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Crypto Law/Level III · Tokens and securities law/3.1 The Howey test/Lesson 3

A common enterprise

The second Howey element, the three competing ways US courts test it, and why pooled sale proceeds and a single fungible token usually satisfy it.

Education, not legal, tax or investment advice. Crypto law differs between countries and states and changes often. Check the current rules where you live with a qualified lawyer or tax adviser before you act.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Lowest-exposure structure: avoid pooling buyer money into one treasury that funds a shared project; without pooling and pro-rata profit, horizontal commonality fails, as in Revak v. SEC Realty Corp. (2d Cir. 1994). The catch: fungible tokens funded by a pooled sale usually satisfy this element.
  2. Selling a finished product or individual items, with each buyer’s outcome independent of the others, is the cleanest way to defeat common enterprise; the SEC’s March 2026 interpretation confirms the element is required, but courts in different circuits apply different commonality tests.
  3. Do not rely on this element alone; most token disputes turn on the third element, issuer promises (lesson 3.1.4). Trace and record where proceeds go and which circuit’s law would apply, free work that shows how easily a court could find commonality.

MaterialsRevak v. SEC Realty Corp., 18 F.3d 81 (2d Cir. 1994), which sets out horizontal and vertical commonalityThe July 13, 2023 SEC v. Ripple Labs opinion, part on common enterpriseSEC Release No. 33-11412 (March 17, 2026), footnote 7 on whether common enterprise is requiredA project’s treasury disclosures or sale terms showing where sale proceeds went

Wonder

  1. What makes buyers part of a ‘common’ enterprise?
  2. Do all US courts use the same test?
  3. Does a token automatically create a common enterprise because everyone holds the same coin?

Explore

  1. Howey’s second element asks whether money was invested ‘in a common enterprise’ (lesson 3.1.1). The Supreme Court never defined the phrase, so the federal courts of appeals built their own tests, and they differ. A ‘circuit’ is one of the regional federal appeals courts; its rulings bind the trial courts in its region. Which test applies can therefore depend on where a case is filed. The leading summary of the approaches is the Second Circuit’s decision in Revak v. SEC Realty Corp., decided February 23, 1994, about condominium units sold to New York investors.
  2. The first approach is horizontal commonality: ‘the tying of each individual investor’s fortunes to the fortunes of the other investors by the pooling of assets, usually combined with the pro-rata distribution of profits.’ Pro-rata means in proportion to each person’s stake. The Second Circuit applies it, and the First Circuit described it in SEC v. SG Ltd. (2001) as ‘the pooling of assets from multiple investors so that all share in the profits and risks of the enterprise.’ In Revak the condominium buyers did not pool their units or profits, so the court found no common enterprise.
  3. The second approach is vertical commonality, which links investors to the promoter rather than to each other. Revak describes two kinds. ‘Broad vertical commonality’ requires only that investors’ fortunes depend on the promoter’s efforts, citing a 1989 Fifth Circuit case. ‘Strict vertical commonality’ requires investors’ fortunes to be tied to the promoter’s own fortunes, citing the Ninth Circuit’s Brodt v. Bache & Co. (1978). Revak rejected the broad version, because it merges this element into the third (lesson 3.1.4), and left the strict version undecided. The Ripple court noted in 2023 that the Second Circuit still had not addressed it.
  4. Some SEC statements, including a 2004 Commission opinion in In re Barkate, could be read to say this element is not required. The SEC’s March 2026 interpretation rejects that reading. Citing SEC v. Barry (9th Cir. 2025) and SEC v. Scoville (10th Cir. 2019), it states that the common enterprise element must be satisfied. In token cases it usually is. In Telegram, buyers held ‘an identical instrument, the value of which is entirely dependent on the success or failure of the TON Blockchain.’ In Kik, the court said the success of the ecosystem drove demand for Kin and so dictated investors’ profits.
  5. In SEC v. Ripple Labs (July 13, 2023), the court found horizontal commonality in Ripple’s direct institutional sales. Ripple pooled the proceeds in bank accounts it controlled, did not segregate or separately manage investor funds, and used the money to fund operations. Every buyer received the same fungible XRP, so when the price rose all profited in proportion to their holdings. The court limited that finding to Ripple and its institutional buyers and expressly did not decide whether the enterprise extended to all other XRP holders or the wider ‘XRP ecosystem’. Those limits matter for secondary trading (lesson 3.1.7).
  6. For builders, the lesson is that fungible tokens sold to fund a shared project rarely escape this element; most disputes are won or lost on the third. A practical check: trace where sale proceeds go. Are they pooled in one treasury or kept separate per buyer? Do all holders own the same unit whose price rides on one project? Is there any promise to share revenue pro rata? Then note which circuit’s law would likely apply. The answers will not settle the question alone, but they show which commonality test a court could use and how easily it would be met.

Key facts

  • Revak v. SEC Realty Corp., 18 F.3d 81, was decided by the Second Circuit on February 23, 1994.
  • Revak defines horizontal commonality as tying each investor’s fortunes to the other investors’ fortunes by pooling assets, usually with pro-rata distribution of profits.
  • Revak held that broad vertical commonality does not satisfy Howey’s common enterprise requirement and left strict vertical commonality undecided.
  • Strict vertical commonality, which ties investors’ fortunes to the promoter’s fortunes, is associated with the Ninth Circuit’s Brodt v. Bache & Co. (1978).
  • The SEC’s March 2026 interpretation states that the common enterprise element must be satisfied, departing from any contrary reading of In re Barkate (2004).
  • In SEC v. Ripple Labs the court found horizontal commonality for institutional sales but did not decide whether the enterprise extended to other XRP holders.

Exercise nine, six, three, one

9CollectList up to 9 facts about a token project’s money and holders: where sale proceeds went, who controls the treasury, whether funds were segregated, and how holders’ returns are linked.
6ClusterSort them into 6 groups: pooling of funds, pro-rata sharing, links between holders, links to the promoter’s efforts, links to the promoter’s own fortunes, and facts pointing to separate, independent outcomes.
3DistillReduce the 6 groups to 3: evidence of horizontal commonality, evidence of vertical commonality, and evidence against any common enterprise.
1CrystallizeWrite 1 sentence explaining why holders of one fungible token funded by a pooled sale are usually found to share a common enterprise.

Fact check

Dates, figures and claims checked against the published sources listed below.

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