“Regulation by enforcement has worked for them so far but now they have a decision against their main theories,”
A decision out of the Southern District of New York that approved some crypto market practices despite claims from the federal agencies is already giving renewed hope for an industry long battered by securities enforcement.
“The opinion is being regarded as a win for the industry because it adds nuance to the regulatory market,” said Winston & Strawn partner and digital assets and blockchain technology group co-chair Daniel Stabile in a webinar Friday morning. Stabile hailed the decision from U.S. District Judge Analisa Torres of the Southern District of New York District, which found some of the uses of the XPR token, created by Ripple Labs, would not be considered a security and was therefore precluded from Securities and Exchange Commission oversight.
The decision is already impacting the long-struggling crypto market with those invested in XPR tokens seeing a nearly 70% increase in its value since Torres ruled Thursday.
And while the judge did find the company could be subject to enforcement related to some of the digital asset sales, the lack of liability for other uses is what’s causing such a strong market shift.
“Where investors knew they were buying tokens from Ripple, knew the money was going to be used by Ripple—in that case it did constitute a security, an investment contract, under the Howey test, and Howey was the correct framework,” said Winston & Strawn partner George Mastoris of the nearly 80-year-old test developed by the U.S. Supreme Court, which has long been used to define when an asset qualifies as a security and is therefore subject to federal enforcement.
“Courts have found the existence of an investment contract even in the absence of Defendants ‘essential ingredients,’” wrote Torres in the partial grant of summary judgment.
Put differently, the Howey test was intended to effectuate ‘[t]he statutory policy of affording broad protection to investors,’ protection that is ‘not to be thwarted by unrealistic and irrelevant formulae.’”
That finding rejected Ripple’s argument “that all investment contracts must include post-sale obligations on the promoter and grant the investor a right to share in profits from the promoter’s efforts,” the Barack Obama appointee wrote.
But when it comes to other sales, including programmatic sales, where the buyer had no way of knowing the sales were done pursuant a blind sale, Torres found the third prong of the Howey test wasn’t satisfied.
“The application to secondary transaction markets, which Torres said she wouldn’t reach, seems a fairly straight line to draw to say those transactions may not actually constitute securities for purposes of the Howey analyst,” Mastoris said. “The focus is whether the purchaser’s money is being utilized by the issuer and whether they know their money is being paid for by the issuer, that’s the critical component and it’s missing.”
This impact from tokens given to employees and the like, for someone’s labor for example, that’s not enough to qualify. “I expect there will be a lot of discussion around that finding,” Mastoris said.
Notably the company’s due process arguments, that the agency failed to inform Ripple of their violations before enforcement, were denied, and that’s in line with other enforcement actions which have found the same.
“The law does not require the SEC to warn all potential violators on an individual or industry level,” Torres wrote, citing Second Circuit precedent that asks “whether the law presents an ordinary person with sufficient notice of or the opportunity to understand what conduct is prohibited or proscribed, not whether a particular [party] actually received a warning that alerted him or her to the danger of being held to account for the behavior in question.”
Still, the decision is one in a long line of otherwise bad legal decisions or settlements for the crypto industry. The SEC has a nearly flawless record of prosecutions and settlements against alleged crypto-related securities and fraud violations.
Winston & Strawn partner Thania Charmani went as far as to hypothesize that the SEC will appeal and the Second Circuit may be very inclined to side with them.
“In the meantime, the decision could still impact other courts,” she offered as a shining light. As influential as the Southern District of New York is, she said people could expect the Ripple decision to ripple through other cases in some ways. There’s also the hope that this ruling may inspire Congress to act. Sens. Cynthia Lummis, R-Wyoming, and Kirsten Gillibrand, D-New York, reintroduced an effort to address much of that uncertainty earlier this week.
“This type of decision that changes the legal landscape could prompt congress to act sooner than later,” Charmani said. “Regulation by enforcement has worked for them so far but now they have a decision against their main theories.”
Ripple was represented by Andrew Edward Goldsmith of Kellogg, Hansen, Todd, Figel & Frederick and Andrew J. Ceresney of Debevoise & Plimpton in the dispute.