TheCorporateCounsel.net

As readers of this blog know, the SEC has — at least recently — made clear that it believes that most digital assets are a “security” under the Howey test. But, as Liz noted earlier this year, it has been waiting on a ruling (or settlement) in its case against Ripple Labs, where it alleged that Ripple raised over $1.3 billion through unregistered sales of its XRP cryptocurrency token. Last Thursday, a SDNY judge issued the long-awaited order, which found that XRP both was and was not a security.

The court found that Ripple’s initial sales of XRP to institutional buyers satisfied the last prong of Howey but sales through exchanges and algorithms did not. Citing statements in promotional brochures and market reports for XRP, the court distinguished the Institutional Sales from the Programmatic Sales as follows:

From Ripple’s communications, marketing campaign, and the nature of the Institutional Sales, reasonable investors would understand that Ripple would use the capital received from its Institutional Sales to improve the market for XRP and develop uses for the XRP Ledger, thereby increasing the value of XRP.

[…] Here, the record establishes that with respect to Programmatic Sales, Ripple did not make any promises or offers because Ripple did not know who was buying the XRP, and the purchasers did not know who was selling it. In fact, many Programmatic Buyers were entirely unaware of Ripple’s existence. […] There is no evidence that a reasonable Programmatic Buyer, who was generally less sophisticated as an investor, shared similar “understandings and expectations” and could parse through the multiple documents and statements that the SEC highlights, which include statements (sometimes inconsistent) across many social media platforms and news sites from a variety of Ripple speakers (with different levels of authority) over an extended eight-year period.

If you’re confused, you’re not alone. So is Twitter and Tulane securities professor Ann Lipton, who has this to say:

The purchasers may not have known they were supplying capital to Ripple, but they knew what the institutional investors knew about Ripple’s intentions.  They knew Ripple was making efforts to expand the business, promote the token, and develop it as an asset.  They almost certainly were motivated to buy it for that reason; Ripple made statements encouraging them to do so.  That they didn’t know their particular moneys would assist that effort isn’t really …. relevant.  Moreover, as I said, the cross border system depended on a liquid market for XRP – of course Ripple would promote one.

What it looks to me is going on is that the court kind of stealthily accepted defendants’ “contract” argument after all, in a way.  The judge held that it was a security for the buyers who had a direct relationship with Ripple and knew where their money was going.  For buyers who had no such relationship, there was no security.

She also addresses the other thing we’re all thinking:

Let’s just get out of the way that it’s perverse that sales to institutions are treated as securities because institutions are sophisticated.  That’s backwards; it subverts the purpose of the securities laws (to protect less sophisticated investors) and contradicts other tests for whether assets are securities (the Reves test often weights investor sophistication against finding the presence of a security).

I should note, as Bloomberg’s Matt Levine points out in his column, that the argument “an investment contract is only an investment contract when you buy it from the issuer” is not new to crypto enthusiasts and, in fact, is a key argument made by Coinbase, but this opinion “goes way beyond” the argument Coinbase is making.

Crypto may be calling this a victory, but I’m not so sure. The SEC’s win here seems solid; Ripple’s less so. I guess we’ll have to wait a little longer for the answer to crypto. I don’t know about you, but this reminds me of The Hitchhiker’s Guide to the Galaxy, where a supercomputer takes millions of years to answer the meaning of “life, the universe and everything” and eventually responds with “42”.

– Meredith Ervine