On July 13, 2023, a decision was rendered by the New York Court in the case filed by the US Securities and Exchange Commission (hereinafter referred to as SEC) against Ripple Labs Inc (hereinafter referred to as ripple). Although the decision has been described as a “victory for ripple” on social media and cryptocurrency markets, when we start reading the text of the decision, we can see that there is actually no “victory” even in the first paragraphs. In this article, we aim to analyze the text of the decision in headings and share our opinion without going too deep into the American legal system, but in order to be understandable.
SUBJECT OF LAWSUIT
The case was brought by the SEC against Ripple and two company executives (Bradley Garlinghouse and Christian A. Larsen) for illegal offers and sales of securities in violation of Securities Act regulations. Company executives were also alleged to have aided and abetted the company’s violations of the law.
WHAT HAPPENED?
As a factual background in the decision, it is seen that an examination was made from the establishment of ripple (first NewCoin Inc. then OpenCoin Inc. and finally until its establishment as Ripple Labs in 2014). It is claimed that 20 billion of the 100 billion xrp that ripple offered to the market was owned by the 3 founders, ripple had 80 billion xrp, ripple sold xrp directly to certain individuals and/or organizations (primarily institutional buyers, venture funds, ODL customers *Open and Distance Learning) through institutional sales through its wholly owned subsidiaries. ripple is claimed to have sold 728.9 million USD worth of xrp from these sales.
Second, ripple made sales on digital asset exchanges as part of a “program” or through trading algorithms. Ripple does not have information about who these sales were made to, but it is alleged that it sold approximately USD 757.6 million worth of xrp in these sales.
In addition, ripple also distributed some xrp under the heading of “other distributions”, for example, to cover the allowances of its employees.
Along with ripple, Larsen and Garlinghouse have also individually sold xrp. It is claimed that Larsen earned 450 million USD from his sales between 2013-2020.
ADDITIONAL INFORMATION – WHAT IS THE HOWEY TEST?
The Howey Test is a legal framework used by the SEC to determine whether a particular financial instrument constitutes a security. The test was developed by the SEC and used in the 1946 case SEC v. W.J. Howey Co. The Howey Test investigates the existence of four basic criteria to determine whether an investment can be considered a security. Accordingly;
- An investment must be realized using money, foreign currency or a money-like asset. That is, the investment instrument must represent value realized in cash or other financial instruments.
- An investment instrument is an investment offered by a business, partnership or other venture and collected from investors. That is, investors make a financial contribution to a venture.
- Investors should expect to receive dividends or returns from the investment instrument. That is, investors should hope to make a profit if their investment is successful.
- The success of the investment should depend on the activities carried out by the investor or the venture. That is, the investors’ expectation of profit should be based on the result of the investor’s efforts.
In sum, an investment contract exists if there is “an investment of money in a common enterprise with a reasonable expectation of profit from the efforts of others”.
WHAT IS THE TECHNICAL TERM “SUMMARY JUDGMENT”?
In the American legal system, a “motion for summary judgment” asks the court to decide a dispute without a trial on the merits because there is no dispute about the key facts of the case. Normally, when the parties do not agree on the facts, judgment is sought. However, when the parties agree on the facts, or when a party has no evidence to support its version of what actually happened, the court may decide the matter on the basis of the documents submitted by the parties.
CONCLUSION
- The SEC’s motion for summary judgment with respect to the part of the transactions subject to the lawsuit related to institutional sales was granted, and its other motions were denied;
- Defendants’ motion for summary judgment is granted with respect to programmed sales, other distributions and Garlinghouse and Larsen’s sales, and their other motions (with respect to institutional sales) are denied;
- The SEC’s motion for summary judgment on the issue of aiding and abetting by Garlinghouse and Larsen is denied.
SO..
In the SEC’s lawsuit against ripple, it was ruled by the court that ripple’s sales were in violation of the American Securities Act regulations (these sold xrp are in the nature of a bond/securities – otherwise they would not be illegal) and must be made in accordance with the regulation.
Sources used in the preparation of this article:
https://storage.courtlistener.com/recap/gov.uscourts.nysd.551082/gov.uscourts.nysd.551082.874.0_2.pdf
https://www.investopedia.com/terms/h/howey-test.asp#:~:text=The%20Howey%20Test%20determines%20what,from%20the%20efforts%20of%20others.”
https://tile.loc.gov/storage-services/service/ll/usrep/usrep328/usrep328293/usrep328293.pdf
https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets
https://law.stanford.edu/wp-content/uploads/2019/01/Mendelson_20180129.pdf