SEC V. Ripple: When A Security Is Not A Security

• Published date: 24 July 2023
• Subject Matter: Corporate/Commercial Law, Technology, Compliance, Contracts and Commercial Law, Securities, Fin Tech
• Law Firm: Holland & Knight
• Author: Scott Mascianica, Jessica B. Magee and Shawn M. Turner

In a monumental decision that will likely have substantial ramifications for crypto industry developers, securities practitioners, and millions of investors and token purchasers alike, on July 13, 2023, the U.S. District Court for the Southern District of New York issued its long-anticipated opinion ruling on competing summary judgment motions in SEC v. Ripple Labs, et al., 20-cv-10832 (S.D.N.Y). Judge Analisa Torres issued a split decision, granting and denying different aspects of each of the parties' motions. Torres found that XRP, the primary digital token at issue in the matter, "is not in and of itself a 'contract, transaction [,] or scheme' that embodies the Howey requirements of an investment contract." This finding is singularly important not only for the Ripple defendants, but also to the larger digital assets industry, as the SEC has long taken the position that nearly all tokens are, in and of themselves, investment contract securities.

Rejecting the token-as-security argument as to XRP, the court assessed the totality of the circumstances for each type of transaction at issue, finding that three of the four categories of XRP transactions did not involve securities and thus could not serve as the basis for liability under federal securities laws. Although issued at the summary judgment stage with cabined language from the court and subject to potential down-the-line appeals, the potential implications for this decision are significant. For its part, the SEC walked away from the decision claiming a partial, but more limited victory: It defeated defendants' due process challenge that they lacked "fair notice" that the token and transactions at issue were securities, and it secured a finding that Ripple's XRP sales to institutional investors were, in fact, securities transactions.

The split nature of the decision is bound to raise questions, such as: Why doesn't a decision that an XRP token itself isn't a security end the analysis altogether? How could sales of XRP tokens be securities for some transactions and not for others? In this post, we distill the answers to these questions, provide an overview of the key aspects of the decision and offer several key takeaways.

Background

As we previously covered, in December 2020, the SEC charged Ripple and two of its executives (Christian Larsen and Bradley Garlinghouse) with purportedly raising more than $1.3 billion through an unregistered offering of digital asset securities in alleged violations of Section 5 of the Securities Act of 1933 (Securities Act). To establish violations of Section 5 under the Securities Act, the SEC needs to establish no registration statement was filed or in effect as the transaction at issue and the defendant directly or indirectly offered to sell or sold securities via interstate commerce. In simplest terms, the SEC needed to persuade the court that securities were involved.

The crux of the lawsuit involves whether Ripple's token - XRP - is itself a security under the federal securities laws or if the underlying transactions involving XRP were securities transactions. This analysis turned on the court's application of the multipart test established by the U.S. Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), which held that an investment contract is a "contract, transaction[,] or scheme whereby a person (1) invests his money (2) in a common enterprise; and (3) is led to expect profits solely from the efforts of the promoter or third party." 328 U.S. at 298-99.

After years of discovery battles chock full of combative briefing and compelling debates around such things as deliberate process privilege, the SEC and defendants filed cross motions for summary judgment earlier this year. The court's decision focused on two primary issues:

1. Did the four categories of XRP transactions constitute securities transactions based on the Howey test for establishing an investment contract security?¹
2. Did the defendants have "fair notice" about what conduct they were required or forbidden to take?²

Four Categories of XRP Sales

Although the parties disagreed on many aspects of the factual record in their briefing, there was seeming agreement on the four types of XRP distribution transactions at issue:

1. Sales of XRP...