, SEC chairman Gary Gensler said “many tokens may be unregistered securities” because “folks buying these tokens are anticipating profits, and there’s a small group of entrepreneurs and technologists standing up and nurturing the projects.” 

Peirce argued that the existence of an investment contract doesn’t just center on the asset but also the promises that are attached to it. She put forth the opinion that the two components are separate from each other.

“Just because I sold you the orange grove as part of an investment contract doesn't turn the orange grove into a security,” she said. “The orange grove, plus the promises I made to you about how I was going to tend the orange grove and generate profits for you—that was the securities offering.”

Whether or not a crypto asset itself is a security is something that isn’t addressed by the Howey test, said Peirce.

“You can say, ‘Well, look, a lot of these initial sales sure look like securities offerings,’ but then the question is, is that token, is the crypto asset itself, a security?” she asked.  “That's a much harder question to answer, and I think it's one that people answer differently.”

The agency’s reliance on the Howey test is also somewhat flawed, said Peirce, because of the interpretation's apparent permanence.