Written By: Patrick Cramer
The case between Ripple Labs, a cryptocurrency provider, and the Securities Exchange Commission (SEC), concluded last week, reigniting discussions surrounding the classification of cryptocurrencies as securities in the United States. In the complaint, the SEC accused Ripple Labs of selling 1.3 billion USD in unregistered securities by offering and selling their XRP token as a cryptocurrency. The Southern District of New York ruled partially in favor of Ripple Labs, that it did not violate federal securities laws by selling its XRP token on public cryptocurrency exchanges. However, it also sided with the SEC that Ripple had violated federal securities laws by selling XRP directly to sophisticated investors.
SEC v. Ripple Labs, Inc.
In SEC v. Ripple Labs, Inc., ruled that Ripple Lab’s XRP token must be classified as a security when sold to institutional investors, but that Ripple is not considered a security when sold to the general public. The court reasoned that Ripple Labs’ offerings of the XRP coins were not offerings for securities because the purchasers did not have a reasonable expectation of profit that was tied to the performance of Ripple Labs. To support this, the court referenced the Supreme Court’s decision in SEC v. C.M. Joiner Leasing Corp., which states that an investor who buys, for example, “a horse or an automobile,” hopes to realize a return on their investment, but that expected return is not contingent on the future performance of another person or entity. So, to be a security, the thing being purchased must have a projected increase in value that is based on the contributions of an entity, like a company.
Furthermore, the lower court reasoned that the relevant inquiry into whether a cryptocurrency is a security is whether the expected return is “derived from the entrepreneurial or managerial efforts of others.” From this, the court concluded that individual investors, taken as a whole, could not have made purchases with the belief that their expected returns would be derived from Ripple Lab’s performance as a company. This was because Ripple Labs never made any promises to investors and did not have knowledge of who was buying their XRP token.
The distinction made in the ruling was based on the level of awareness that investors had regarding XRP’s securities-like characteristics. XRP is a token designed for use in international bank transfers to speed up and decrease the cost of such transfers.
How Might the Ripple Labs Ruling Affect the Cryptocurrency Industry?
The Ripple ruling has potential implications for crypto projects that rely on pre-sales to institutional investors and venture capitalists to secure funding before their public launch. Many of these cryptocurrency networks proactively raise money before officially launching their cryptocurrency tokens. If cryptocurrencies are classified as securities, there will likely be a chilling effect on the cryptocurrency industry. This is because when classified as a security, every sale of that security must be registered under section 5 of the Securities Act of 1933, unless an exemption is available. However, despite potentially chilling the cryptocurrency market, the registration requirements may help to protect investors from fraudulent investment activity.
The SEC’s oversight of cryptocurrencies has the potential to further solidify the safety of cryptocurrencies as more viable and dependable investments. However, the purpose of cryptocurrencies as a form of currency is to deregulate financial markets so that transactions are not carried out through channels regulated by the government. With this ruling and the debate that has sprung from it, Congress will likely search for ways to create legislation so that the SEC can expand its influence as a regulator over cryptocurrency markets.
Sources:
Investopedia, SEC vs. Ripple: What It Means for Cryptocurrencies, Investopedia https://www.investopedia.com/sec-vs-ripple-6743752 (last visited July 15, 2023).
Sec. & Exch. Comm’n v. Ripple Labs, Inc., No. 20 CIV. 10832 (AT), 2023 WL 4507900 (S.D.N.Y. July 13, 2023).
United Hous. Found., Inc. v. Forman, 421 U.S. 837, 95 S. Ct. 2051, 44 L. Ed. 2d 621 (1975).
15 U.S.C.A. § 77.