The XRP ruling is no knockout punch against the SEC

The recent ruling in SEC v. Ripple Labs has been hailed as a huge step forward for the crypto sector. 

And in a way, it is. 

The overarching highlight of Judge Analisa Torres’ 34-page ruling? 

She held that Ripple Labs had not violated US securities laws, as it was selling XRP anonymously to the average digital exchange user. This presents a significant roadblock to the Securities and Exchange Commission’s drawn-out campaign to try regulating cryptocurrencies by judicial order and piecemeal actions.

Yes, XRP holders should be thrilled about finally owning and purchasing XRP tokens without strings attached. The ruling is already affecting the SEC’s strategy in similar cases against players like Terra. 

However, that does not mean that today’s emerging crypto projects are in the clear. 

A road map to regulation

In her decision, Judge Torres teed up two standards of review when assessing whether Ripple Labs sold unregistered securities: one for how it addressed XRP sales to sophisticated hedge funds and other institutional investors, and another for how it approached the everyday consumer investor who uses publicly-accessible crypto exchanges. 

In the process, she found that while Ripple Labs did not sell unregistered securities to lay crypto traders, it did so when selling to sophisticated investors.

Judge Torres based this distinction on the idea that everyday investors who purchased XRP from 2011 to 2020 on exchanges did not receive any investment promotional materials, direct communications or legal agreements from Ripple when they traded XRP. To the contrary, many of these traders would not have known if they had purchased their tokens from Ripple Labs based on how digital exchanges operate.

In contrast, she found that the institutional investors Ripple pitched relied on Ripple’s token purchase contracts, marketing materials, and executive speeches and communications regarding Ripple’s role in creating value for the XRP tokens. Because of these communications, Judge Torres found that Ripple’s activities would have signaled to these sophisticated investors that it was presenting a “speculative value proposition” in XRP tied to the success of Ripple Labs.

This kind of analytical dichotomy is nothing unusual; the SEC promulgated a similar analysis in its “Framework for ‘Investment Contract’ Analysis of Digital Assets” back in 2018.

Still, it should place public-facing crypto projects on notice that they could still come up against sanctions depending on how they sell their tokens and market their offerings to different audiences.

Read more from our opinion section: Ratioing Gensler on Twitter is sadly crypto’s most powerful protest

Fortunately for the crypto industry, the decision identifies several steps companies can take to assess whether their activities align with US securities regulations. Judge Torres, for example, found that Ripple’s purchase contracts resembled investment contracts in how they incorporated lock-up provisions, resale restrictions, indemnification clauses and statements of purpose. 

The company’s market reports, and even brochures to potential investors, also presented XRP tokens and their performance as materially tied to the success of Ripple Labs. It also didn’t help that the leadership of Ripple Labs touted on YouTube and Reddit on how by driving interest and certain capital investments in Ripple, the company could lift the price of XRP.

At this stage, the SEC could — and likely will — request the Second Circuit to revisit Judge Torres’ decision. While not delivering everything the crypto industry had hoped for, the decision in Ripple does provide a road map out of the current legal uncertainty bedeviling the crypto industry.

Andrew St. Laurent is a New York-based partner at Harris St. Laurent & Wechsler LLP. He was part of the legal team defending former Coinbase product manager Ishan Wahi in SEC v. Wahi, which is among the first SEC actions to claim cryptocurrencies as securities. Andrew is a first-chair trial lawyer who has tried more than 20 cases to verdict, from federal jury trials, to FINRA, AAA and JAMS arbitrations, and numerous New York State court bench and jury trials. He regularly represents plaintiffs and defendants in employment cases, shareholder and partnership disputes, and criminal and regulatory matters.

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