Federal court rules Ripple’s sale of XRP on crypto exchanges are not securities transactions

SEC v. Ripple Labs Inc.
Date: June 14, 2023

Issue: Whether Ripple Labs Inc.’s sales and distribution of the XRP digital token constituted the sale of unregistered securities.

‌Case Summary:  A Manhattan (New York) federal district court determined Ripple’s “institutional sales” of XRP violated the Securities Act of 1933, but all other ways Ripple sold or distributed XRP did not.

Ripple is a technology company which operates as an enterprise blockchain company. The company’s mission is to realize an “Internet of Value” by using technology to facilitate the transfer of value across the internet. Ripple offers XRP, a cryptocurrency token designed to provide an energy-efficient alternative to other blockchain tokens.

The Securities & Exchange Committee (SEC) launched an enforcement action against Ripple in 2020. The SEC alleged Ripple engaged in the unregistered offer and sale of securities by offering XRP to investors. SEC alleged Ripple engaged in three categories of unregistered XRP offers and sales from 2013 to the end of 2020. First, SEC alleged Ripple made “Institutional Sales” by selling XRP to institutional investors, such as hedge funds, and institutional buyers to raise money to finance its operations and build a global payments network. Ripple allegedly raised approximately $728.9 million through these Institutional Sales. Second, SEC alleged Ripple made “programmatic sales” by selling XRP on digital asset exchanges or through trading algorithms. Ripple allegedly sold $757.6 million of XRP in Programmatic Sales and used the proceeds to fund its operations. Third, SEC alleged Ripple made “other distributions” when it distributed XRP as a form of payment for services, including employee compensation and payments to fund third parties to develop new applications for XRP and the XRP ledger.

SEC sued Ripple alleging its sales and distributions were unlawful offers and sales of securities in violation of Section 5 of the Securities Act. According to SEC, Ripple sold XRP as an “investment contract” which is a security as defined by the Securities Act. Ripple contended it did not sell XRP as an investment contract, and therefore no registration statement was required. The primary test for determining whether a given digital asset constitutes an investment contract, and therefore a security, is the “Howey test” established in SEC v. W.J. Howey Co. Under the Howey test, an investment contact exists “when a person: (i) invests his money, (ii) in a common enterprise, and (iii) is led to expect profits solely from the efforts of the promoter or a third party.”

Delivering a split decision on competing summary judgment motions, the court found XRP, as a digital token, is not a contract, transaction, or scheme to qualify as an investment contract under the Howey test. The court rejected the token-as-security argument for XRP and assessed the totality of the circumstances for each type of transaction at issue. The court found that two of the three categories of XRP transactions did not involve securities to trigger liability under federal securities laws.

The court determined Ripple’s Institutional Sales of XRP constituted an investment contract and violated the Securities Act. The court found each element of Howey satisfied, ruling the evidence supported an investment of money by the institutional investors; “horizontal commonality” between Ripple and the Institutional Sales investors based on a pooling of investor funds tied to the success of the common enterprise; and Ripple’s communications, marketing campaign, and the nature of the Institutional Sales would lead a reasonable investor to have an expectation of profits based on Ripple’s efforts.

However, the court ruled Ripple’s programmatic sales of XRP did not constitute an investment contract. The court determined the third prong of the Howey test was not met because the Programmatic Sales were blind bid/ask transactions, and investors could not know the seller from which they XRP. According to the court, institutional buyers knowingly purchased XRP directly from Ripple under a contract, but programmatic buyers did not know to whom or what it was paying its money.” For this reason, buyers were not led to expect profits solely from the efforts of the promoter or a third party, and thus the transaction was not an investment contract.

Finally, the court concluded the “other distributions of XRP to employees and third parties as compensation did not satisfy the Howey Test because these distributions did not involve an investment of money.

Bottom Line: The SEC has appealed the district court’s decision. While this is a major ruling, it is not binding on other district courts, even those in the Southern District of New York.

Documents: Opinion