By the time he reached his 30s, William John Howey was an accomplished, self-made man, with an impressive resume that featured sales of insurance, automobiles, land, and produce in places as varied as Illinois, Oklahoma, Kansas City, Mexico, and Florida.  Beginning in 1908, Howey merged two of his endeavors — land development and citrus growing — into an investment product by which he amassed his fortune.  Howey’s system of land development was based on the simple business principle of buying undeveloped land at a low price, developing the land, and then selling the land at a premium.  Howey developed hundreds of acres of land by planting groves of orange trees upon them, and then sold the land in tracts of one acre, plus or minus a fraction of an acre, to interested investors.  To sweeten the deal, he set up a service company that managed the citrus groves to produce both fruit and profit, and he put a “no-risk” offer on the table.  In short, Howey assured investors that, if they would sign a service contract with his service company, and if the yield should fail to turn a profit within an agreed-upon timeframe, the investor could sell the tract of land back to Howey for the original purchase price plus interest.


Howey died in 1938, but his land development and agricultural service companies lived on, managed first by his widow, and then by his former sales manager, Dodge Taylor, who was assisted by C. V. Griffin, Sr.  In the 1940s, their business model came to the attention of the Securities and Exchange Commission (SEC).  The SEC filed suit, in the United States District Court for the Southern District of Florida, Orlando Division, against the land development company (called the Howey Company), and against its companion service company (called Howey-in-the-Hills Service, Inc.), alleging that the investment, which took the form of a service contract, constituted an unregistered security, in violation of Section 5(a) of the Securities Act of 1933.  The SEC wanted the Howey companies to stop selling their investment, register with the SEC, and apply for approval to sell the investment before resuming sales of the product.  The case was styled Securities and Exchange Commission v. W. J. Howey Co. et. al. (60 F.Supp. 440).


Drawing upon “the legal principle and interpretation of the Securities Act” put forth by Judge Louie Willard Strum in Securities & Exchange Commission v. Bailey et al. (41 F.Supp. 647), which at the time was a recent case, District Judge Dozier Adolphus DeVane ruled against the SEC and in favor of the Howey companies in April of 1945.  The SEC promptly appealed Judge DeVane’s decision to the United States Court of Appeals for the Fifth Circuit, which in November of 1945 affirmed Judge DeVane’s opinion in a case styled Securities & Exchange Commission v. W. J. Howey Co. et. al. (151 F.2d 714).  Attorneys for the Howey companies successfully argued that the Howey companies were selling land, orange groves, and the services necessary to maintain them.  In the appellate court’s opinion, Circuit Judge Joseph Chappell Hutcheson, Jr. cited an even more recent case, Securities and Exchange Commission v. C. M. Joiner Leasing Corp. (320 U.S. 344).  After noting that the so-called Joiner case and others like it were “close cases,” the appellate court concluded that “the critical question” hinged upon “whether in fact the purchase was of a specific thing having specific value in itself or was a thing having no value unless the enterprise as a whole should succeed.”  Finding, among other things, that the sale of land, orange groves, and maintenance service was the sale of specific things with specific inherent value, the appellate court ruled in favor of the Howey companies.


Undaunted, the SEC petitioned for a writ of certiorari to the Supreme Court of the United States, which granted the request and reviewed the circuit court’s judgment.  Arguing on behalf of the SEC was Roger S. Foster, General Counsel for the SEC, assisted with respect to his brief by Solicitor General James Howard McGrath, Robert S. Rubin, and Alexander Cohen.  Arguing on behalf of the Howey companies were Florida attorneys C. E. Duncan and George C. Bedell.  In SEC v. W. J. Howey Co. (328 U.S. 293), a landmark decision that has influenced cases of a similar nature to this day, the Supreme Court reversed the decisions of the lower courts and ruled in favor of the SEC.  In fact, several important points arise from the Supreme Court’s so-called Howey decision, beginning with a clearer explanation of what constitutes a security.  Referring to the Securities Act of 1933, the Supreme Court declared that the term “security” applies not only to “the commonly known documents traded for speculation or investment,” such as stocks and bonds, but also to documents “of a more variable character, designated by . . . descriptive terms,” such as an “investment contract.”


In its consideration of the term “investment contract,” the Supreme Court noted that it was “undefined by the Securities Act [of 1933] or by relevant legislative reports,” but that it was a term that had already often been referenced “in many state ‘blue sky’ laws.”  The Supreme Court further noted that the term “had been broadly construed by state courts so as to afford the investing public a full measure of protection.”  This recognition and broad application of the term “investment contract” by the Supreme Court is significant, in that it led the Supreme Court to follow the state courts, and the United States Congress, in a universal application of the term “to a variety of situations where individuals were led to invest money in a common enterprise with the expectation that they would earn a profit solely through the efforts of the promoter or of someone other than themselves.”  By reference to this four-prong consideration, which has come to be known as the Howey test, the Supreme Court has equated the definition of an “investment contract” with “a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”


So what does this mean to you?  When you consider venturing your capital in a product and/or a service — indeed, in a financial investment of any kind — you need to know whether your money is being invested in a security, and whether the person or entity offering it to you has registered it with the SEC.  If you have invested your capital in a product or service and you are unsure of the laws protecting your interests, please contact Chris Bebel of Tefteller Law, PLLC, at 903-843-5678.