Background

On September 17, 2022, both the Securities and Exchange Commission and Ripple Labs, Inc. (with its Executive Chairman and CEO) filed motions for summary judgment in the SEC’s suit alleging that Defendants sold billions of units of a virtual currency called XRP, which in the SEC’s view should be considered a “digital asset security.”[1] According to the SEC’s Complaint, the sale of XRP would constitute an unregistered sale of securities in violation of the registration and disclosure requirements of federal securities laws.[2]

Ripple is a privately-held financial technology company founded in 2012, with a particular focus on facilitating cross-border payments. The Company’s products generally rely on the open-source blockchain created by Ripple, called the “XRP Ledger,” and the associated XRP native virtual currency. When the XRP Ledger was created in 2012, a fixed supply of 100 billion units of XRP was created, 20% of which was retained by the founders and the remaining 80% was given to Ripple.[3] Over the years the Defendants have sold and distributed some XRP currency, transactions which are being challenged by the SEC as unregistered securities sales.[4]

The question of whether XRP is a security and therefore subject to the requirements of the federal securities law is a significant one for the digital asset industry, which has repeatedly asked for further guidance from the SEC on the application of securities law to these novel assets and technologies.[5] SEC Chairman Gary Gensler has been aggressive about claiming jurisdiction over digital assets,[6] claiming that the law is clear and recently stating that “nothing about the crypto market is incompatible with securities laws.” He advised that digital asset companies should “come in, talk to us, and register.”[7]

The SEC’s Position

The SEC’s Complaint in the Ripple matter asserts that XRP currency should be considered a “digital asset security” because it qualifies as an “investment contract” under the traditional Howey securities test: “an instrument through which a person invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others.”[8] In particular, the SEC argues the economic reality shows “a purchase of XRP is an investment in a common enterprise with other XRP holders and with Ripple.”[9] The SEC also points to multiple public representations in which Ripple “publicly tied the potential for profit to its promised entrepreneurial and managerial efforts.”[10]

The Complaint’s arguments are consistent with the position the SEC has taken in other recent enforcement actions and in its public pronouncements.[11] Chairman Gensler has publicly questioned the digital asset industry’s calls for greater guidance, arguing that the agency has “spoken with a pretty clear voice”[12] and concluding that “most crypto tokens are investment contracts under the Howey Test” and thus subject to the securities laws and SEC jurisdiction.[13]

Ripple’s Response

In its summary judgment motion, Ripple pushed back, arguing that distribution of XRP by the Defendants lacks the “essential ingredients” to be considered “investment contracts” under the Howey Test.[14] First, Ripple notes that in many of the transactions covered by the Complaint there was no actual contract between a promoter and an investor (for example, donations and giveaways).[15] Second, the Brief argues that when contracts were present, they established no post-sale obligations for Ripple or rights for the purchaser of XRP to share in profits from the Company’s efforts.[16] Third, the Defendants point to the absence of a “‘common enterprise’ in which those who purchase XRP invest,” arguing that the “XRP ecosystem,” comprised by multiple third parties who interact with the XRP Ledger or own XRP currency, cannot be characterized as a “common enterprise” under Howey.[17]

In essence, Ripple claims that sales of XRP merely represent sales of assets, not securities. The Defendants assert that the SEC’s theory represents an “open-ended assertion of jurisdiction over any transfer of an asset (for consideration or not) that the SEC thinks may benefit from the registration and disclosure requirements of securities law.”[18] As such, Ripple contends that accepting the SEC’s position could have unintended effects, converting sales of ordinary assets—such as gold and soybeans—into sales of securities.

Analysis

As we have noted previously,[19] it has become abundantly clear that the SEC will continue to take an aggressive position in asserting its authority over digital assets.

On the other hand, the Defendants raise significant questions about the wisdom of applying an orange grove case from 1946 to a class of assets developed only in the last ten years. While the SEC has historically favored at least in some area’s flexibility over certainty in application of the securities laws—see insider trading for example—the regulation of digital assets would seem to be a place in which certainty would assist all parties in making informed decisions.[20]

Perhaps a ruling on Ripple’s summary judgment motion will help. It may also shed light on the potential consequences of the SEC’s current approach to regulating digital assets through piecemeal enforcement actions.