10 basic facts of the SEC v. Ripple case and how the judge decided

Author: Golden Finance cryptonaitive

Nearly three years after the U.S. SEC sued Ripple’s token XRP, the securities case finally has some results. However, judging from the judgment of the judge, Whether the Ripple token XRP is a security is still in a "Schrödinger" state.

On July 13, 2023, Judge Analisa Torres of the U.S. District Court for the Southern District of New York made a summary judgment on the SEC v. Ripple case. In the judge's judgment, part of the Ripple token XRP was identified as a security, and part was determined not to be a security .

“Ripple’s institutional sales of XRP constituted investment contracts and sales of unregistered securities in violation of Section 5 of the Securities Act,” the judge’s ruling stated. “Ripple’s programmatic sales of XRP, other distributions, and sales by Larsen and Garlinghouse Do not constitute investment contracts and sales of unregistered securities.”

According to the court judgment document, the SEC v. Ripple case will enter the trial stage (Note: The general procedure in the United States is divided into 5 stages: the plaintiff’s prosecution and the defendant’s defense; evidence disclosure; witness pretrial review; trial; ruling). The District Court for the Southern District of New York said it would issue a separate order in due course setting a trial date and related pretrial deadlines.

After the verdict came out, the encryption market reacted strongly, the price of XRP doubled overnight, and multiple tokens identified as securities by the SEC also achieved large gains.

But while cheering for the encryption industry's rare "victory" against the US SEC, we still need to know some basic facts of this case, and whether the judge's judgment is reasonable or not depends on the judge's specific judgment. The main reason for his judgment in accordance with.

10 Essential Facts

1. Before the end of 2020, Ripple had 50-80 billion XRP. From 2013 until the end of 2020, Ripple conducted various sales and distributions of XRP.

2. First, Ripple, through its wholly-owned subsidiaries, sells directly to certain counterparties (mainly institutional buyers, hedge funds and "on demand Liquidity" client) sold XRP for $728 million.**

3. Second, Ripple sells XRP "programmatically" through digital asset exchanges, that is, trading through trading algorithms ("programmatic sales"). These sales are blind transactions: Ripple does not know who is buying XRP, nor does the buyer know who is selling.

4. US SEC accused Ripple of selling approximately $757.6 million in XRP in programmatic sales.

5. Ripple also distributes XRP as a form of payment service (“Other Distributions”). For example, Ripple distributes to its employees in the form of XRP as a form of employee compensation. Ripple is also offering XRP with its Xpring program to third parties developing new applications for XRP and the XRP Ledger.

6. U.S. SEC accuses Ripple of $609 million worth of XRP distributed to individuals and entities.

7. Former Ripple CEO Larsen and former COO and current CEO Garlinghouse personally sold XRP on the exchange.

8. From 2013 to 2020, Larsen programmatically sold XRP on digital asset exchanges and earned at least $450 million from the sales.

9. From April 2017 to 2020, Garlinghouse sold XRP on digital asset exchanges. US SEC accused Garlinghouse of selling approximately $150 million in XRP during this period.

10. Defendant did not file an application for registration with respect to any offer or sale of XRP. Ripple has not publicly filed any financial statements or other periodic reports, nor has it made EDGAR filings with the Securities and Exchange Commission for Ripple or XRP, such as Form 10-Q, Form 10-K, or Form 8-K in relation to XRP.

Based on these facts, the US SEC filed four main charges against Ripple and its executives:

Ripple conducted three types of unregistered XRP investment contracts and sales: 1. Sales of XRP to professional individuals and entities pursuant to written contracts ("institutional sales") for $728 million; 2. Programmatic sales on digital asset exchanges 3. Distribution of XRP in "forms other than cash" pursuant to written contracts ("other distributions"), which amounted to $609 million.

and:

4. The two CEOs of Ripple, Larsen and Garlinghouse, sold unregistered XRP in their personal capacity. Larsen received at least US$450 million and Garlinghouse received US$150 million.

How did the judge decide

According to the judgment of Judge Analisa Torres of the U.S. District Court for the Southern District of New York, the main basis for whether Ripple’s token XRP is a security is the Howey test.

Institutional Sales

**1. The first element of the Howey test is whether the transaction involves "funding". **

In SEC v. Ripple, institutional buyers contributed funds by offering fiat or other currencies in exchange for XRP. Ripple argues that "putting money in" is not the same as "just paying out money," but Judge Analisa Torres argued that this distinction is not supported by legal cases and that the correct question is whether institutional buyers "provide capital," "put money in ", or "give" cash. Defendants did not deny the existence of payment of funds; therefore, the Court found that element had been established.

**2. The second element of the Howey test is the existence of a "common enterprise". **

This can be demonstrated through "horizontal commonality," where investors' assets are pooled and each investor's fortunes are tied to the success of other investors and the business as a whole. And Ripple funnels funds from institutional sales into a network of bank accounts across its various subsidiaries. Furthermore, the profitability of each institutional buyer is closely tied to Ripple's fate and that of other institutional buyers. When the value of XRP rises, the profit of all institutional buyers increases in proportion to their XRP holdings. Accordingly, the court held that a common enterprise existed because the records indicated that there was a pooling of assets and that the fate of the institutional buyer was tied to the success of the business as well as the success of other institutional buyers.

**3. The third element of the Howey test is "the reasonable expectation of profiting from the entrepreneurial or managerial endeavors of others". **

The court found that institutional buyers purchased XRP with the reasonable expectation that they would profit from Ripple's efforts.

Accordingly, the court held that Ripple’s institutional sale of XRP constituted the offer and sale of an unregistered investment contract, in violation of Section 5 of the Securities Act.

Programmatic Sales

The SEC alleges that in a programmatic sale of digital asset exchanges to public buyers (“programmatic buyers”), “Ripple knew that people were speculating in XRP as an investment” and “explicitly targeted the speculators. ", and "increased speculative trading volume" as the "goal target".

Judge Analisa Torres held that the record failed to substantiate the third element of the Howey test. Whereas institutional buyers have a reasonable expectation that Ripple will use the proceeds from its sales to improve the XRP ecosystem and thereby increase the price of XRP, programmatic buyers cannot reasonably expect the same outcome.

Ripple's programmatic sales are anonymous buyer-seller transactions, and programmatic buyers have no way of knowing whether their payment is going to Ripple or another seller of XRP.

Since 2017, Ripple’s programmatic sales have accounted for less than 1% of global XRP transaction volume (note: note the difference between flow and stock). As a result, the vast majority of individuals who purchase XRP from digital asset exchanges are not investing their funds in Ripple at all.

The SEC argued that Ripple’s “clear targeting of speculators” or “Ripple’s knowledge that people were speculating in XRP as an investment” was not sufficient, as speculative motives “do not indicate the existence of an ‘investment contract’ under [securities law]”. Judge Analisa Torres opined that the returns expected by public buyers are not dependent on the continued efforts of others, and that many programmatic buyers may have purchased XRP with the expectation of a profit, but they have not derived this expectation from Ripple's efforts, especially since None of the programmatic buyers knew that the XRP they were buying came from Ripple, its employees and executives.

Judge Analisa Torres stated that in terms of programmatic sales, Ripple did not make any promises, because Ripple did not know who was buying XRP, and buyers did not know who was selling.

Accordingly, Judge Analisa Torres concluded that Ripple’s programmatic sale of XRP did not constitute an offer and sale of an investment contract.

As with the "programmatic sales" above, other distributions, as well as Larsen's and Garlinghouse's sales of XRP on exchanges, are not investment contracts and sales of registered securities.