Companies and individuals who have been considering the use of cryptotokens for funding, marketing, or even customer rewards programs have been following the SEC vs. Ripple XRP case for some time. Finally last mid-July 2023, Judge Analisa Torres of the Southern District of New York Federal Court released her decision on the case. Basically the SEC alleged that XRP, the Ripple Corporation cryptotoken designed for fast cross border fund remittance, is an unregistered security.
In the US, only accredited investors are allowed to buy unregistered securities. Accredited investors generally have at least one million dollars in net worth, or earn at least $200,000 a year individually, or $300,000 as a married couple. There are several other possible qualifiers, but it is enough to say that only accredited investors are allowed to buy unregistered securities.
The SEC, through its current Chairman Gary Gensler, has alleged that many (if not most) of the several thousand cryptotokens on the market today are unregistered securities. In fact the SEC has also brought suit against two giant crypto exchanges, Binance and Coinbase. While the Binance suit has some allegations that could be criminal in nature, both the SEC Binance and Coinbase suits allege that they have both been selling unregistered securities to the public.
The Binance and Coinbase suits allege that major cryptocurrencies such as Solana, Matic, Cardano, and others are unregistered securities. The recent decision by Judge Torres has an impact on this, and could be used by the two defendants to probably argue that the charge of selling unregistered securities is no longer valid because of this ruling. Where Binance and Coinbase run afoul of the SEC in the selling of these alleged crypto unregistered securities is that these were sold to the general public.
To be defined as a Security, US jurisprudence generally relies on what is known as the Howey Test. This was a case involving a Florida orange grove and its investors (US SEC vs. W.J. Howey Corporation) that the US Supreme Court used as a basis to define what constituted an investment agreement and a security.
Basically the Howey Test says that if money if placed in a common enterprise (e.g. a business), and if that money is expected to yield profit based on the efforts of others (e.g. a management team), then it is a security and investment contract.
Cryptocurrency advocates say that the Howey Test is difficult to apply to crypto because the common enterprise is often a community spread out across the world who do not really know each other, except that they all hold the crypto token, and that the value of the token is often defined by the buying and selling and not the efforts of a centralized team. Often the upgrades or updates are done by different members of the developer community and not run by a management team.
The ruling has big implications for crypto because being classified as a security imposes requirements such as annual reports, ESG reports, and others that a decentralized community would not be able to do.
Judge Torres basically said the following in her 34 page ruling. She said that:
- The XRP token by and in of itself, is not an investment contract or security that passes the Howey Test.
- Retail buyers who buy the tokens from an exchange are doing a blind bid or ask. They do not know the counterparty seller. These types of sales through exchanges are NOT securities and do not pass the Howey Test.
- Institutional sales where the two parties met and where the founders/Ripple sold the tokens directly to these institutions satisfies the Howey Test and are unregistered securities. This portion of the case will go to trial.
Only the institutional sales will go to trial, but based on the public statement of the new judge, Sarah Netburn, she prefers that the two parties come to a settlement on the matter.
The most important part of the Torres verdict is that XRP (and possibly precedent for most cryptos) are not securities per se. Rather it is the means of how these are sold that determine whether these are securities. The verdict seems to indicate that if the general public buys a crypto token from Coinbase, Binance or other exchanges, they are not buying an unregistered security since it is a “blind bid and ask” transaction. It is when these tokens are bought direct from the issuers, such as through an Initial Coin Offering (ICO) that it may be problematic.
This clarity is good for the crypto sector and also companies and individuals who want to use it for fundraising, marketing, or customer reward programs. But since a court verdict can be appealed to a higher court, either a final Supreme Court verdict or a new crypto law from the Congress is the right way to ensure that crypto leadership remains in the US.
SOURCES