Last week’s highly publicized decision in the Securities and Exchange Commission (SEC) case against Ripple, touted by many as a significant victory against the SEC and Chairman Gary Gensler, may not be the end of the story.
Former SEC attorney, John Reed Stark, cautions against premature celebrations, pointing out the decision’s shaky ground and the likelihood of an appeal that could result in a reversal. Stark’s perspective challenges the prevailing narrative surrounding the ruling.
The court ruling on the Ripple case categorizes the company’s offering of securities into three distinct categories: institutional sales, programmatic sales, and other sales. The court’s ruling on each category is critical in determining the legal implications for Ripple and its investors.
Regarding institutional sales, the court deemed Ripple’s sale of XRP to sophisticated individuals and entities a violation of securities laws. The court ruled that XRP was a security during these transactions, entitling investors to rescission and imposing penalties on Ripple.
In addition, the court dismissed Ripple’s attempt to reimagine the conventional Howey test by introducing a new test known as the “Essential Ingredients Test.” Additionally, it rejected Ripple’s claim that, according to the Howey framework, an “investment of money” differs from “merely payment of money.”
In the case of programmatic sales, where XRP was sold to the public on digital asset exchanges, the court ruled that XRP ceased to be a security once it was sold anonymously to exchanges. The court concluded that the sources of programmatic buyers’ profit expectations were independent of Ripple’s efforts.
According to Stark, this presumption ignores the possibility that many programmatic buyers purchased XRP, expecting to profit from Ripple’s endeavours, undermining investor protection principles.
The last category, “Other Distributions,” involved written contracts with Ripple, where $609 million in non-cash consideration was recorded in Ripple’s audited financial statements. These distributions included compensation for employees and support for Ripple’s Xpring initiative.
Stark expresses his concerns regarding the Ripple decision, highlighting several troubling aspects. Firstly, the decision grants full SEC protection and remedies to institutional investors while leaving retail investors without any SEC protection, a seemingly backward approach, according to Stark.
Secondly, he argues that the ruling implies that securities regulations do not apply if tokens are sold through exchanges, based on the presumption that exchange customers are ignorant of the token issuer’s identity. However, Stark finds this argument contradicts established principles of securities law.
Stark argues that even if retail investors are uninformed or refuse to conduct research, their investments should still be considered securities. Retail investors speculatively buy tokens, banking on the “Greater Fool Theory.” Stark argues that the court’s decision seems to transform tokens from securities when sold to institutional investors into “not securities” when sold on exchanges, an inconsistent stance with basic investing principles.
He finds the court’s distinction between tokens awarded to employees and third parties also problematic. Stark points out that these distributions should be considered compensation, similar to restricted stock units or stock options, and therefore subject to securities laws.
Additionally, the ruling seems to go against SEC precedent regarding the volume of consideration required to bring on registration requirements. Stark references past SEC cases involving “free stock” offerings, where a nominal review was sufficient to require registration. The court’s refusal to consider the employee and third-party distributions as securities due to a lack of consideration contradicts this precedent.
Stark said, “The trial order in the Ripple case is a partial summary judgment from a single district court judge. While important and certainly worthy of study, the decision is not binding precedent on other courts.”
Appeals and future cases could yield different interpretations and outcomes, highlighting the complexity of crypto-related legal matters.
Stark predicts that “the SEC will likely appeal the Ripple decision to the 2nd Circuit, where the District Court’s rulings on ‘programmatic’ and ‘other sales’ may be overturned.” Otherwise, the ruling could set a precedent that exempts specific tokens from securities regulations based on investor sophistication and ignorance.
In conclusion, the Ripple decision raises issues surrounding investor protection, the distinction between institutional and retail investors, and the classification of tokens as securities. The future of the case remains uncertain, and the broader implications of this ruling could shape the regulatory landscape for cryptocurrency offerings.
