The last few months have seen a seismic shift in the crypto industry, putting the Securities and Exchange Commission squarely in the hot seat. The agency seems to have taken the wrong regulatory approach at every possible juncture: cozying up to fraudster Sam Bankman-Fried while excoriating crypto innovators and companies that seek to do business lawfully in the United States.
We’ve seen in the cases of SEC v. LBRY, SEC v. Ripple, Grayscale v. SEC and others that the commission’s overriding desire to protect entrenched political interests instead of consumers facilitated the demise of well-intentioned companies, the loss of hundreds of millions of dollars in consumers’ wealth and massive fraud going unchecked, like at FTX.
The courts have attempted to right the ship, pushing back on the SEC’s “arbitrary and capricious” rejection of its Bitcoin ETF and issuing a legally sound victory for Ripple on core legal questions in the SEC’s lawsuit against the payments company. In fact, the Ripple decision from Judge Analisa Torres of the Southern District of New York could be considered a roadmap for other crypto companies because she carefully laid out how and why the facts and circumstances of cryptocurrency offers and sales matter under existing securities law.
At its heart, this “Ripple roadmap” recognizes the nuances of how unique digital assets and their trading can be while still applying existing securities law dating back to the 1946 U.S. v. Howeydecision, where the Supreme Court defined what makes a security.
The SEC tried to circumvent a strict application of the Howey test by arguing an alternative “fact” without citing any case law to support it. The XRP token itself, the SEC argued, is a “digital asset security” by its very nature, and all sales, therefore, met the Howey test as investment contracts in Ripple. The commission, therefore, had indiscriminate power to regulate it wherever and whoever bought or sold it, no matter what those facts and circumstances might be.
Torres reaffirmed that even with this new technology, facts and circumstances around specific offers and sales are highly relevant in a Howey analysis. Tokens like XRP are traded on crypto exchanges through blind bid/ask transactions between parties who don’t know each other, and Torres concluded that the SEC can’t ignore those facts and circumstances like it tried to do in Ripple.
The judge reviewed all individual sales categories about which the SEC sued Ripple and its two top executives, Brad Garlinghouse and Chris Larsen, and the vast majority of them were blind bid/ask transactions on exchanges. Torres also acknowledged that thousands of retail XRP holders who submitted affidavits to the court didn’t know there was a company named Ripple when they acquired their tokens in those transactions on exchanges. The SEC failed to show how Ripple’s public communications about XRP could have reached those buyers to prove the existence of a package of promises that would make XRP an investment contract in Ripple and, therefore, a security.
In short, objective facts and circumstances in the crypto space provide plenty of legal room for token distributions to not be securities. As SEC Chairman Gary Gensler states, Congress did give the commission “a broad brush” to apply the Howey test. But the Ripple roadmap clarifies it’s not so broad that the SEC can make up facts and circumstances that don’t exist. It could serve as a template for rules that adapt to the unique needs of crypto asset owners in the same way the SEC has adapted a wealth of rules in the past. Securities lawyers know that the commission created new and adapted registration rules for asset-backed securities, variable rate securities, master limited partnerships, and new communication rules for CEOs’ online delivery and social media communication.
The saga of SEC v. Ripple and its implications for similar enforcement actions is a testament to the resilience of industry players committed to navigating the complex web of regulations. It invites regulators to recalibrate their approach and align with technological advancements rather than stifle them. It’s a call for a regulatory framework that supports innovation, ensures market integrity and fosters the United States’ position as a leader in the crypto space.
SEC v. Ripple offers a lens through which we can re-examine the role of regulation in the digital age. It highlights the importance of a tailored approach to oversight, one that distinguishes between different types of crypto assets, their uses and the facts around how they are traded. This will enable a regulatory environment that is precise and adaptive, rather than one that is overbroad, stifling and, ultimately, not following the law.
