Regulatory

Court Decision in SEC v. Ripple Supportive of US Trading Platforms, But Underscores Importance of Compliant Token Issuances

BitOoda Regulatory Analysis - 7/17/2023

Key Takeaway #1

The Court determined that “XRP, as a digital token, is not in and of itself, a[n]…investment contract.”

Key Takeaway #2

The Court’s decision supports the ability of centralized digital asset trading platforms listing a range of tokens, where transactions are matched blindly between buyers and sellers.

Key Takeaway #3

The Court determined that sales of XRP as a primary offering to institutional investors did constitute an unregistered securities transactions.

Key Takeaway #4

New token issuers need to consider whether their initial offering is a registerable security.

On July 13, the Southern District of New York (the “Court”) issued a significant decision related to the SEC’s lawsuit against Ripple alleging that Ripple sold its XRP tokens as illegal, unregistered securities. The key issue in the case is whether or not XRP tokens are “investment contracts” that need to be registered with the SEC. The digital asset industry has been eagerly awaiting this decision, as the SEC has taken the position that the vast majority of tokens are unregistered securities.

The Court issued a nuanced split decision, but the headline, in the Court’s words, is that “XRP, as a digital token, is not in and of itself, a[n]…investment contract” under the Howey Test. In order for a transaction to qualify as an investment contract under Howey, an investor must (1) invest money (2) in a common enterprise (3) with the expectation of profits derived solely from the efforts of the promoter or a third party.

In examining the circumstances surrounding XRP sales, the Court determined that programmatic sales of XRP to the public on digital asset trading platforms with blind matching order books did not meet the requirements of an investment contract because the buyers in these transactions did not knowingly invest money in Ripple – these buyers did not know who was receiving the proceeds of their purchase.

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On July 13, the Southern District of New York (the “Court”) issued a significant decision related to the SEC’s lawsuit against Ripple alleging that Ripple sold its XRP tokens as illegal, unregistered securities. The key issue in the case is whether or not XRP tokens are “investment contracts” that need to be registered with the SEC. The digital asset industry has been eagerly awaiting this decision, as the SEC has taken the position that the vast majority of tokens are unregistered securities.

The Court issued a nuanced split decision, but the headline, in the Court’s words, is that “XRP, as a digital token, is not in and of itself, a[n]…investment contract” under the Howey Test. In order for a transaction to qualify as an investment contract under Howey, an investor must (1) invest money (2) in a common enterprise (3) with the expectation of profits derived solely from the efforts of the promoter or a third party.

In examining the circumstances surrounding XRP sales, the Court determined that programmatic sales of XRP to the public on digital asset trading platforms with blind matching order books did not meet the requirements of an investment contract because the buyers in these transactions did not knowingly invest money in Ripple – these buyers did not know who was receiving the proceeds of their purchase.

Similarly, the Court determined that Ripple’s distributions of XRP to employees and third parties as consideration for services also did not meet the standards of an investment contract. Here, the Court noted that the parties receiving XRP as a distribution did not invest money in Ripple at all. Rather, they received XRP as compensation.

The Court, however, did determine that Ripple’s sales of XRP to institutional investors met the requirements of an investment contract, and were therefore unregistered securities transactions. According to the Court, In these sales, the institutional investors bought XRP from Ripple with the expectation that Ripple would use the funds to create a valuable network, which would positively impact the price of XRP.

The key takeaway is that the Court looked at the conduct of Ripple, not the nature of the XRP token itself, in determining whether or not in certain circumstances XRP was an unregistered security. The Court made a distinction between primary transactions involving a token issuer and direct investors, andsecondary market transactions where the buyer has no direct privity to the issuer.

We expect this to be an interim boon for U.S.centralized trading platforms, even in the face of the SEC enforcement actions against Coinbase and Binance. The decision supports the ability of these platforms to list a range of tokens where transactions are matched blindly between buyers and sellers. In the long run, we still think both U.S. legislators and regulators will need to establish firmer rules and jurisdictional boundaries between agencies for spot digital asset markets, as well as broader-based definitions of ‘security’ and ‘commodity’ as applied to digital assets.

Projects considering issuing a new token should be mindful of the Court’s determination that sales to institutional investors were investment contracts. To market new tokens compliantly, these issuers will probably need to register the primary institutional sales as securities. As a result, new token issuers should consult with appropriately regulated financialprofessionals to ensure they are launching their token effectively and compliantly.

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Disclosures

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This research is only for the clients of BitOoda. This research is not intended to constitute an offer, solicitation, or invitation for any securities and may not be distributed into jurisdictions where it is unlawful to do so. For additional disclosures and information, please contact a BitOoda representative at info@bitooda.io.

Analyst Certification

Tom Nath, the author of this report, hereby certifies that all of the views expressed in this report accurately reflect his personal views, which have not been influenced by considerations of the firm’s business or client relationships.

Conflicts of Interest

This research contains the views, opinions, and recommendations of BitOoda. This report is intended for research and educational purposes only. We are not compensated in any way based upon any specific view or recommendation.

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