Latest Ripple Development Highlights SEC’s Crypto Approach – Fin Tech
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The U.S. Securities and Exchange Commission has shown continued
commitment to regulating digital assets through enforcement
actions.
While the SEC’s actions and public pronouncements
consistently take the position that the application of securities
law to digital assets is clear, the agency’s “regulation
by enforcement”1 approach has led many to call for
cooperation with the industry and for rulemaking, which would
provide far greater certainty.
In this context, recent developments in the SEC v. Ripple Labs
case demonstrate that the question of whether any particular
digital asset should be considered a security remains consequential
and contentious.
On Sept. 17, both the SEC and Ripple Labs Inc., with its
executive chairman and CEO, filed motions for summary judgment in
the SEC’s U.S. District Court for the Southern District of New
York suit alleging that Ripple Labs sold billions of units of a
virtual currency, XRP, which the SEC believes should be considered
a digital asset security.2
According to the SEC’s complaint, the sale of XRP
constituted an unregistered sale of securities in violation of the
registration and disclosure requirements of federal securities
laws.3
Ripple is a private financial technology company that was
founded in 2012 with a particular focus on facilitating
cross-border payments. Its 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.4
Over the years the defendants have sold and distributed some XRP
currency, transactions which are being challenged by the SEC as
unregistered securities sales.5
The SEC’s Position
The question of whether XRP is a security and therefore subject
to the requirements of the federal securities laws is a significant
one for the digital asset industry, which has repeatedly asked for
clear guidance from the SEC on the application of securities law to
these novel assets and technologies.6
SEC Chairman Gary Gensler has been aggressive about claiming
jurisdiction over digital assets,7 while publicly
questioning the digital asset industry’s calls for greater
guidance, claiming that the agency has “spoken with a pretty
clear voice.”8
In its case against Ripple, the SEC alleges that XRP should be
considered a digital asset security because it qualifies as an
investment contract under the traditional securities test laid out
in the U.S. Supreme Court’s 1946 decision in SEC v. Howey Co.:
“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.”9
In particular, the SEC argues that “economic reality”
indicates that “a purchase of XRP is an investment in a common
enterprise with other XRP holders and with
Ripple.”10 The SEC also points to multiple public
representations in which Ripple “publicly tied the potential
for profit to its promised entrepreneurial and managerial
efforts.”11
The complaint’s arguments are consistent with the position
the SEC has taken in other recent enforcement actions involving
cryptocurrency assets, including its July 21 insider trading charge
against a former Coinbase Global Inc. exchange manager, SEC v.
Wahi.12
Both in Ripple and Wahi, the SEC relied on its broad
interpretation of the term “investment contract” under
Howey to assert authority over transactions involving digital
assets. Its Ripple arguments are also consistent with recent public
pronouncements in which the SEC has stated that the securities
laws, and which digital assets those laws govern, are sufficiently
clear that additional guidance is unnecessary.13
In particular, Gensler’s view is that “nothing about
the crypto market is incompatible with securities laws,”
concluding that “most crypto tokens are investment contracts
under the Howey Test,” and thus subject to the securities laws
and SEC jurisdiction.14
He warned companies acting as intermediaries in digital asset
transactions that they should “come in, talk to us, and
register.”15
Ripple’s Response
Ripple pushed back in its own summary judgment motion, arguing
that distribution of XRP lacks the “essential
ingredients” to be considered investment contracts under the
Howey test.16
First, Ripple noted 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.17
Second, Ripple argued 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.18
Third, Ripple pointed 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.19
In essence, Ripple asserts that sales of XRP merely represent
sales of assets, not securities, and 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.”20
As such, Ripple contends that the SEC’s position, at least
if it were taken literally and applied consistently, would convert
sales of ordinary assets — such as gold and soybeans —
into securities transactions.21
Looking Forward
These concerns about potential consequences of the SEC’s
aggressive reading of the securities laws have been voiced by other
regulators as well, most notably by one of the SEC’s primary
competing regulators in the digital asset space — the
Commodity Futures Trading Commission.
In a public statement published on the same day that the Wahi
indictment and complaint were filed, CFTC Commissioner Caroline
Pham noted that the SEC’s decision to pursue the former
Coinbase manager’s actions as securities fraud “could have
broad implications beyond this single case, underscoring how
critical and urgent it is that regulators work together” and
“[engage] the public to develop appropriate policy with expert
input.”22
These calls for cooperation were joined by SEC Commissioner
Hester Peirce,23 who has suggested that the SEC
“need[s] to commit to working with … companies to craft
sensible, timely, and achievable regulatory
paths.”24
Gensler has at least implicitly determined to take a different
path, given that these calls for greater cooperation and regulatory
certainty have to date not resulted in a more nuanced regulatory
approach.
We may also get some insight into the SEC’s internal
deliberations regarding this topic, given that the SEC was recently
ordered to disclose emails written by a former SEC director of the
Division of Corporation Finance as part of an ongoing dispute about
the scope of discovery in the Ripple case.25
Despite the SEC’s continued aggressive positioning as it
asserts its authority over digital assets, the Ripple 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 10 years, particularly as the term “digital assets”
encompasses a broad spectrum of assets with varying properties and
characteristics.
While the SEC has at least in some contexts historically favored
flexibility in the application of the securities laws — for
example, in the insider trading context — the regulation of
digital assets would seem to be a place in which certainty would
assist all parties in making informed decisions and moving an
innovative industry forward in a more orderly
fashion.26
While it will not substitute for a robust regulatory framework,
perhaps a ruling on Ripple’s summary judgment motion will shed
some light on how digital assets will be treated moving forward. It
will not, however, end the debate as to whether the SEC’s
approach to digital asset regulation is an appropriate one.
Footnotes
1. Statement of Commissioner Caroline D. Pham on SEC v.
Wahi, CFTC (Jul. 21, 2022).
2. Complaint at 1-2, SEC v. Ripple Labs, 20-cv-10832
(S.D.N.Y. Dec. 22, 2020).
3. Id.
4. 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).
5. Complaint at 1-2, SEC v. Ripple Labs, 20-cv-10832
(S.D.N.Y. Dec 22, 2020).
6. Coinbase, Petition for Rule-making—Digital Asset
Securities Regulation, (Jul. 21, 2022).
7. Chair Gary Gensler, Kennedy and Crypto, SEC (Sept. 8,
2022).
8. Id.
9. Complaint at 6-7, SEC v. Ripple Labs, 20-cv-10832
(S.D.N.Y. Dec. 22, 2020).
10. Plaintiff’s Memorandum of Law in Support of Its
Motion for Summary Judgment at 2, SEC v. Ripple Labs, 20-cv-10832
(S.D.N.Y. Dec. 22, 2020).
11. Id.
12. SEC Charges Former Coinbase Manager, Two Others in
Crypto Asset Insider Trading Action, SEC (Jul. 21,
2022).
13. Chair Gary Gensler, Kennedy and Crypto, SEC (Sept. 8,
2022).
14. Id.
15. Id.
16. Defendants’ Memorandum of Law in Support of Their
Motion for Summary Judgment at 1-2, SEC v. Ripple Labs, 20-cv-10832
(S.D.N.Y. Dec. 22, 2020).
17. Id. at 2.
18. Id.
19. Id. at 3.
20. Id.
21. Id.
22. Statement of Commissioner Caroline D. Pham on SEC v.
Wahi, CFTC (Jul. 21, 2022).
23. Caroline D. Pham and Hester M. Peirce, Making
Progress on Decentralized Regulation — It’s Time to Talk
About Crypto Together, The Hill (May 26, 2022).
24. Commissioner Hester M. Peirce, Statement on
Settlement with BlockFi Lending LLC, SEC (Feb. 14,
2022).
25. Order Overruling SEC’s Objections, Sept. 29,
2022, SEC v. Ripple Labs, 20-cv-10832 (S.D.N.Y. Dec. 22,
2020).
26. Coinbase, Petition for Rule-making—Digital
Asset Securities Regulation, (Jul. 21, 2022).
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