The Howey Test Turns 64: Are the Courts Grading this Test on a Curve?

Sixty-four years ago, the Supreme Court decided SEC v. W.J. Howey, crafting a definition for one form of security, known as an investment contract. The Supreme Court’s definition of investment contract in Howey is flexible, consistent with the Congressional approach to defining the broader concept of what constitutes a security. This choice of adopting a flexible definition for investment contract is not without cost, and raises the specter of inconsistent interpretation and/or application by the lower courts that threatens to undermine the utility of the Howey test itself as a trigger for investor protection. The intentional breadth and adaptability of the definition of investment contract necessarily leads to complex and factintensive judicial inquiries in the application thereof, and allows for inconsistent results between and among the various courts engaging in such inquiries, creating the possibility of similarly-situated litigants winding up with dissimilar outcomes. Examples of these disparate outcomes are present in a number of industries, including the viatical settlement industry. Viatical settlements are a form of “asset-backed securities” under which purchasers buy the right to receive death benefits under life insurance policies from policyholders. These days, the very words “asset-backed security” may cause the public to recoil in horror, thinking of the sub-prime mortgage ∗ Miriam R. Albert, Professor of Skills, Hofstra University School of Law; B.A., Tufts University; J.D./M.B.A., Emory University; LL.M., New York University School of Law. E-mail: miriam.r.albert@hofstra.edu. This Article benefited from presentations at the University of Ghent, Belgium and at the Hofstra Law School Summer 2010 Workshop Series. 2 WILLIAM & MARY BUSINESS LAW REVIEW [Vol. 2:001 debacle and Bernard Madoff being led off in handcuffs while his devastated victims sobbed on the evening news. But not all asset-backed securities are problematic, and when undertaken legally and ethically, these interests can be solid investment vehicles, providing needed liquidity to the capital markets. As the financial markets continue to grow and innovate, new forms of asset-backed securities will likely be created, and the potential for inconsistent treatment of similarly-situated investors in these asset-backed securities arguably increases, prompting the question explored herein of whether the definition of investment contract in the Howey test is too flexible to further the underlying legislative intent of the federal securities laws to protect investors through mandatory disclosure and anti-fraud liability. At present, investors and issuers have no certainty as to the absolute parameters of the test or how any given court will articulate or interpret the definition of investment contract. The test has been burdened by judicially-imposed nuances, as judges try to give meaning to the Supreme Court’s words, and as a consequence, has triggered uneven applications. This Article challenges the Howey test in light of today’s increasingly complicated and volatile securities markets, focusing on whether the underlying legislative goals of the federal securities laws are still met by the Howey test, as currently construed by the courts. The Article provides an overview of the legislative history and current status of the U.S. law on the definition of investment contracts, with a brief examination of the component parts of the Howey test, followed by a discussion of the current regulation of the purchase of insurance policies from insurance policy holders in viatical settlement transactions, as background for the analysis highlighting the shortcomings of the Howey test discussed therein. The Article examines the resale of interests in life insurance policies purchased in viatical settlements, focusing on the inconsistent characterization of viatical settlements by the federal courts, specifically in the D.C. Circuit’s decision in SEC v. Life Partners, Inc. and the Eleventh Circuit’s decision in SEC v. Mutual Benefits Corp. and offers recommendations to further the underlying goals of the securities laws with respect to investor protection through disclosure and anti-fraud requirements in an effort to honor these goals without sacrificing consistency for the very investors these laws were enacted to protect. The Article ultimately concludes that the benefits of the flexibility of the Howey test outweigh the costs in terms of dissimilar results for similar investments and that the uneven applications of the Howey test by courts should be considered necessary collateral damage, acceptable in light of the significant protections still triggered by the Howey test. 2011] THE HOWEY TEST TURNS 64 3