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A US federal judge has partially sided with Ripple Labs in a Securities and Exchange Commission (SEC) lawsuit alleging the San Francisco-based blockchain developer issued an unregistered security offering with its $XRP token.
The summary judgment comes after a three-years long legal battle and could set a precedent for future token classification cases.
The judge granted part of the SEC’s motion pertaining to institutional sales.
“Because the Court finds that only the Institutional Sales constituted the offer and sale of investment contracts, the Court does not address Defendants’ asserted fair notice defense as to the other transactions and schemes,” the judge ruled.
The court ruled against Ripple’s “essential ingredient” defense, in which Ripple argues that a physical contract must exist in order to be considered an investment contract.
The court assessed the three-pronged Howey test in its ruling as follows:
Howey prong 1:
“The first prong of Howey examines whether an “investment of money” was part of the relevant transaction.
Defendants do not dispute that there was a payment of money; the Court finds, therefore, that this element has been established.”
Howey prong 2:
“The second prong of Howey, the existence of a “common enterprise,” 328 U.S. at 301, may be demonstrated through a showing of “horizontal commonality.”
“The Court finds the existence of a common enterprise because the record demonstrates that there was a pooling of assets and that the fortunes of the Institutional Buyers were tied to the success of the enterprise as well as to the success of other Institutional Buyers.”
Howey prong 3:
“The third prong of Howey examines whether the economic reality surrounding Ripple’s Institutional Sales led the Institutional Buyers to have “a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
“Based on the totality of circumstances, the Court finds that reasonable investors, situated in the position of the Institutional Buyers, would have purchased $XRP with the expectation that they would derive profits from Ripple’s efforts.”
The court ruled against Ripple’s “essential ingredient” defense, in which Ripple argued that a physical contract must exist in order to be considered an investment contract.
“In each instance where Defendants offered or sold $XRP as an investment contract, a contract existed,” the judge wrote in Thursday’s summary judgment.
“For the foregoing reasons, the SEC’s motion for summary judgment is GRANTED as to the Institutional Sales, and otherwise DENIED. Defendants’ motion for summary judgment is GRANTED as to the Programmatic Sales, the Other Distributions, and Larsen’s and Garlinghouse’s sales, and DENIED as to the Institutional Sales.”
The role of the Hinman docs
In December 2020, the SEC alleged Ripple Labs illegitimately raised $1.3 billion by selling $XRP to investors, starting in 2013.
A legal battle ensued, and by September 2022, the SEC and Ripple Labs had agreed to bypass a trial and allow a judge to issue a summary judgment based on the evidence submitted.
Part of the Ripple team’s strategy involved gaining access to what are now known as the Hinman documents — internal SEC drafts and emails relating to a former director’s speech more than four years ago.
William Hinman, the former director of the SEC’s Division of Corporation Finance, said he didn’t consider ether (ETH) a security in the 2018 speech and suggested tokens could initially start out as securities but evolve into something else over time.
Prior to his SEC appointment, Hinman worked at Simpson Thacher, a law firm that sits on the Enterprise Ethereum Alliance, which is dedicated to promoting the commercial use of Ethereum. Since leaving the SEC, Hinman has returned to Simpson Thatcher.
The emails highlight a conflict of interest, Ripple’s defense argued, suggesting that the regulator may be cherry-picking which projects to target. Although, Hinman’s comments never reflected official SEC stance. The emails were later released to the public in June.
The Hinman documents’ true impact on the Ripple outcome is unclear. Still, the ruling comes months after the SEC classified nine other cryptocurrencies as securities in an enforcement action against a former Coinbase employee for insider trading, and one months after it named nearly two dozen tokens across its Coinbase and Binance suits.
While none of the token issuers mentioned in complaints are listed as defendants, industry members speculated that the SEC may choose to bring charges against their issuers at a later date.
After the ruling on Ripple, however, things may change.
In the years since the SEC sued Ripple, the agency has charged firms including the Tron Network and founder Justin Sun, Kraken, Nexo and BlockFi. The latter three elected to settle.