Ripple Labs’ Major Victory: Court Ruling on XRP’s Status & Industry Implications

A New York District Court handed Ripple Labs a significant victory yesterday in the case brought against it by the SEC. In a case that has been watched closely by the industry, the SEC has alleged that XRP, the native token to the XRP Ledger, is a security. The court issued an opinion yesterday on cross-motions for summary judgment, which settles some of the issues in dispute. The SEC won some issues, Ripple others. A quick summary below:

1. The SEC alleged that Ripple sold XRP as an investment contract, a type of security. Ripple argued that XRP is not an investment contract, and therefore laws applicable to the sales of securities do not apply. An investment contract is defined in the now infamous Supreme Court case from 1946: SEC v. W.J. Howey. In Howey, the Supreme Court stated that an investment contract is a “contract, transaction[,] or scheme whereby a person [(1)] invests his money [(2)] in a common enterprise and [(3)] is led to expect profits solely from the efforts of the promoter or a third party.”

2. The court held that XRP itself was not a security, but could be, and sometimes was when sold in a manner that formed an investment contract. The court stated that “XRP, as a digital token, is not in and of itself a “contract, transaction[,] or scheme” that embodies the Howey requirements of an investment contract. Rather, the Court examines the totality of circumstances surrounding Defendants’ different transactions and schemes involving the sale and distribution of XRP. See Marine Bank v. Weaver, 455 U.S. 551, 560 n.11, 102 S.Ct. 1220, 71 L.Ed.2d 409 (1982) (“Each transaction must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served, and the factual setting as a whole.”). Sec. & Exch. Comm'n v. Ripple Labs, Inc., No. 20 CIV. 10832 (AT), 2023 WL 4507900, at *8 (S.D.N.Y. July 13, 2023).”

3. Ripple sold XRP in three primary ways, some were determined by the court to be sales of investment contracts, some were not:
   1. Institutional Sales under written contracts for which it received $728 million.
      1. The court found that these sales were investment contracts.  Based in large part on statements and publications by Ripple (both public and directly with investors) that the court determined would have created in a reasonable investor an expectation of profit from the efforts of Ripple.  The court also commented that those sales couldn’t reasonably be considered sales for consumptive use, mentioning in particular lock up clauses in the sales contracts. Citing the Telegram court the Ripple court said: “Simply put, a rational economic actor would not agree to freeze millions of dollars ... if the purchaser's intent was to obtain a substitute for fiat currency.” Sec. & Exch. Comm'n v. Ripple Labs, Inc., No. 20 CIV. 10832 (AT), 2023 WL 4507900, at *11 (S.D.N.Y. July 13, 2023)(internal citations omitted).
   2. Programmatic Sales on digital asset exchanges for which it received $757 million.
      1. The court found that these sales did not constitute investment contracts.  The court cites a number of reasons for this conclusion, but they all add up to one general idea: there was no contract between Ripple and exchange purchasers.  The court found that Ripple did not know who was purchasing its XRP, and the purchasers did not know who was selling it.  Without this knowledge, Ripple could not be said to be making promises or offers to purchasers, nor could purchasers have a reasonable expectation of profit through the efforts of Ripple.  This is true even if the purchasers were purchasing with a motive to profit through speculation.
   3. Other Distributions under written contracts for which it recorded $609 million in “consideration other than cash.”  These included distributions to employees and third parties developing applications for XRP and XRP Ledger.
      1. The court found that these distributions also did not constitute investment contracts. In these cases, the court determined that there was no “investment of money” as required for an investment contract to be formed.  To the contrary, as the court stated, it was Ripple that paid the recipients of these distributions.

While this case is not over, and the court’s holdings only create legal precedent for other cases tried in the Southern District of New York, it is still anticipated to ripple (see what we did there) through the industry and is likely to influence decisions of federal courts in other jurisdictions. In particular, we have our eye on Freil v. Dapper Labs, a class action alleging that NBA Top Shots Moments are investment contracts, and the cases brought by the SEC against Binance, Bittrex, and Coinbase.