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A judge in the US District Court for Southern New York, Analisa Torres, has ruled that the defendants in the SEC v. Ripple case committed violations of the Securities Act of 1933. Torres also ruled that Ripple’s co-founders, Brad Garlinghouse and Chris Larsen, should stand trial in front of a jury for their violations.
In a move that was interpreted by some as a partial win for Ripple, Judge Torres also partially denied the SEC’s request for summary judgment.
The ruling states that Ripple illegally sold $728 million worth of unregistered securities via institutional sales of XRP. However, Torres ruled that Ripple did not illegally offer $757 million worth of unregistered securities via programmatic sales of XRP.
Nor, according to Torres, did Ripple illegally offer $609 million worth of other distributions (bonuses, compensation for labor, etc.) of XRP.
SEC v. Ripple: A split decision
In short, the judge issued a split decision. She granted in part and denied in part both parties’ motions for summary judgment (summary requests a judge to rule on a matter without deferring to a jury of peers).
However, the crypto community extrajudicially interpreted one ruling regarding programmatic sales of XRP — which account for less than 1% of XRP trading volume since 2017 — plus a confusingly-written page 15 — comparing the alphanumeric cryptographic sequence of code that is the literal XRP token to whiskey casks, payphones, condominiums, and beavers — as a ruling that meant that “XRP is not a security.”
The judge didn’t issue that ruling. Nevertheless, the price of XRP rallied over 60% within a few hours of the news.
The reality is more nuanced. In fact, Judge Torres explicitly declined to rule on the legality of 99% of XRP trading volume since 2017.
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The court does not address secondary market sales
After explaining that programmatic sales of XRP were not unregistered securities offerings and that programmatic sales accounted for less than 1% of global XRP trading volume since 2017, she wrote, “The Court does not address whether secondary market sales of XRP constitute offers and sales of investment contracts because that question is not properly before the Court.”
Secondary markets are regular crypto exchanges like Bitstamp or Coinbase.
In other words, Judge Torres didn’t rule on whether 99% of XRP transactions since 2017 were legal. Deciding that question was not necessary to resolve this lawsuit.
The judge simply ruled that institutional sales of XRP were illegal, but that programmatic sales and other distributions of XRP were not.
Institutional sales were pretty clearly unregistered securities transactions. Institutions signed literal paper contracts with Ripple and received investment materials from the company when buying XRP. Ripple never registered those sales despite it being required by law. Simple.
Regarding other distributions, Judge Torres ruled that no one “invested money” to receive those distributions — the first prong of the Howey Test. Because no one invested money, no unregistered investment contracts existed.
The most interesting category to the crypto community was the second category: Programmatic sales. So what, exactly, were programmatic sales of XRP?
As opposed to a typical crypto exchange transaction that matches a customer’s bid with another customer’s offer (often while secretly trading against its own customers), programmatic sales of XRP accounted for a tiny amount of trading volume since 2017 ($757 million versus trillions), sold in “blind bid/ask transactions,” via algorithms, where “purchasers did not know who was selling.”
These bids and offers weren’t manually placed by a human and didn’t involve any regular crypto exchange customer selling XRP.
These particular transactions weren’t unregistered offerings of securities, according to Judge Torres.
The history of crypto exchanges trading against their own customers
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Background on the lawsuit
Section 5 of the Securities Act of 1933 states that it’s “unlawful for any person, directly or indirectly… to offer to sell, offer to buy or purchase, or sell a security” unless it’s registered with the SEC or qualifies for a registration exemption.
The SEC originally filed a lawsuit in December 2020 alleging that Ripple, Garlinghouse, and Larsen raised $1.3 billion via unregistered securities sales. Rather than settle the matter, Ripple decided to fight it in court. The battle has lasted more than two and a half years.
Although they now have a ruling from a judge, either party may appeal to the Second Circuit. The lawsuit will probably continue for another year or two on appeal. If appealed to the Supreme Court, a final ruling could take many, many years.
The primary issue in this case involved whether Ripple’s native token, XRP, could meet the conditions of the Howey Test, which the SEC typically uses to determine whether an asset is a security. The SEC initially argued that Ripple and its cofounders failed to register its offering with the SEC and failed to make required disclosures regarding the nature of their XRP offerings.
The Howey Test specifically states that a transaction counts as a sale of a security if the following conditions are met:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To be derived from the efforts of others
This test stems from an early case that involved a company that sold orange groves to investors and then leased them back to manage them and sell the oranges, offering to share the profits with them. The company’s name was W. J. Howey Co.
The US Supreme Court ruled on Howey in 1946.
Summary
Torres ruled that Ripple’s XRP sales to institutional buyers were unregistered securities. Torres also ruled that Ripple had its constitutionally-guaranteed “fair notice.” The Howey Test applies to crypto; Ripple knew that the Howey Test applies to crypto; and Ripple knew it was violating Howey.
However, programmatic buyers — those who bought XRP through blind bid/ask transactions via an algorithm — didn’t necessarily know whether they were entering into an investment contract with Ripple. This blindness helped rule out the possibility that these XRP purchasers had a reasonable expectation of profit.
Most importantly, Torres declined to rule on whether 99% of sales of XRP on regular crypto exchanges were unregistered investment contracts.
Nonetheless, many exchanges have already decided to relist XRP.
Ripple and the SEC are still likely to go through years worth of appeals. Over a billion dollars worth of disgorgement and fines are at stake.