According to the SEC, an "investment contract" is under the umbrella term of a Security. In short, a Security can be a note, stock, bond, other common investment instruments, or an "investment contract." In the interest of cryptocurrency and NFTs, organizations and projects need to determine if they fall under the category of an "investment contract." The Howey Test is used to determine if an "investment contract" exists, and thus if it is considered a Security.
What determines a Security?
If there is an "investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others," the transaction is subject to disclosure and registration requirements under the Securities Act of 1933 and the Security Exchange Act of 1934. In others words a Security.
How is a Security Defined?
The Securities Act of 1933 and the Security Exchange Act of 1934 define what a security is.
They define things such as stocks, bonds, other common investment instruments, and also what is called an "investment contract." This is a flexible term to capture investments that act like securities, but don't fit within any other categories of securities.
The Howey Test - Determining if an Investment Contract exists
SEC v. W.J. Howey Co. 1946 was the case that legally defined if a transaction qualifies as an "investment contract" and thus a Security.
The supreme court determined that an "investment contract" or the "Howey Test" is defined by the following attributes.
For a transaction to qualify as a security it must involve as 4 elements below:
1) An investment of money
Straightforward, an exchange of money or wealth must occur.
2) In a common enterprise
the enterprise in which the investor's fortunes are interwoven with either the person offering the investment, a third party, or one or more investors.
3) With the expectation of profit
This element looks at the investor's intent for buying the asset. Are they buying the transaction because they're expecting a profit? Was this communicated to them through advertisements, social media, discussions, on the contract/NFT, or on the website? Or are they investing in the NFT project because they like the art or see it as a mechanism to store wealth?
4) To be derived from the efforts of others
This element is used to separate the investor from the third party. If the investor is actively working in the investment and thus has a role in its success, it's most likely not an investment.
If all 4 of these elements are met, your NFT project is a Security.
What does this mean for your NFT project?
Use the Howey Test to determine if your project falls under an "investment contract" definition and thus a Security. If it does, you will need to register as a Security. Consult a lawyer that is familiar with SEC Securities law and NFTs as a technology.
Disclaimer: This is not legal advice, consult a lawyer when making decisions regarding securities law.