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I have no education in legal matters and was only thinking about some investments. I stumbled on something called the Howey Test and tried to read a little about it. I still don't understand it, and will demonstrate my confusion with a scenario.

Scenario

Renzo owns a house. Renzo sells the house to Samir. Samir wants to generate rental income with the house. Samir has no experience in the rental business. Samir pays Renzo $2k per month to perform the following services:

  • find suitable tenants for the house by performing marketing services, background checks of tenants etc...
  • maintain the property (eg. cut the grass, fix toilet, re-shingle root etc...)
  • manage any financial issues such as paying taxes, etc...

Based on the above points, does this scenario pass the Howey Test? Do any of the following points (or combination of points) affect the scenario's ability to pass the Howey Test?

  1. Samir and Renzo are siblings
  2. Samir and Renzo agree to split any profit/loss generated from the rental income
  3. Samir owns all the profit/loss generated from rental income. Renzo does not make any other income beyond his $2k per month.
  4. The value of the house at time of transaction was under $100k USD
  5. The value of the house at time of transaction was over $100k USD

Note

I don't fully understand the term common enterprise. I was hoping someone can give an example of common enterprise based on the points I mentioned in the scenario.

When trying to read wikipedia's article on SEC v. W. J. Howey Co., I couldn't confirm why anyone would want to buy land from W. J. Howey if both of these conditions are true:

  • they have no agricultural experience
  • they have "no right of entry and no right to any produce harvested" (is this the same as saying you own nothing but the land? If you don't own the produce harvested, then how do you sell it for money/profit? What use is the land then? Buyer's of the land only opportunity to profit is based on capital gains appreciation?)
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In the Hovey case, the purchasers would get the profits from the agricultural operations, less a service fee. They would not operate the farms themselves, nor get the produce. Instead they would hire the associated company "Hovey in the Hills" (HH) to run the farms, and get only money. HH had the "sole right" to run the farms and sell the produce.

Consider a somewhat similar situation. I want to build and operate a mall. I don't have enough money to do this on my own. So I sell shares of the enterprise. By contract, I retain "sole right" to build and operate the mall. The investors will not do any part of the work of running the mall, and their skill and knowledge will not be used and will have no effect on its success or failure. All that they get is a share of the profits from my work, in return for providing the money which lets me create the mall. The mall is the common enterprise here, and the money provided by others is an investment.

Suppose instead I want not investors but partners. Each of the partners will pout up money, but they will also co-operate in creating and running the mall. Decisions will be made jointly, after consultation. Partners will be expected to some part of the work, and it is our joint skills and efforts will will lead to success or failure. That would not be an investment in the sense of Hovey, because the profit would not derive solely from the work of others.

In the scenario in the question, Renzo does all the work, Samir only puts up money. The amount of profit will depend on the skill and efforts of Renzo in maintaining the house, finding tenants, and collecting rents. As described, this would seem to pass the Hovey test, and be classed as an investment. This would be true whether Renzo gets a share of the profit or a fixed fee, and whether the value of the house is over or under $100,000.

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