Judge rules in SEC case vs Ripple
Both sides have something to celebrate as a judge rules on the SEC v. Ripple lawsuit
STILLFX/Shutterstock modified by Blockworks
A US federal judge has partially sided with Ripple Labs in a Securities and Exchange Commission (SEC) lawsuit alleging the San Francisco-based blockchain developer issued an unregistered security offering with its XRP token.
In answering requests from both sides for summary judgement, the court ruled that while Ripple’s institutional sales of XRP were found to constitute an unregistered securities offering, programmatic sales were not.
In the decision, the court notes that “having considered the economic reality of the Programmatic Sales, the Court concludes that the undisputed record does not establish the third Howey prong.”
“Since 2017, Ripple’s Programmatic Sales represented less than 1% of the global XRP trading volume. Therefore, the vast majority of individuals who purchased XRP from digital asset exchanges did not invest their money in Ripple at all. An Institutional Buyer knowingly purchased XRP directly from Ripple pursuant to a contract, but the economic reality is that a Programmatic Buyer stood in the same shoes as a secondary market purchaser who did not know to whom or what it was paying its money.”
“Therefore, having considered the economic reality and totality of circumstances, the Court concludes that Ripple’s Programmatic Sales of XRP did not constitute the offer and sale of investment contracts.”
The summary judgment comes after a three-year-long legal battle and could set a precedent for future token classification cases.
The judge granted part of the SEC’s motion pertaining to $728 million in institutional sales. At the time of the SEC’s lawsuit in December 2020, the regulator calculated Ripple’s XRP sales in total to $1.4 billion.
Institutional sales are different
The court said, “reasonable investors…in the position of the Institutional Buyers, would have purchased XRP with the expectation that they would derive profits from Ripple’s efforts.”
“XRP, as a digital token, is not in and of itself a “contract, transaction[,] or scheme” that embodies the Howey requirements of an investment contract”, the court ruled.
“Rather, the Court examines the totality of circumstances surrounding Defendants’ different transactions and schemes involving the sale and distribution of XRP,” the filing added.
The court ruled against Ripple’s “essential ingredient” defense, in which Ripple argues that a physical contract must exist to be considered an investment contract.
In assessing institutional sales, the court evaluated the three-pronged Howey test in its ruling as follows:
Howey prong 1:
“The first prong of Howey examines whether an ‘investment of money’ was part of the relevant transaction.”
“Defendants do not dispute that there was a payment of money; the Court finds, therefore, that this element has been established.”
Howey prong 2:
“The second prong of Howey, the existence of a ‘common enterprise,’ 328 U.S. at 301, may be demonstrated through a showing of “horizontal commonality.”
“The Court finds the existence of a common enterprise because the record demonstrates that there was a pooling of assets and that the fortunes of the Institutional Buyers were tied to the success of the enterprise as well as to the success of other Institutional Buyers.”
Howey prong 3:
“The third prong of Howey examines whether the economic reality surrounding Ripple’s Institutional Sales led the Institutional Buyers to have ‘a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.'”
“Based on the totality of circumstances, the Court finds that reasonable investors, situated in the position of the Institutional Buyers, would have purchased XRP with the expectation that they would derive profits from Ripple’s efforts.”
“In each instance where Defendants offered or sold XRP as an investment contract, a contract existed,” the judge wrote in Thursday’s summary judgment.
“For the foregoing reasons, the SEC’s motion for summary judgment is GRANTED as to the Institutional Sales, and otherwise DENIED. Defendants’ motion for summary judgment is GRANTED as to the Programmatic Sales, the Other Distributions, and Larsen’s and Garlinghouse’s sales, and DENIED as to the Institutional Sales.”
Brad Garlinghouse and Chris Larsen
In a lengthy analysis, the judge concluded that “the SEC need not demonstrate that [Ripple co-founder Chris] Larsen and [CEO Brad] Garlinghouse were aware that Ripple’s transactions and schemes were illegal.”
“Based on the disputed facts in the record, therefore, a reasonable juror could find that Larsen and Garlinghouse did not know or recklessly disregard Ripple’s Section 5 violations.”
In response, Garlinghouse tweeted, “we were on the right side of the law, and will be on the right side of history.”
The role of the Hinman docs
In December 2020, the SEC alleged Ripple Labs illegitimately raised $1.3 billion by selling XRP to investors, starting in 2013.
A legal battle ensued, and by September 2022, the SEC and Ripple Labs had agreed to bypass a trial and allow a judge to issue a summary judgment based on the evidence submitted.
Part of the Ripple team’s strategy involved gaining access to what are now known as the Hinman documents — internal SEC drafts and emails relating to a former director’s speech more than four years ago.
William Hinman, the former director of the SEC’s Division of Corporation Finance, said he didn’t consider ether (ETH) a security in the 2018 speech and suggested tokens could initially start out as securities but evolve into something else over time.
Prior to his SEC appointment, Hinman worked at Simpson Thacher, a law firm that sits on the Enterprise Ethereum Alliance, which is dedicated to promoting the commercial use of Ethereum. Since leaving the SEC, Hinman has returned to Simpson Thatcher.
The emails highlight a conflict of interest, Ripple’s defense argued, suggesting that the regulator may be cherry-picking which projects to target. Although, Hinman’s comments never reflected official SEC stance. The emails were later released to the public in June.
The Hinman documents’ true impact on the Ripple outcome is unclear. Still, the ruling comes months after the SEC classified nine other cryptocurrencies as securities in an enforcement action against a former Coinbase employee for insider trading, and one months after it named nearly two dozen tokens across its Coinbase and Binance suits.
While none of the token issuers mentioned in complaints are listed as defendants, industry members speculated that the SEC may choose to bring charges against their issuers at a later date.
After the ruling on Ripple, however, things may change.
In the years since the SEC sued Ripple, the agency has charged firms including the Tron Network and founder Justin Sun, Kraken, Nexo and BlockFi. The latter three elected to settle.
Updated July 13, 2023 at 12:17 pm ET: Added context throughout.
Get the news in your inbox. Explore Blockworks newsletters:
- Blockworks Daily: Unpacking crypto and the markets.
- Empire: Crypto news and analysis to start your day.
- Forward Guidance: The intersection of crypto, macro and policy.
- 0xResearch: Alpha directly in your inbox.
- Lightspeed: All things Solana.
- The Drop: Apps, games, memes and more.
- Supply Shock: Bitcoin, bitcoin, bitcoin.
