The Flaw of Broad Vertical Commonality:
Within “Broad Vertical Commonality” we’re told that a “Common Enterprise” is one that is established based on situations where we are reliant on the expertise of the issuer or promoter of a security.
This definition seems fine at first glance, but creates some odd situations that are noteably problematic.
A Thought Experiment:
Let’s imagine a scenario in which an open source developer has created a new WordPress theme. This theme is a video streaming site similar to Youtube, however, it’s automated and pulls in videos from various websites and places ads on them so the website owner can profit.
I purchase the theme, and as is common on most theme marketplaces, I purchase the set up service so that the vendor installs this theme on my webserver for me.
While there are actions that I as an individual could take to improve my individual earnings, it is not necessary, and for the most part I am dependent on the expertise of the individual who is created this script and hopefully keeps it up to date whenever websites update their APIs.
Have I entered into a “Common Enterprise” with this vendor?
Have I purchased a security?
The gut check answer seems to be “No.” but if we apply the analysis of the Howey Test using only a “Broad Vertical Commonality” lens then:
- I have made an investment of money.
- I have the expectation of profit.
- I am dependent on the expertise of another individual.
Now let’s extend this scenario even further, imagine the scenario in which the ads displayed on my site are from a service that this vendor provides where they also get a cut of the ads.
In this case I’ve now had my fortune tied to that of the vendor so the analysis is now:
- I have made an investment of money.
- I have the expectation of profit.
- I am dependent on the expertise of another individual.
- My fortune is tied to that of the issuer.
Have I purchased a security?
There are major challenges in the vertical commonality perspective, but especially in the “Broad Vertical Commonality” perspective where we are tied only on the basis of expertise.
This is why the third prong of the Howey Test is so critical, in that we must expect the profit is derived from the efforts of others, and not that we are just profiting from our own efforts when a “Common Enterprise” is established, because the bar for such commonality can be remarkably low.
The Howey Test and the views of commonality applied to securities regulation are remarkably outdated in a modern world in which we’re more connected as individuals and enterprises than ever before. Our world has become more cooperative, not because we’re selling more securities, but because we have more ability to interconnect and take part cooperatively in digital economies; as this continues we’ll see more and more that the view of Broad Vertical Commonality is fundementally flawed.