U.S. v. Leonard: Will the Howey Test Prize Substance Over Form?
In U.S. v. Leonards, the Second Circuit Court of Appeals ruled that interests in various Limited Liability Companies constituted "securities" for purposes of the federal securities laws. By expanding the scope of the inquiry to include promoter expectations, Leonard arguably manifests the courts intent to turn the Howey Test back to its most justifiable interpretation.
Mr. Colesanti writes: The primary (and, at times, sole) obstacle to recovery under the securities laws is the finding of the presence of a security, a determination made accessible to jurists in widely varying locales by the 1946 Supreme Court ruling in S.E.C. v. W.J. Howey Co. The resulting and eponymous Howey Test details a four-part analysis weighing, in turn, the investing of money, the commonality of enterprise between investor and promoter, the investors expectation of profits, and the degree to which each supplies efforts.
At times coined the "economic realities test," the Howey Test has been formally cited over a thousand times and utilized in countless other pleadings and negotiations. It has grown from a tool for the inquiry into the presence of an "investment contract" to a weapon for discerning statutory stock, bonds and notes; its even been utilized to un-do arrangements that the parties concurred should be governed by the securities laws. At its core, the Test seeks to distinguish financial arrangements between equals from those deals that, in simple terms, provide hope of profits earned from the efforts of others (i.e., evidencing the presence of "passive investors"). And thus investment schemes as varied as contractual demand notes and animal breeding plans have been found to unlock the doors to investor rescission established by the Securities Act of 1933.
The Howey Test has been dignified by its longevity but is never above critique. For example, one of the drafters of the Securities Act, Section 2 of which includes a robust listing of potential "securities", at the outset cautioned that courts should "not [] bring every innocent transaction within the scope of the Act simply because a perversion of them is covered by the Act." [footnotes omitted]