10 Basic Facts of the SEC v. Ripple Case and How the Judge Ruled Specifically
10 Basic Facts of the SEC v. Ripple Case # Background The SEC filed a lawsuit against Ripple Labs Inc. and its executives in December 2020, alleging that XRP was a security and that Ripple had conducted an unregistered securities offering. # Basic Facts 1. The SEC alleges that XRP is a security, and therefore, Ripple must comply with securities laws and register its offering with the SEC. 2. Ripple has argued that XRP is a currency, not a security. 3. The SEC claims that Ripple conducted an unregistered securities offering of XRP worth $1.3 billion. 4. Ripple has denied the SEC's allegations and has argued that the SEC did not provide clear guidance on whether XRP was a security or not. 5. The SEC has accused Ripple of misleading investors by selling XRP as an investment opportunity. 6. Ripple has argued that XRP is not an investment contract. 7. The SEC has cited multiple instances where Ripple executives made statements that indicated XRP was an investment opportunity. 8. Ripple has argued that the statements made by its executives were taken out of context. 9. The case has been closely watched by the cryptocurrency industry. 10. In August 2021, the judge denied Ripple's motion to dismiss the case, stating that XRP is a security and that Ripple must comply with securities laws. # Judge's Ruling The judge ruled that the SEC had shown that XRP was a security and that Ripple had conducted an unregistered securities offering. The case will proceed to trial, where Ripple will have the opportunity to present its case and defend itself against the SEC's allegations.
After nearly three years since the US SEC sued Ripple’s XRP token for being a security, there are finally some results. However, from the judge’s ruling, the question of whether Ripple’s XRP is a security or not remains in a state of “Schrödinger’s cat”.
On July 13, 2023, Judge Analisa Torres of the US Southern District of New York made a summary judgment in the SEC v. Ripple case. In the judge’s ruling, parts of Ripple’s XRP token were deemed to be securities, while others were deemed not to be securities.
The judge’s ruling stated, “Ripple’s XRP institutional sales constituted investment contracts and sales of unregistered securities, in violation of Section 5 of the Securities Act.” “Ripple’s programmatic sales, other distribution, and sales by Larsen and Garlinghouse do not constitute investment contracts and sales of unregistered securities.”
According to the court’s ruling document, the SEC v. Ripple case will enter the trial phase. The Southern District of New York stated that it will issue a separate order at the appropriate time to set the trial date and related pre-trial deadlines.
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After the ruling was announced, the cryptocurrency market reacted strongly, with XRP prices doubling overnight, and multiple tokens that were deemed securities by the SEC experiencing large gains.
However, while the cryptocurrency industry celebrates the rare “victory” against the US SEC, we still need to know some basic facts about this case, and whether the judge’s ruling is reasonable or not depends on how the judge specifically ruled and the main basis for his ruling.
10 Basic Facts
1. Before the end of 2020, Ripple held between 50 billion and 80 billion XRP. From 2013 to the end of 2020, Ripple conducted various sales and distributions of XRP.
2. First, Ripple directly sold XRP to some trading counterparts (mainly institutional buyers, hedge funds, and “on demand liquidity” customers) through its wholly-owned subsidiary under a written contract (“institutional sales”), and obtained $728 million.
3. Secondly, Ripple sold XRP “programmatically” through digital asset exchanges, that is, trading was conducted through trading algorithms (“programmatic sales”). These sales were blind trades: Ripple did not know who was buying XRP, and the buyer did not know who was selling.
4. The US SEC has charged Ripple with selling approximately $757.6 million worth of XRP in programmatic sales.
5. Ripple also distributes XRP as a form of payment service (“Other Distribution”). For example, Ripple distributes XRP to its employees as a form of employee compensation. Ripple also provides XRP to third parties developing new applications for XRP and the XRP Ledger as part of its Xpring initiative.
6. The US SEC has charged Ripple with distributing approximately $609 million worth of XRP to individuals and entities.
7. Ripple’s former CEO Larsen and former COO and current CEO Garlinghouse personally sold XRP on exchanges.
8. From 2013 to 2020, Larsen programmatically sold XRP on digital asset exchanges and derived at least $450 million from those sales.
9. From April 2017 to 2020, Garlinghouse sold XRP on digital asset exchanges and the US SEC has charged Garlinghouse with selling approximately $150 million worth of XRP during this period.
10. Defendants did not submit a registration statement for any offer or sale of XRP. Ripple did not publicly file any financial statements or other periodic reports, nor did Ripple or XRP submit any EDGAR filings with the Securities and Exchange Commission, such as Form 10-Q, Form 10-K, or Form 8-K related to XRP.
Based on these facts, the US SEC has made four primary allegations against Ripple and its executives:
Ripple engaged in three types of unregistered XRP investment contracts and sales: 1) sales of XRP to professional individuals and entities pursuant to written contracts (“Institutional Sales”) for approximately $728 million; 2) programmatic sales of XRP on digital asset exchanges (“Programmatic Sales”) for approximately $757.6 million; and 3) distribution of XRP pursuant to written contracts in “other than cash” form (“Other Distribution”) for XRP worth approximately $609 million.
4. Ripple’s two CEOs, Larsen and Garlinghouse, sold unregistered XRP as individuals, with Larsen receiving at least $450 million and Garlinghouse receiving $150 million.
How the judge ruled specifically
According to Judge Analisa Torres of the US Southern District Court in New York’s ruling, the primary basis for whether Ripple’s XRP token is a security or not is the Howey test. The judge categorized Ripple’s XRP token distribution and sales into two main categories: Institutional Sales and Programmatic Sales, and then applied the elements of the Howey test to the specific sales process.
1. The first element of the Howey test is whether “investment capital” is involved in the transaction.
In the SEC v. Ripple case, institutional buyers invested money by exchanging fiat or other currencies for XRP. Ripple argued that the difference between “investment capital” and “mere payment of funds” was significant, but Judge Analisa Torres believed that this distinction was not supported by legal precedent, and that the correct question was whether institutional buyers “provided capital,” “invested funds,” or “supplied” cash. The defendant did not deny the payment of funds existed; therefore, the court found that the element had been satisfied.
2. The second element of the Howey test is the existence of a “common enterprise.”
This can be demonstrated by “horizontal commonality,” which means that investors’ assets are pooled together, and each investor’s fate is tied to the success of the other investors and the overall enterprise. Ripple pooled the institutional sales funds into the bank account network of its various subsidiaries. In addition, the profitability of each institutional buyer is closely tied to the fate of Ripple and the other institutional buyers. When the value of XRP rises, the profits of all institutional buyers increase in proportion to the XRP they hold. Therefore, the court found that a common enterprise existed, as the record showed the pooling of assets and the fate of institutional buyers was tied to the success of the enterprise and other institutional buyers.
3. The third element of the Howey test is the “reasonable expectation of profits from the efforts of others.”
The court found that institutional buyers had a reasonable expectation when they purchased XRP that they would profit from Ripple’s efforts.
Therefore, the court found that Ripple’s XRP institutional sales constituted the offer and sale of unregistered investment contracts, in violation of Section 5 of the Securities Act.
In the SEC’s complaint, it claimed that in the programmatic sales made to the public buyers (“programmatic buyers”) on digital asset exchanges, “Ripple knew people were buying XRP for speculative investment” and “explicitly targeted speculators,” with “the goal of increasing speculative trading volume.”
Judge Analisa Torres found that the record did not establish the third element of the Howey test. Unlike institutional buyers who had a reasonable expectation that Ripple would use the funds raised through sales to improve the XRP ecosystem and increase XRP’s price, programmatic buyers could not reasonably expect the same result.
Ripple’s programmatic sales were anonymous buyer-seller transactions, with programmatic buyers unable to know whether their payments were being made to Ripple or to other sellers of XRP.
Since 2017, Ripple’s programmatic sales have accounted for less than 1% of the global XRP trading volume (note: note the difference between traffic and stock). Therefore, the vast majority of individuals who purchase XRP from digital asset exchanges have not invested their funds in Ripple.
The SEC argued that it was not enough for Ripple to explicitly target speculators or for Ripple to know that people are speculating on XRP as an investment, because the speculative motive “does not indicate the existence of an ‘investment contract’ under [securities law].” Judge Analisa Torres believed that the expected return of public buyers did not depend on the continuous efforts of others, and many programmatic buyers may have bought XRP with the expectation of profit, but they did not get this expectation from Ripple’s efforts, especially since programmatic buyers did not know that the XRP they bought came from Ripple and its employees and executives.
Judge Analisa Torres stated that, as far as programmatic sales are concerned, Ripple has not made any promises, because Ripple does not know who is buying XRP, and buyers do not know who is selling it.
Therefore, Judge Analisa Torres concluded that Ripple’s programmatic sales of XRP do not constitute an offer and sale of investment contracts.
Similarly, other distributions as well as Larsen and Garlinghouse’s sale of XRP on exchanges are not investment contracts and sales of registered securities.