Background
On September 17, 2022, both the Securities and Exchange
Commission and Ripple Labs, Inc. (with its Executive Chairman and
CEO) filed motions for summary judgment in the SEC’s suit
alleging that Defendants sold billions of units of a virtual
currency called XRP, which in the SEC’s view should be
considered a “digital asset security.”1
According to the SEC’s Complaint, the sale of XRP would
constitute an unregistered sale of securities in violation of the
registration and disclosure requirements of federal securities
laws.2
Ripple is a privately-held financial technology company founded
in 2012, with a particular focus on facilitating cross-border
payments. The Company’s products generally rely on the
open-source blockchain created by Ripple, called the “XRP
Ledger,” and the associated XRP native virtual currency. When
the XRP Ledger was created in 2012, a fixed supply of 100 billion
units of XRP was created, 20% of which was retained by the founders
and the remaining 80% was given to Ripple.3 Over the
years the Defendants have sold and distributed some XRP currency,
transactions which are being challenged by the SEC as unregistered
securities sales.4
The question of whether XRP is a security and therefore subject
to the requirements of the federal securities law is a significant
one for the digital asset industry, which has repeatedly asked for
further guidance from the SEC on the application of securities law
to these novel assets and technologies.5 SEC Chairman
Gary Gensler has been aggressive about claiming jurisdiction over
digital assets,6 claiming that the law is clear and
recently stating that “nothing about the crypto market is
incompatible with securities laws.” He advised that digital
asset companies should “come in, talk to us, and
register.”7
The SEC’s Position
The SEC’s Complaint in the Ripple matter asserts that XRP
currency should be considered a “digital asset security”
because it qualifies as an “investment contract” under
the traditional Howey securities test: “an instrument through
which a person invests money in a common enterprise and reasonably
expects profits or returns derived from the entrepreneurial or
managerial efforts of others.”8 In particular, the
SEC argues the economic reality shows “a purchase of XRP is an
investment in a common enterprise with other XRP holders and with
Ripple.”9 The SEC also points to multiple public
representations in which Ripple “publicly tied the potential
for profit to its promised entrepreneurial and managerial
efforts.”10
The Complaint’s arguments are consistent with the position
the SEC has taken in other recent enforcement actions and in its
public pronouncements.11 Chairman Gensler has publicly
questioned the digital asset industry’s calls for greater
guidance, arguing that the agency has “spoken with a pretty
clear voice”12 and concluding that “most
crypto tokens are investment contracts under the Howey Test”
and thus subject to the securities laws and SEC
jurisdiction.13
Ripple’s Response
In its summary judgment motion, Ripple pushed back, arguing that
distribution of XRP by the Defendants lacks the “essential
ingredients” to be considered “investment contracts”
under the Howey Test.14 First, Ripple notes that in many
of the transactions covered by the Complaint there was no actual
contract between a promoter and an investor (for example, donations
and giveaways).15 Second, the Brief argues that when
contracts were present, they established no post-sale obligations
for Ripple or rights for the purchaser of XRP to share in profits
from the Company’s efforts.16 Third, the Defendants
point to the absence of a “‘common enterprise’ in
which those who purchase XRP invest,” arguing that the
“XRP ecosystem,” comprised by multiple third parties who
interact with the XRP Ledger or own XRP currency, cannot be
characterized as a “common enterprise” under
Howey.17
In essence, Ripple claims that sales of XRP merely represent
sales of assets, not securities. The Defendants assert that the
SEC’s theory represents an “open-ended assertion of
jurisdiction over any transfer of an asset (for consideration or
not) that the SEC thinks may benefit from the registration and
disclosure requirements of securities law.”18 As
such, Ripple contends that accepting the SEC’s position could
have unintended effects, converting sales of ordinary
assets—such as gold and soybeans—into sales of
securities.
Analysis
As we have noted previously,19 it has become
abundantly clear that the SEC will continue to take an aggressive
position in asserting its authority over digital assets.
On the other hand, the Defendants raise significant questions
about the wisdom of applying an orange grove case from 1946 to a
class of assets developed only in the last ten years. While the SEC
has historically favored at least in some area’s flexibility
over certainty in application of the securities laws—see
insider trading for example—the regulation of digital assets
would seem to be a place in which certainty would assist all
parties in making informed decisions.20
Perhaps a ruling on Ripple’s summary judgment motion will
help. It may also shed light on the potential consequences of the
SEC’s current approach to regulating digital assets through
piecemeal enforcement actions.
Special thanks to visiting attorney Martin Fischer who
co-authored this publication
Footnotes
1. Complaint at 1-2, SEC v. Ripple Labs,
20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
2. Id.
3. Defendants’ Memorandum of Law in Support of Their
Motion for Summary Judgment at 1, SEC v. Ripple Labs,
20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
4. Complaint at 1-2, SEC v. Ripple Labs,
20-cv-10832 (S.D.N.Y. Dec 22, 2020).
5. Coinbase, Petition for Rule-making—Digital Asset
Securities Regulation, (Jul. 21, 2022).
6. Chair Gary Gensler, Kennedy and Crypto, U.S. SEC
(Sept. 8, 2022).
7. Id.
8. Complaint at 6-7, SEC v. Ripple Labs,
20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
9. Plaintiff’s Memorandum of Law in Support of Its
[confirm?] Motion for Summary Judgment at 2, SEC v. Ripple
Labs, 20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
10. Id.
11. SEC Charges Former Coinbase Manager, Two Others
in Crypto Asset Insider Trading Action, U.S. SEC (Jul. 21,
2022).
12. Id.
13. Id.
14. Defendants’ Memorandum of Law in Support of Their
Motion for Summary Judgement at 1-2, SEC v. Ripple Labs,
20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
15. Id. at 2.
16. Id.
17. Id. at 3.
18. Id.
19. Former Cryptocurrency Exchange Manager
Indicted by DOJ and Charged by SEC: is it ‘Regulation by
Enforcement’?, Shearman & Sterling (Jul.
28, 2022).
20. Coinbase, Petition for Rule-making—Digital
Asset Securities Regulation, (Jul. 21, 2022).
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
