Investment Contract

The Howey test is applied in order to decide whether:

1. A.A security that has already been identified must be registered or is exempt.Wrong. Registration and exemption are separate questions that arise only once something is known to be a security.
2. B.A registered representative made a suitable recommendation to a particular customer.Wrong. Suitability governs how a recommendation is made and presupposes that a security is already involved.
3. C.An arrangement the statute does not name by instrument is nevertheless a security.Correct. The test is the catch-all for novel arrangements, applied when no named instrument fits the facts.
4. D.An issuer has disclosed everything a reasonable investor would want to know.Wrong. The adequacy of disclosure is judged under the registration and antifraud rules, not by this test.

Why: The statutory definition lists instruments such as stock, notes, bonds and warrants, and anything on that list is a security by name. Because promoters invent structures faster than legislatures rename them, the definition also includes investment contract, and the Howey test tells a court whether a given arrangement fits that category. It asks about an investment of money in a common enterprise with an expectation of profits derived from the efforts of others. Once an arrangement is a security, entirely separate rules decide whether it must be registered and how it may be sold.

A venture organizer accepts contributions of equipment and volunteer labor, rather than cash, in exchange for a share of future profits. Does that satisfy the investment of money element of the Howey test?

1. A.Yes; the element is met by any contribution of value the participant surrenders for the interest.Correct. Investment of money is read as any consideration of value placed at risk, including property and services.
2. B.No; the element requires a payment of cash or a cash equivalent to the promoter.Wrong. Nothing in the test turns on the form of payment, and a cash-only reading would let a promoter escape by simply invoicing in goods.
3. C.No; contributions of labor are compensation arrangements and can never create a security.Wrong. Labor can be the very consideration a participant surrenders, and an automatic exclusion would gut the element.
4. D.Yes, but only once the organizer converts the contributed property into cash.Wrong. Conversion to cash is a later act of the venture and has no bearing on whether the participant placed value at risk.

Why: The first Howey element asks whether the participant committed something of value in exchange for the interest, not whether that value arrived as currency. Contributions of property, services or other securities all count, because each represents something the contributor surrendered and now has at risk. Here the contributors handed over equipment and labor for a profit share, so the element is met and the analysis proceeds to common enterprise and reliance on the efforts of others. Only if a participant gave up nothing at all, receiving the interest as an outright gift, would this element fail.

Ravenscourt Links sells 400 memberships at $35,000 each. A membership entitles the holder to play the golf course, use the clubhouse and dining room, and vote for the board. It pays no dividend, carries no claim on the club's earnings or assets, and cannot be resold at a profit because the club buys any surrendered membership back at the original $35,000 with no adjustment. The club's marketing stresses the quality of the greens and the waiting list. Under the Uniform Securities Act, is a Ravenscourt membership a security?

1. A.Yes, because members vote for the board, which gives them an equity interest in the club.Governance rights are not profit rights. Voting alone does not create the expectation of profit an investment contract requires.
2. B.Yes, because $35,000 is an investment of money in a common enterprise operated by the club's management.Investment of money and common enterprise are only two elements. The expectation of profits from the efforts of others is absent.
3. C.No, because the Act excludes any interest sold by a not-for-profit recreational organisation.There is no such exclusion, and the stem never says the club is not-for-profit. The membership fails on the profit element, not on the seller's status.
4. D.No, because the buyer purchases the use of a facility and has no expectation of profit from the efforts of others.Correct. No dividend, no claim on earnings and a fixed-price buyback together eliminate the profit expectation, so the membership is a consumption interest.

Why: An investment contract requires an investment of money in a common enterprise with an EXPECTATION OF PROFITS derived from the efforts of others. The profit element is missing here and missing by design. A member pays $35,000 to consume something: golf, meals and a vote on club governance. There is no dividend, no share of earnings, no claim on assets, and the fixed-price buyback removes any prospect of capital appreciation. What the buyer is purchasing is the use of a facility, not a return on capital, so the membership is not a security. Had the club instead promised members a share of its operating profits or a resale price tied to the club's value, the analysis would change.

Delia Marsh brings four items to her agent at Northgate Securities and asks which are securities: a whole life insurance policy with a fixed death benefit and guaranteed cash value, a variable annuity contract, a certificate of interest in a mineral royalty, and a limited partnership interest in a venture formed to build and operate a marina. Under the Uniform Securities Act, which is NOT a security?

1. A.The whole life insurance policy with a fixed death benefit and guaranteed cash valueCorrect. Fixed insurance contracts are expressly excluded because the insurer, not the buyer, bears the investment risk.
2. B.The variable annuity contractA variable annuity is a security, because its value depends on the performance of a separate account the holder is exposed to.
3. C.The certificate of interest in a mineral royaltyCertificates of interest in oil, gas, and mineral rights or royalties are named in the definition of security.
4. D.The limited partnership interest in the marina ventureAn investment of money in a common venture run by others, with profits expected from their efforts, is an investment contract.

Why: A whole life policy with a fixed death benefit and guaranteed cash value places the investment risk on the insurer, not the policyholder, and fixed insurance and fixed annuity contracts are expressly excluded from the definition of security. The other three are included: variable annuities pass investment risk to the contract holder, certificates of interest in mineral royalties are named in the definition, and a limited partnership interest in a venture run by others is a classic investment contract.