SEC v. Ripple's Programmatic Sales Ruling Paves the Way for Public Token Exchange

The Southern District of New York has issued its long-awaited summary judgment ruling in the SEC v. Ripple case, and there's some game-changing news to discuss.

TL;DR:

• Judge Torres’s ruling carries significant implications for the blockchain industry, specifically with regard to Ripple's Programmatic Sales.
• The court's decision and analysis regarding Ripple's public sales arguably blesses all public exchange sales of cryptocurrencies as non-securities under Howey.
• Additionally, the SEC’s separate allegations, suggesting that Coinbase acted as an unregistered exchange for securities, should not survive following this decision.
• Specifically, the court’s decision raises a question as to whether any of the other tokens listed on Coinbase (or any other exchange), which could be considered programmatic "blind sales," would fall under securities regulations.

Background:

Before we dig in, let's recap the Howey Test and the different types of buyers involved in this legal tussle.

Howey is a 70-year-old case which, in the absence of new SEC rulemaking or Congressional lawmaking (neither of which have been forthcoming), courts use to analyze whether a sale constitutes an investment contract (e.g., a security) under the Securities Act. Howey analyzes three prongs: (i) whether money was invested by the buyer; (ii) whether there was a common enterprise; and (iii) whether the buyer had an expectation of profit solely from the efforts of others—typically the seller/issuer. If you fail any one prong, you are not a security.

In Ripple, we have Institutional Buyers who had high expectations for Ripple's efforts to fuel the growth of the XRP ecosystem. On the flip side, we've got the Programmatic Buyers who engaged in blind bid/ask transactions on various crypto exchanges, unaware of the sellers' identities.

The court ruled that Ripple’s sales of XRP to Institutional Buyers constituted sales of securities, but its sales to Programmatic Buyers, public sales on exchanges, did not constitute sales of securities.

The Court's Analysis:

The court's analysis of Ripple's Programmatic Sales focuses primarily on whether these sales satisfied the third prong of the Howey test – the expectation of profits derived from the efforts of others.

Howey’s Third Prong: Lack of Reasonable Expectation

According to the court, Programmatic Buyers who bought XRP via public exchanges couldn't reasonably expect Ripple's efforts to be the driving force behind their profits. The court focused on the lack of transparency in these blind transactions, stating, "Programmatic Buyers could not have known if their payments of money went to Ripple or any other seller of XRP."

This lack of clarity weakened the link between Ripple's efforts and the buyers' profit expectations.

Speculative Motive and Promises

Judge Torres addressed the SEC's argument that Ripple intentionally targeted speculators and understood that people were treating XRP as an investment. However, the court emphasized that speculation alone doesn't automatically make it an "investment contract" under securities laws. It stated, "Anyone who buys or sells a horse or an automobile hopes to realize a profitable 'investment." But the expected return is not contingent upon the continuing efforts of another."

The court highlighted that Ripple's promises or offers to its Institutional Buyers were not relevant to Programmatic Buyers since they were unaware of buying XRP from Ripple. Critically, with respect to promises made by Ripple, the court noted:

Ripple’s promotional materials, such as the “Ripple Primer” and the “Gateways” brochure, were widely circulated amongst potential investors like the Institutional Buyers. But there is no evidence that these documents were distributed more broadly to the general public, such as XRP purchasers on digital asset exchanges. Nor is there evidence that Programmatic Buyers understood that statements made by Larsen, Schwartz, Garlinghouse, and others were representations of Ripple and its efforts.

Judge Torres also emphasized objectivity and the focus on promises and offers made to investors.

"The record establishes that with respect to Programmatic Sales, Ripple did not make any promises or offers because Ripple did not know who was buying the XRP, and the purchasers did not know who was selling it."

Of course, some Programmatic Buyers may have purchased XRP with the expectation of profits to be derived from Ripple’s efforts. However, “[t]he inquiry is an objective one focusing on the promises and offers made to investors; it is not a search for the precise motivation of each individual participant.”

The court took into major account that Ripple had not to circulated its promotional material to public buyers.

Implications for the Blockchain Industry and Coinbase:

Let’s explore the implications of this ruling for the blockchain industry.

It's a significant win for public sales made by blockchain projects as the court recognizes that blind sales to public exchange buyers may not fall under securities regulations. This acknowledgment aligns with the unique characteristics of blockchain transactions and the decentralized nature of token exchanges.

Arguably, post-TDE exchange sales, in the absence of speculative public statements, do not amount to an issuance because buyers do not know from whom they are buying: "Indeed, Ripple’s Programmatic Sales were blind bid/ask transactions, and Programmatic Buyers could not have known if their payments of money went to Ripple, or any other seller of XRP."

Likewise, expectation of profit on the basis of the issuer is not met when the buyer does not know from whom they are buying: "Programmatic Buyers purchased XRP with an expectation of profit, but they did not derive that expectation from Ripple’s efforts (as opposed to other factors, such as general cryptocurrency market trends)—particularly because none of the Programmatic Buyers were aware that they were buying XRP from Ripple."

This ruling raises intriguing questions about the recent case against Coinbase, where the SEC alleged that Coinbase acted as an unregistered exchange for securities.

Under the Ripple analysis, it casts doubts on whether any of the other tokens listed on Coinbase, which could be considered programmatic "blind sales," would actually fall under securities regulations.

It will be interesting to see how this ruling's precedent affects the ongoing legal battles and whether it prompts the SEC to reconsider its approach to token sales conducted on platforms like Coinbase.