SEC v. Ripple (XRP): What is a Security?
Continuing our series outlining the regulatory environment for crypto in the United States, we look at the pivotal case SEC v Ripple (XRP) in the United States. This recently decided case applies the Howey Test for determining what is a “security” in the United States (read our article on the topic) and has far-reaching consequences for the US regulatory environment. We recommend reading our previous articles outlining the US regulatory environment and the SEC’s role before this one to fully understand this series.
The Howey Test is a pivotal framework used by the U.S. Securities and Exchange Commission (SEC) to determine whether a particular asset qualifies as a security under U.S. securities laws. It has four criteria, and if an asset meets these criteria, it is considered an “investment contract” and falls under the purview of the Securities Act of 1933 and the Securities Exchange Act of 1934. This was discussed in more detail in our previous article.
The most important application of the Howey Test in the cryptocurrency world is the ongoing SEC v. Ripple case involving the XRP cryptocurrency, in the United States District Court for the Southern District of New York.
The SEC v. Ripple (XRP) Case:
In 2020, the SEC initiated legal action against Ripple, the blockchain development company that issues the popular cryptocurrency XRP, alleging that Ripple’s sale of XRP for US$ 1.3 billion in 2013, constituted an unlawful offer and sale of securities — ie an unregistered securities offering (some of the complexity and details about the case have been omitted here to focus on the most relevant points).
Ripple, on the other hand, denied these accusations. Both parties sought summary judgments regarding the sales of XRP to institutional and retail investors (an application for summary judgment is when a party asks the court to rule in its favour based on the preliminary documents submitted without going to a full trial, because — in theory — its case is overwhelmingly strong).
The Court issued a significant July 2023, which carried significant implications. It determined that XRP did NOT pass the Howey Test when sold in secondary markets, such as cryptocurrency exchanges. However, it found that the sale DID meet the Howey Test when XRP was offered to or purchased by institutional investors. Although the ruling is complex and offers a “win” for both sites, it is widely viewed as a victory for Ripple more than the SEC.
The key takeaway is that XRP (and by extension, other cryptoassets) are not automatically securities in all circumstances. In each case, a detailed factual analysis of each crypto-asset is required to determine whether it is a security or not, and the same crypto-asset may be a security in some circumstances but not in others.
This ruling sparked considerable controversy within the crypto industry. Many hailed it as a victory, asserting that XRP was not a security and that the case showed the SEC was overreaching its authority in asserting that (almost) all crypto-assets were under its jurisdiction. However, the SEC remains committed to its expansive jurisdictional approach to the crypto world and its assertion of regulatory authority over almost all crypto tokens.
Despite the SEC’s continued commitment to its aggressive approach to enforcing the securities laws in the crypto space, the Ripple judgment marked a clear setback for its agenda. Under the law, the SEC can appeal when the entire case is concluded (the July 2023 ruling was important in its scope and conclusions but was not a final judgment on the entirety of the case). The case is lengthy and complex and is scheduled for trial in 2024, but it could take months after the trial for the Judge to issue a judgment, so it is likely to be completed perhaps until late 2024, and the SEC cannot appeal as of right until then, so the Judge’s ruling on the security issue will stand as an important judicial precedent on the nature of crypto assets and securities until then.
The SEC can appeal before the case is concluded, if they get permission from Judge Torres who issued the July 2023 ruling (known as an “interlocutory appeal”). However, they filed a request to Judge Torres to allow that, and she denied it in early Oct 2023. They will therefore have to wait until the Ripple case concludes to appeal her ruling on Ripple’s status as a security.
There is a separate case relating to Luna and Terra by US District Judge Jed Rakoff in New York, and he ruled a couple of weeks after Judge Torres that it is plausible the Terra token was a security even when sold to buyers on an exchange (the exact situation where Judge Torres said XRP was not a security). Although this was raised by the SEC before Judge Torres, she said in her Oct 2023 ruling denying permission to appeal that Judge Rakoff’s ruling was made in a different context and did not necessarily conflict with her ruling in the Ripple case, and this did not justify allowing permission to appeal.
Now we wait and see what happens next — it appears the SEC has had a setback but its approach to enforcing US laws and regulations against DeFi appears as strong as ever.
October 2023
— The Compliant Defi Team
www.compliantDefi.org
