Editor’s Note: The NYU Law Program on Corporate Compliance and Enforcement is following the recent decision in SEC v. Ripple Labs, Inc., in which the district court decided competing summary judgment motions for both the SEC and Ripple by holding that contractual sales of XRP, Ripple’s native token, to institutional investors were securities while the XRP token itself was not.  In this post, former SEC attorneys and federal prosecutors and current securities regulatory and white collar attorneys react to the decision.

Implications for Public Policy and Legislation

by Joseph Hall, Robert Cohen, Fiona Moran, and Zachary Zweihorn

The paradox in Judge Torres’s ruling is that the protections of the securities laws accrue to sophisticated investors who purchase digital assets directly from an issuer or affiliate—but not to retail investors who purchase in anonymous secondary markets.

While backward from a policy perspective, this result flows from the SEC’s need to rely on the proposition that digital assets are “investment contracts.” There is logic in concluding that a purchaser who knows they’re in privity with the issuer is entering an investment “contract,” while a secondary-market trader is not.

As this implication of Judge Torres’s decision becomes clearer, Congress and other policymakers may come to be persuaded that our 1930s-era securities and commodities laws are due for an update.

Joseph Hall, Robert Cohen, Fiona Moran, and Zachary Zweihorn are Partners at Davis Polk & Wardwell LLP. Earlier in their careers, Hall and Cohen were attorneys at the SEC.

The SEC v. Ripple Decision: Are Tokens Trading in the Secondary Markets Investment Contracts?

by David I. Miller

The highly anticipated summary judgment decision in SEC v. Ripple Labs, Inc., et al. has been viewed by several in the cryptocurrency community as a victory for Ripple Labs, Inc. and the individual co-defendants (collectively, “Ripple”), and for cryptocurrency enterprises more broadly.  The question before the Court was whether Ripple’s offers and sales of its XRP token were “investment contracts” under SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and thus transactions in a security requiring registration with the SEC.[1]  Notably, in arguing that XRP was not a security, Ripple urged the Court to look to the so-called “blue sky” law cases on which Howey relied to find that all investment contracts must also contain the following “essential ingredients”: (1) a contract between a promoter and an investor that establishes the investor’s rights as to an investment; (2) the contract imposes post-sale obligations on the promoter to take specific actions for the investor’s benefit; and (3) the contract grants the investor a right to share in profits from the promoter’s efforts to generate a return on the use of investor funds.[2]  While in its decision the Court rejected the proposed “essential ingredients” test, and focused on Howey’s language, the Court declined to evaluate the merits of the first “essential ingredient”—i.e., whether an “investment contract” under Howey presumes the existence of an underlying contract between the parties—because “in each instance where Defendants offered or sold XRP as an investment contract, a contract existed.”[3]

In ruling on dueling summary judgment motions, the Court found that the SEC showed that the “Institutional Sales”—through which Ripple sold XRP directly to institutional buyers, hedge funds, and other sophisticated customers pursuant to written contracts—satisfied Howey with horizontal commonality (“each Institutional Buyer’s ability to profit was tied to Ripple’s fortunes and the fortunes of other Institutional Buyers because all Institutional Buyers received the same fungible XRP”) and because the purchasers had “a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”[4]  But the Court contrasted those sales with the “Programmatic Sales”—XRP sold through the use of trading algorithms on digital asset exchanges—where “Ripple’s Programmatic Sales were blind bid/ask transactions, and Programmatic Buyers could not have known if their payments of money went to Ripple, or any other seller of XRP.”[5]  The Court added, “[i]t may certainly be the case that many Programmatic Buyers purchased XRP with an expectation of profit, but they did not derive that expectation from Ripple’s efforts (as opposed to other factors, such as general cryptocurrency market trends)—particularly because none of the Programmatic Buyers were aware that they were buying XRP from Ripple.”[6] 

There are several key takeaways from the Court’s decision.  Judge Analisa Torres made clear that the relevant Howey inquiry is not whether a particular asset is, in and of itself, determined to be a security, but instead whether the circumstances of the asset’s offer or sale—the totality of the circumstances surrounding the transaction—render it an investment contract and thus a security.  Further, as in the Telegram, Kik, and LBRY cases, the Ripple court continued to support a pragmatic approach to Howey, favoring an observance of the “economic realities” behind cryptocurrency offerings in lieu of “unrealistic and irrelevant formulae.”[8]  Also, while the Court declined to adopt the “essential ingredients” test as promulgated by Ripple, the Court did not reach the merit of the first element of that test; namely, whether the existence of an “investment contract” requires the presence of an underlying contract between two parties (be it written, oral, or implied)—because a written contract existed for the Institutional Sales.  Finally, the critical distinction drawn by the Court between Ripple’s Institutional Sales and its Programmatic Sales was that institutional purchasers—generally highly sophisticated professional entities in a written contractual relationship with Ripple—reasonably expected that the funds they provided to Ripple would be used to increase XRP’s value. 

In sum, the Ripple decision is important precedent in an uncertain and developing cryptocurrency enforcement space.  If not modified on appeal, Ripple may have significant utility for cryptocurrency exchanges (like those currently in litigation with the SEC) and secondary market purchasers who can argue that tokens trading in the secondary markets—where there may be no agreement or expectation that an issuer or promoter will undertake efforts to enhance token profits—are not securities.  To this end, it bears noting that the “investment contract” in Howey was the land sale agreement with orange grove servicing, not the oranges.  Regardless of whether the decision explicitly supports the proposition that a contract is required for an investment contract, the Ripple opinion appears to draw a critical distinction between direct contractual efforts between issuers/promoters and purchasers and market purchasing in the token space, and thus this decision could be the first major chink in the SEC’s armor in its cryptocurrency enforcement efforts.

[1] Under Howey, an “investment contract” is a “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 a third party.”  Howey, 328 U.S. at 298-99.

[2] See SEC v. Ripple Labs, Inc. et al., 20-cv-10832-AT-SN, ECF No. 825, Defendants’ Motion for Summary Judgment at 18-21.

[3] ECF No. 874, Summary Judgment Decision at 13.

[4] See id. at 16-22.

[5] Id. at 23.

[6] Id. at 24.  The Court also found that Ripple’s “Other Distributions” of XRP—through which Ripple distributed XRP as a form of payment for services (e.g., to employees as a form of compensation)—did not satisfy Howey’s first requirement that there be an “investment of money” as part of a transaction.  See id. at 26.  Additionally, the Court dispensed with the issue of the individual co-defendants’ personal sales of XRP.  As with Ripple’s Programmatic Sales, the Court held that individual defendants’ XRP sales were programmatic sales on various digital asset exchanges made through blind bid/ask transactions.  Thus, the record did not establish the third Howey prong as to these transactions.  See id. at 27-28.

[7] Id. at 13-14 (citations omitted).

David I. Miller is a Shareholder at Greenberg Traurig, LLP and a former Assistant US Attorney for the Southern District of New York (SDNY).

Ripple Wins the “Split” Decision

by Daniel Payne

There was a mildly viral meme from several years back showing a college football coach cheering ecstatically at the end of the game.  The joke?  The screen showed the score was “0-0.”  Turns out he was cheering a missed field goal that sent the tied game into overtime, but the meme conveys the funny feeling of winning a tied game.

Judge Torres’s ruling on the cross-motions for summary judgment in the SEC v. Ripple Labs et al. case shows that one side really can win a split decision.  Ripple Labs, Case No. 1:20-cv-10832, Dkt. No. 874 (S.D.N.Y. July 13, 2023).  Judge Torres ruled that Ripple Labs’ sales of hundreds of millions of dollars of XRP to institutional investors constituted sales of unregistered securities (a win for the SEC), but programmatic sales on secondary exchanges (along with secondary market sales by Ripple executives) did not (a win for Ripple and those executives).  A Solomonic split-the-baby ruling, except that the most important ruling was unambiguously in Ripple’s favor: “XRP, as a digital token, is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract.” P. 15.  Even if the score was somewhat “tied,” Ripple (and the rest of the crypto community) got to cheer ecstatically because this was a win.

That XRP the token is not a security is a monumental shift in the U.S. crypto regulatory environment.  The SEC has long taken the position that essentially every token other than Bitcoin (and possibly Ether) is a security.  That theory has been rejected.  The SEC is currently suing multiple digital asset exchanges for failing to register as securities exchanges on the theory that their listed digital assets are securities.  That theory appears to have been kneecapped.  XRP has regulatory certainty that it is not a security, which is something no other digital asset (including bitcoin!) has.  The SEC’s self-proclaimed “undefeated” record in crypto enforcement actions is toast and, if the recent preliminary hearing in SEC v. Coinbase is any guide, deference to the SEC has started to evaporate in crypto cases.  The politics of new crypto legislation may have shifted in favor of a new law.

Although we will have to wait to see how much influence this decision has on other pending cases and what the appellate courts do if and when they are asked to review it, Ripple seems to have won this split decision.

Daniel Payne is a Senior Fellow at the International Congress of Blockchain Advisors and serves as in-house counsel to blockchain brands.

The Court’s Decision in SEC v Ripple Forces Everyone to Ask The Right Questions

by Avi Weitzman and Nicolas Morgan

Judge Torres’ recent Ripple decision is a clear rebuke to the SEC’s broadside against the crypto industry.  And while the SEC initially claimed to be “pleased” with part of the result, SEC Chair Gensler later acknowledged he was “disappointed” with the ruling, and, most recently, the SEC signaled its intent to appeal.

Many of the issues that appeared poised to take center stage in the run-up to the decision fell by the wayside (“Fair Notice,” “Major Questions,” internal SEC debate).  However, by returning to the well-worn Howey framework, Judge Torres issued an important reminder as to first principles: unlike “stocks” and “bonds,” which are explicitly enumerated as securities by statute, determining whether a digital token is an “investment contract” depends on the particular facts and circumstances of specific transactions.  As a result, Judge Torres made clear that the token created by Ripple (the XRP token) “is not in and of itself a ‘contract, transaction[,] or scheme.’”  Howey requires analysis of transactions rather than objects.

Relying on Howey’s dynamic, transaction-based framework (rather than the static framework implying that once an object is a security, it’s always a security), yielded three different results in Judge Torres’s ruling, depending on the facts and circumstances of the transactions involved.  The Second Circuit will weigh in eventually—as might the Supreme Court one day—but in the meantime Judge Torres reminded us all that asking “Is XRP a security?” misses the point under Howey.  The question the SEC, crypto market participants, and judges should be asking is:  “Is this transaction an ‘investment contract’?”  Particularly with the SEC’s recent crypto crackdown, the Ripple decision foreshadows years of continued litigation regarding the application of the Howey test to crypto transactions.

Avi Weitzman and Nicolas Morgan are Partners at Paul Hastings, LLP. Weitzman was previously a federal prosecutor at the SDNY and Morgan was previously a federal prosecutor and an SEC attorney.

Court Order on Ripple Motions for Summary Judgment Provides No Further Clarity on Crypto Securities Question

by Ijeoma Okoli

In the waning days of the Trump Administration, the Securities and Exchange Commission (“SEC”) charged Ripple Labs (“Ripple”) and its former and current CEOs with conducting a $1.3 billion unregistered securities offering.  Over two and a half years and one presidential administration later, we are nowhere close to a final resolution of the case, but the United States District Court for the Southern District of New York has ruled on summary judgment motions filed by both parties in the case. Who won round 1 of SEC v. Ripple?  Both the SEC and Ripple won.  The court sided with the SEC’s assertion that the sales of XRP, the crypto token native to Ripple’s blockchain, to institutional investors were unregistered securities offerings, and at the same time sided with Ripple that the anonymous primary sales of XRP to retail investors on exchanges were not unregistered offerings of securities and therefore not subject to registration requirements pursuant to the Securities Act of 1933. 

The real losers of round 1 were retail investors.  The court’s ruling that the primary sales[1] to investors on crypto exchanges (where retail investors have access to purchase crypto assets) did not satisfy all the prongs of an investment contract under the authoritative SEC v. Howey[2] US Supreme Court case, and therefore did not constitute an offering of securities seems to strip retail investors of protections afforded to institutional investors.  In ruling on the summary judgment motions, the United States District Court of the Southern District of New York has perhaps unwittingly injected further confusion into the crypto market and put additional pressure on the US House of Representatives and Senate to act on crypto legislation.  The ruling that the sales of XRP to institutional investors were subject to the protections afforded investors contained in the Securities Act of 1933, as amended, but that the sales of the same assets by the same entity to the retail investors at issue in the case did not warrant the same protections, even as the court acknowledged that such investors were “generally less sophisticated as an investor,” seems incongruous and perhaps unjust.

The opening paragraph of the Securities Act of 1933 indicates that it is “an act to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof, and for other purposes.”[3]  Although protections against fraud or fraudulent practices may still be available to retail investors regardless of the status of the purchased asset, examples of which can be found in the SEC’s enforcement action against crypto exchange, Binance[4] and the Federal Trade Commission’s enforcement action against crypto lender, Celsius[5], both of which look to prosecute fraud under multiple different statutes, it should be uncontroversial to assert that disclosure and other investor protections, if provided to institutional investors should also be provided to retail investors regardless of the classification of the investment asset as a commodity, security or something else.

[1] It is worth noting that the court did not address the issue of “whether secondary market sales of XRP constitute[ed] offers and sales of investment contracts because that question [wa]s not properly before the Court.“  See note 16 of SEC v. Ripple Labs, Inc., No. 20-CV-10832 (S.D.N.Y. July 13, 2023).

[2] S.E.C. v. W.J. Howey Co., 328 U.S. 293 (1946).

[3] See introductory paragraph to Securities Act of 1933, 15 U.S.C. § 77a.

[4] SEC v. Binance Holdings Limited, et al., No. 1:23-01599 (D.C. June 5, 2023).

[5] Federal Trade Commission v. Celsius Network Inc., et al., No. 1:23-CV-6009 (S.D.N.Y. July 13, 2023).

Ijeoma Okoli is a finance and regulatory lawyer and strategic adviser on digital assets; a co-Director of the Digital Economy Initiative, an independent digital assets think tank in London focused on US and UK digital assets public policy and a founding member and limited partner of Impact X Capital Partners, an ESG focused venture capital fund. 

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