On July 13, 2023, the Federal District Court for the Southern District of New York issued the hotly anticipated ruling in the SEC’s case against Ripple Labs, Inc. (Ripple). On cross-motions for summary judgment, the court found that only Ripple’s sale of its XRP tokens to institutional buyers pursuant to sales contracts constituted unregistered sales of securities in violation of Section 5 of the Securities Act of 1933. But according to the court, Ripple’s programmatic sales of XRP through crypto exchanges, Ripple using XRP to pay employees and service providers and Ripple executives’ personal sales of XRP through exchanges are not investment contracts and therefore not sales of unregistered securities.
The court’s analysis focused on the Howey test for investment contracts, measuring each of the four types of XRP transactions at issue against the well-established factors for identifying a security. In a win for Ripple, the court did not waste time analyzing whether the XRP token itself was an investment contract and therefore a security. It stated that XRP “is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract.”
The court repeatedly emphasized the importance of evaluating the “economic reality” of the transaction at issue in order to appropriately apply the Howey standard. In the discussion regarding Ripple’s sales to institutional buyers, the court efficiently moved through its analysis that the first two Howey prongs were satisfied. In assessing whether the institutional buyers were purchasing the XRP for speculative motives, the court instructed that this should be an objective analysis of the promises and offers made to investors, not the specific reason for each individual investor’s decision.
The court points to Ripple’s marketing materials to institutional buyers that tied the success of Ripple overall to the success of XRP and its increase in value. Notably, Ripple’s marketing efforts highlighted that one of the value drivers for XRP is the talent of the Ripple team building the ecosystem around XRP. Combined with problematic public statements by Ripple executives that Ripple was committed to investing its capital in ways that would increase the price of XRP, the court found that the third Howey prong was satisfied.
The court bolstered this finding by analyzing the economic reality of the sales to institutional buyers, which were made pursuant to sales contracts that included lock-up provisions and resale restrictions. The court referenced similar facts from the 2020 ruling in the SEC’s case against Telegram, and concluded that, “[t]hese various provisions in the Institutional Sales contracts support the conclusion that the parties did not view the XRP sale as a sale of a commodity or a currency—they understood the sale of XRP to be an investment in Ripple’s efforts.”
“Of course, some Programmatic Buyers may have purchased XRP with the expectation of profits to be derived from Ripple’s efforts. However, ‘[t]he inquiry is an objective one focusing on the promises and offers made to investors; it is not a search for the precise motivation of each individual participant.’ Telegram, 448 F. Supp. 3d at 371”
In a victory for Ripple, the court held that Ripple’s sales of XRP through exchanges were not unregistered securities offerings. The court’s analysis focused only on the third Howey prong and found that because these sales were blind, bid/ask transactions facilitated through an exchange, the purchasers were ignorant to the fact that Ripple was the counterparty. As a result, there is no way to conclude that the purchasers knew they were contributing money to Ripple with the expectation that the proceeds from their purchase would be used to increase the value of XRP. The court noted that it is possible that some of these programmatic purchasers bought XRP for speculative purposes, but their individual motivation was not relevant. Again citing the Telegram decision, the court emphasized that Ripple could not have made promises or offers to these buyers because it had no idea who they were. The court engaged in a similar analysis in finding in favor of Ripple regarding its executives’ personal sales of XRP through exchanges.
In evaluating the other distributions of XRP by Ripple as payment for employees or service providers, the court concluded that the first Howey prong was not satisfied since there was no money exchanged. These recipients of XRP did not put up any capital that would be reinvested into the business by Ripple.
If it survives a potential appeal by the SEC, this decision can be seen as a win for Ripple and a blow to the SEC’s jurisdictional reach with respect to the regulation of digital assets, at least insofar as secondary market trading is concerned. Shortly after the opinion was released, XRP was reinstated on a variety of crypto exchanges for trading. Market participants should take note, however, that this ruling does not address secondary market sales of all digital assets on exchanges, but rather only held that Ripple’s sales and its executives’ sales of XRP through an exchange were not unregistered securities offerings under the Howey test. Because this case was being evaluated by the court as cross-motions for summary judgment, it only narrowly decided the issues of law in dispute. The court also held that Ripple had fair notice that its sales to institutional buyers could be illegal securities offerings based on advice it received from a law firm, and there were issues of fact that a jury will need to decide in order to determine whether Ripple executives aided and abetted this unregistered offering of XRP to institutional buyers.