Beyond Howey - Other Tests and Frameworks

"Note" appears in Section 2(a)(1)'s definition of security. But not every note is a security—a personal loan between friends, a consumer credit agreement, a short-term business loan. If every note were a security, ordinary commercial transactions would require SEC registration.

The Supreme Court addressed this in Reves v. Ernst & Young (1990).

The Farmer's Cooperative of Arkansas and Oklahoma sold demand notes to raise money. The notes paid variable interest and could be cashed on demand. When the cooperative collapsed, note holders lost money. They sued, arguing the notes were unregistered securities.

The question: Were these notes "securities" under the '33 and '34 Acts?

The Supreme Court rejected both extremes—that all notes are securities, or that notes are never securities. Instead, it adopted a "family resemblance" test:

Starting Point: Notes are presumed to be securities.

Rebuttal: The presumption is rebutted if the note bears a "family resemblance" to categories of notes previously held not to be securities.

Four-Factor Analysis:

If the note doesn't resemble these categories, courts apply four factors:

1. Motivations of the parties: Is the seller raising capital for general business use, or for consumer/commercial purposes? Is the buyer interested in profit, or in facilitating a commercial transaction?

2. Plan of distribution: Is the note offered to a broad segment of the public? Securities regulation addresses broad distribution.

3. Reasonable expectations of the investing public: Would reasonable investors consider the note an investment?

4. Risk-reducing factors: Are there other regulatory schemes that reduce risk, making securities regulation unnecessary?

The Court found the cooperative's notes were securities:

• Motivation: The cooperative sought capital; note holders sought profit (interest)
• Distribution: Sold to over 23,000 people—broad public distribution
• Expectations: Advertised as investments; public reasonably expected investment
• Risk reduction: No other regulation protected note holders

Does Reves apply to crypto? It could, in specific contexts:

DeFi Lending Protocols:

When users deposit assets into lending protocols and receive interest, are the deposits "notes"?

• Motivation: Protocol seeks capital to lend; depositors seek yield
• Distribution: Potentially broad (open to anyone)
• Expectations: Users expect investment returns (interest)
• Risk reduction: Generally no other regulation

This analysis suggests DeFi lending products might be securities under Reves, independent of Howey.

ICO "Loans":

Some ICOs structured as "loans" to avoid Howey. But Reves might capture them:

• If funds are raised for general business purposes
• If broadly distributed
• If investors expect repayment with profit

The BlockFi/Celsius Issue:

SEC enforcement against yield products like BlockFi and Celsius didn't rest solely on Howey—the products also resembled notes offered to the public for profit.

Key differences:

Why It Matters:

A crypto product might survive Howey but fail Reves, or vice versa. Comprehensive analysis requires considering both.

United Housing Foundation v. Forman (1975) predates crypto but provides essential framework for "utility token" arguments.

The Forman case involved shares in a housing cooperative called Co-Op City. To obtain an apartment, residents had to purchase "stock" in the cooperative. The "stock" was required to get housing—it couldn't be sold on the open market and had restrictions on transfer.

When housing costs increased, residents sued, claiming the "stock" was an unregistered security.

The Court held the cooperative shares were NOT securities, despite being labeled "stock."

The Form vs. Substance Principle:

"In searching for the meaning and scope of the word 'security'... form should be disregarded for substance and the emphasis should be on economic reality."

Just because something is called "stock" doesn't make it a security under the Acts.

The Consumption vs. Investment Distinction:

The critical finding: Purchasers bought shares to acquire housing, not to invest:

"The inducement to purchase was solely to acquire subsidized low-cost living space; it was not to invest for profit... [T]here can be no expectation of profits."

The shares provided utility (access to housing), not investment returns.

Profit Expectation Analysis:

The Court identified what counts as "profits" under Howey:

• Capital appreciation (increase in investment value)
• Participation in earnings (dividends, distributions)

What doesn't count:

• Tax benefits
• Cost savings
• Access to services or goods

Forman provides the theoretical basis for "utility token" arguments:

The Argument:

If a token is purchased for consumptive use—to access a service, use a network, pay for transactions—rather than profit expectation, it might not be a security under Forman reasoning.

When It Might Work:

• Token provides genuine, functioning utility
• Token is actually used for that utility (not just held)
• Marketing emphasizes utility, not investment
• Price reflects utility value, not speculation
• Network is operational (not dependent on development)

When It Has Failed:

The utility defense has failed repeatedly in SEC enforcement because:

1. Marketing contradicts utility framing: Projects emphasize appreciation potential
2. No functional network: Token bought for future utility that doesn't exist yet
3. Speculative holding: Users hold rather than use tokens
4. Price disconnected from utility: Market price far exceeds utility value

SEC v. Munchee (2017):

Munchee planned a token for restaurant reviews. Despite claiming utility, the SEC found:

• Company emphasized profit potential
• Token had no current utility (app wasn't functional)
• Marketing materials discussed appreciation
• Plan to create secondary market trading

Result: Investment contract, not utility token.

The utility defense is much harder to win than many projects assumed:

The Timing Problem:

A token might eventually have utility, but at the time of sale, buyers are investing in a promise. They're relying on the team's efforts to build the network. That's Howey, regardless of future utility potential.

The Mixed Motive Problem:

Many buyers have both motivations—they want utility AND appreciation. Forman distinguished pure consumption from pure investment. Mixed motives complicate the analysis.

The Marketing Problem:

Token projects want high prices (for fundraising and team holdings). High prices require buyer interest. Buyer interest comes from appreciation potential. This creates incentive to emphasize investment, undermining utility claims.

Based on enforcement patterns and case law, utility arguments are strongest when:

These conditions rarely exist at token launch, which is why most ICO projects failed the utility test.

While federal securities law uses Howey, some states apply a different test: the "risk capital" test.

California, Idaho, Hawaii, Oregon, and a few other states use variations of this approach.

The risk capital test, originating in California's Silver Hills Country Club v. Sobieski (1961), asks whether:

Key Differences from Howey:

• No requirement that profits come from "efforts of others"
• Focus on whether capital is "at risk"
• Less focus on profit expectation, more on risk exposure
• Generally broader than Howey

The risk capital test could capture tokens that escape Howey:

Decentralized Networks:

Even if no identifiable promoter's efforts drive value (Howey Element 4), investors' capital is still at risk in an enterprise they don't control. Risk capital test potentially satisfied.

Utility Tokens:

Even if primary motivation is utility, purchasers put capital at risk. Risk capital test doesn't require pure profit motive.

Why This Matters:

Token projects might structure to avoid federal Howey analysis but remain exposed to state risk capital claims in California, Oregon, etc.

The risk capital test has limited application:

• Only in states that have adopted it
• State enforcement is less resourced than SEC
• Federal preemption questions for offerings using federal exemptions
• Less developed case law than Howey

Still, sophisticated analysis should consider state law exposure, especially for projects with California connections.

Existing tests have problems when applied to crypto:

• Howey assumes identifiable promoters and centralized enterprises
• Reves designed for debt instruments, not tokens
• Forman's utility doctrine doesn't fit tokens with mixed characteristics
• Risk capital test is state-specific and limited

Many argue that crypto needs purpose-built frameworks.

SEC Commissioner Hester Peirce proposed a Token Safe Harbor in February 2020 (updated in April 2021).

Key Provisions:

• Initial Development Team can sell tokens without securities registration

• Three-year window to develop network toward "Network Maturity"

• Decentralized (no person or group controls more than 20% of tokens or network functions), OR

• Functional (token holders can use tokens for transmission, storage, or exchange of value)

• Source code (or access pathway)

• Transaction history

• Token economics (supply, distribution, holdings)

• Development roadmap

• Material team members' token holdings

• Sales details and use of proceeds

• Achieve Network Maturity (no longer securities)

• Comply with securities registration

• Cease operations

Enforcement Protection:
During safe harbor period, SEC wouldn't bring registration enforcement actions (fraud actions still permitted).

Status:
Proposal only. Never adopted by SEC (Chair Gensler opposed). Would require SEC vote or congressional action.

The Simple Agreement for Future Tokens (SAFT) was a pre-2018 attempt to structure compliant token sales.

The Structure:

1. Phase 1: Sell SAFTs to accredited investors under Regulation D

2. Phase 2: Develop functional network

3. Phase 3: Distribute tokens when network is functional

The Problem:

The SEC rejected this structure in multiple enforcement actions:

• The SAFT being a security doesn't cleanse the token
• Token distribution is itself an offer/sale
• If token is still an investment contract when distributed, structure fails
• Functionally, delayed the securities question rather than solving it

Current Status:

SAFT framework is largely discredited. Projects that used it still faced enforcement.

Several congressional proposals would create crypto-specific frameworks:

FIT21 (Financial Innovation and Technology for the 21st Century Act):

Passed House in May 2024. Key provisions:

• CFTC Primary Jurisdiction: Most digital commodities under CFTC, not SEC
• Decentralization Test: Clear criteria for when tokens become commodities
• SEC Jurisdiction: Retains SEC authority over true securities and fraud
• Disclosure Framework: Specific disclosure requirements for digital assets

Lummis-Gillibrand Proposals:

• Clear jurisdictional divide between SEC and CFTC
• Registration pathways for crypto exchanges
• Consumer protection standards
• Stablecoin framework

State Legislation:

• Digital asset definitions
• Custody frameworks
• DAO recognition
• Bank charter availability

Current Status:

No comprehensive federal legislation has passed. The landscape remains enforcement-driven rather than legislatively clarified.

Other jurisdictions offer alternative frameworks:

• Three explicit token categories (E-Money Tokens, Asset-Referenced Tokens, Other)

• XRP classified as "other crypto-asset"—not a security

• Clear licensing regime for service providers

• Ex-ante clarity rather than case-by-case determination

• Payment tokens, utility tokens, asset tokens

• Clear guidance on which category applies

• Functional classification based on token characteristics

• Influenced multiple other jurisdictions

• Crypto-assets under Payment Services Act

• Separate from securities under FIEA

• XRP treated as payment token since 2017

• Evolving framework for security tokens specifically

• Digital payment tokens vs. capital markets products

• Clear guidance documents

• Regulatory sandbox for innovation

• Payment Services Act framework

What International Models Demonstrate:

It's possible to create clear, ex-ante frameworks for digital assets. The US has simply chosen not to—relying instead on enforcement applying old tests to new technology.

LEGAL TEST APPLICATION MATRIX

Scenario │ Applicable Tests
──────────────────────────────────┼────────────────────────────────────
Token sold to fund development │ Howey (investment contract)
│ Risk capital (in certain states)
──────────────────────────────────┼────────────────────────────────────
Yield-bearing deposit product │ Howey (investment contract)
│ Reves (note analysis)
──────────────────────────────────┼────────────────────────────────────
Token with genuine utility │ Howey (with Forman defense)
(functional network) │ Risk capital (utility may not defeat)
──────────────────────────────────┼────────────────────────────────────
Token explicitly labeled "stock" │ Landreth Timber (stock is stock)
with equity rights │ Traditional securities analysis
──────────────────────────────────┼────────────────────────────────────
Debt instrument/loan structure │ Reves (note analysis)
│ Howey (if investment contract theory)
──────────────────────────────────┼────────────────────────────────────
Decentralized network token │ Howey (potentially Element 4 fails)
(no identifiable promoter) │ Risk capital (may still apply)
```

For Projects:

• Howey avoidance isn't enough—consider Reves, risk capital
• Utility framing requires genuine, current functionality
• Safe harbors don't exist yet—compliance is case-by-case
• International structuring has limits (US reach is broad)

For Investors:

• A token surviving Howey analysis might fail Reves
• State law exposure exists beyond federal
• Legislative clarity could change classification
• International classification doesn't determine US treatment

No perfect framework exists for crypto. The US relies on:

• Howey (primary test, 1946)
• Reves (for note-like instruments, 1990)
• Forman (for utility arguments, 1975)
• Enforcement (case-by-case application)

Until legislation passes or the Supreme Court provides new guidance, uncertainty continues.

✅ Multiple legal tests exist beyond Howey. Reves for notes, Forman for utility, risk capital in some states. Comprehensive analysis requires considering all potentially applicable tests.

✅ The utility defense has largely failed. Projects claiming tokens are utility instruments have repeatedly lost when actual use cases weren't developed or marketing emphasized appreciation.

✅ Proposed frameworks haven't been adopted. The Peirce Safe Harbor remains a proposal. SAFT was rejected. Legislative proposals haven't passed.

✅ International jurisdictions offer clearer frameworks. MiCA, Swiss FINMA guidance, Japan's FSA classification demonstrate that ex-ante clarity is achievable—the US has simply not chosen that path.

⚠️ How courts will apply Reves to DeFi lending. Yield products resemble notes, but comprehensive case law hasn't developed.

⚠️ Whether utility tokens can ever succeed under current enforcement approach. The SEC's position has been that most tokens are securities regardless of utility claims.

⚠️ Whether legislation will pass and what form it will take. FIT21 passed the House but Senate prospects are unclear. Administration changes affect likelihood.

⚠️ How state risk capital tests interact with federal law. Preemption questions remain for offerings using federal exemptions.

Howey dominates current crypto securities analysis, but it's not the complete picture. Sophisticated analysis considers Reves (for debt-like instruments), Forman (for utility arguments), and state risk capital tests. Meanwhile, proposed crypto-specific frameworks—while intellectually interesting—haven't been adopted. Until legislation clarifies or enforcement patterns stabilize, the legal landscape remains multi-dimensional and uncertain.

Assignment: Analyze a DeFi lending protocol using both the Howey test and the Reves test. Determine whether the analysis produces the same or different conclusions.

Requirements:

• Select a DeFi lending protocol (Aave, Compound, MakerDAO, etc.)

• Briefly describe how the protocol works

• Identify the specific product to analyze (e.g., depositing ETH to earn yield)

• Investment of money: What do users contribute?

• Common enterprise: How are user interests connected?

• Expectation of profits: What return do users expect?

• Efforts of others: Whose efforts generate returns?

Conclude: Is this an investment contract under Howey?

• Does the product resemble a "note"?
• Does it bear family resemblance to non-security notes?
• Apply the four Reves factors:

Conclude: Is this a security under Reves?

• Do Howey and Reves produce the same conclusion?

• If different, why? What accounts for the divergence?

• Which test better fits this product?

• What does this tell you about the limits of each framework?

• 1,500-1,800 words total

• Clear section headers

• Specific facts about the protocol (not generic DeFi description)

• Acknowledge uncertainties

• Accurate application of Howey (25%)

• Accurate application of Reves (25%)

• Quality of comparison analysis (30%)

• Specific protocol facts (20%)

Time Investment: 2-3 hours
Value: This exercise demonstrates that securities analysis is multi-dimensional. Products that might survive one test could fail another. Real legal risk assessment requires comprehensive framework application.

1. The Reves Presumption:

Under the Reves test, what is the starting presumption for notes?

A) Notes are presumed NOT to be securities, and the SEC must prove otherwise
B) Notes are presumed to BE securities, and the defendant must show "family resemblance" to non-security notes to rebut
C) Notes are analyzed identically to investment contracts under the Howey test
D) Notes are categorically excluded from securities regulation by statute

Correct Answer: B
Explanation: Reves creates a presumption that notes are securities. The defendant can rebut this presumption by showing the note bears a "family resemblance" to categories historically held not to be securities (consumer financing, home mortgages, character loans, etc.). If no family resemblance exists, the four-factor analysis applies. Option A reverses the presumption. Option C is wrong—Reves and Howey are different tests. Option D is wrong—notes are explicitly listed in the securities definition.

2. The Forman Utility Doctrine:

In United Housing Foundation v. Forman, why did the Supreme Court hold that cooperative housing "stock" was not a security?

A) The stock was labeled as "membership shares" rather than securities
B) Purchasers bought shares to acquire housing (consumption), not to earn profits (investment), so the "expectation of profits" element was not satisfied
C) Housing cooperatives are exempt from securities laws by congressional statute
D) The cooperative was nonprofit, and nonprofit entities cannot issue securities

Correct Answer: B
Explanation: Forman distinguished consumption motivation from investment motivation. The cooperative shares were purchased to obtain apartments—a consumptive purpose—not to earn investment returns. Because the "expectation of profits" element wasn't satisfied, the shares weren't securities regardless of being labeled "stock." Option A is wrong—labels don't determine classification (substance over form). Option C is incorrect—no such statutory exemption exists. Option D is wrong—nonprofit status doesn't categorically exempt from securities laws.

3. Risk Capital Test:

How does the risk capital test (used in California and some other states) differ from the federal Howey test?

A) The risk capital test is identical to Howey but uses different terminology
B) The risk capital test focuses on whether capital is at risk in an enterprise the investor doesn't control, without requiring that profits derive from "efforts of others"
C) The risk capital test only applies to debt instruments, while Howey applies to equity
D) The risk capital test requires that investments exceed $10,000 to qualify as securities

Correct Answer: B
Explanation: The risk capital test asks whether an offeror solicits risk capital from the investing public for an enterprise over which the investor has no managerial control. Unlike Howey, it doesn't require proving that profits come from "efforts of others"—capital at risk in an uncontrolled enterprise may be sufficient. This makes it potentially broader than Howey. Option A is wrong—the tests differ. Option C is wrong—both tests apply broadly. Option D is fabricated.

4. The Peirce Safe Harbor:

What is the key feature of Commissioner Peirce's proposed Token Safe Harbor?

A) It would permanently exempt all cryptocurrencies from securities regulation
B) It provides a three-year development period during which projects can sell tokens without registration, if they meet disclosure requirements and work toward network maturity
C) It requires all token projects to register as securities but reduces compliance costs
D) It transfers jurisdiction over all digital assets from the SEC to the CFTC

Correct Answer: B
Explanation: The Peirce Safe Harbor proposes a three-year grace period for Initial Development Teams to develop their networks toward "Network Maturity" (decentralization or functionality). During this period, token sales wouldn't require registration, but projects must meet disclosure requirements. At three years, projects must achieve maturity, register under securities law, or cease operations. Option A is wrong—it's a development pathway, not permanent exemption. Option C is wrong—it delays registration, not reduces costs. Option D is wrong—it's an SEC safe harbor, not jurisdictional transfer.

5. SAFT Framework:

Why has the Simple Agreement for Future Tokens (SAFT) framework largely failed as a compliance strategy?

A) Courts held that SAFTs are not enforceable contracts under state law
B) The SEC rejected the argument that Regulation D compliance for the SAFT cleanses the subsequent token distribution, finding that token delivery itself can be a securities offering if the token is an investment contract
C) SAFT transactions were found to violate anti-money laundering regulations
D) SAFT agreements were prohibited by the CFTC as derivatives violations

Correct Answer: B
Explanation: The SAFT framework assumed that: (1) the SAFT itself was a security (sold under Reg D), and (2) the future token, once delivered to a functional network, would be utility, not security. The SEC rejected this, finding that the token distribution is itself an offer/sale, and if the token is still an investment contract at distribution, the structure fails. The framework delayed the securities question rather than solving it. Multiple enforcement actions targeted SAFT-structured projects. Options A, C, and D are fabricated.

For Next Lesson:
Lesson 5 examines global securities law frameworks—how other major jurisdictions (EU, UK, Japan, Singapore, Switzerland) approach securities classification, and what these alternatives reveal about possible US evolution.

End of Lesson 4

Total words: ~5,500
Estimated completion time: 55 minutes reading + 2-3 hours for deliverable