Ripple Decision Brings Opportunity for Broader Crypto Reform
The Securities and Exchange Commission (SEC) has been on a crusade against the crypto industry, claiming that most digital tokens are securities that must comply with its rules and regulations. The SEC has sued several crypto companies and individuals, including Ripple Labs and its executives, for allegedly conducting unregistered securities offerings. The SEC has made similar allegations in lawsuits against crypto exchanges like Binance and Coinbase, despite approving the Coinbase’s business model described in its S-1 registration filing.
The SEC’s aggressive approach to digital assets is based on a flawed and outdated interpretation of the federal securities laws, which were enacted in the 1930s to protect investors from fraudulent schemes involving stocks and bonds. The SEC has tried to apply the so-called Howey test from a 1946 Supreme Court decision which determines whether a transaction is an investment contract and therefore a security, to crypto tokens that have very different characteristics and functions.
The SEC has ignored the fact that many crypto tokens are not issued by a central entity, but are created and distributed by a decentralized network of users and validators. The SEC has also disregarded the fact that many crypto tokens are not bought for speculative purposes, but are used as a medium of exchange, a store of value, or a utility token that enables access to certain services or platforms.
The SEC’s overreach has not gone unnoticed by the courts, which have shown more willingness and competence to understand the technology and its nuances. A recent example is the partial victory of Ripple in its ongoing lawsuit with the SEC.
In a landmark ruling, Judge Analisa Torres of the U.S. District Court for the Southern District of New York rejected the SEC’s argument that all sales of XRP, the native token of the XRP Ledger, are sales of securities in Ripple solely because XRP was initially distributed to some buyers as part of an investment contract in the company. Judge Torres excluded all other sales including on exchanges.
The court correctly recognized that just because an asset was sold as part of an investment contract in some transactions does not mean that the asset itself is a security. This is a basic principle of securities law that has been established by hundreds of cases involving various assets, such as oranges, chinchillas, rum, and even beanie babies.
The Ripple ruling also has implications for other cases involving crypto tokens, as it suggests that determinations of whether or not a particular token is a security will depend on the facts and circumstances of each case, rather than on a sweeping assertion by the SEC about an entire asset class.
The judge also cautioned in footnote 16 of the opinion that she was not making a general statement that all trades of crypto tokens on secondary markets are not securities, and that some sales may still fall under the SEC’s jurisdiction. This footnote will likely form a shield against the SEC’s planned appeal of the ruling as it narrowly tailors her ruling’s reach.
When a judge is willing to spend that much time to understand the technology, it suggests that the tide is turning against the SEC’s historical leverage to extract settlements against crypto defendants who historically found it difficult to educate judges about the realities of decentralized finance. Instead, the SEC’s shotgun approach to claiming everything is a security in the crypto space is now more likely to ricochet back on the agency in the form of more precedent constraining their flexibility in the future.
In cases like this, when the odds shift against you, it’s time to settle. The SEC is indicating its intention to appeal, time will tell if this is part of a broader strategy or if they actually plan to see it through. However, the agency has an opportunity to settle the remaining questions with Ripple for a reasonable fine and move forward. Moreover, the SEC should settle its unregistered securities cases against exchanges now that its central theory has been taken apart with a strict reading of Howey.
This would give a wider set of enforcement agencies, like the Department of Justice and the Office of Foreign Assets Control (OFAC), the opportunity to join the SEC and work with the largest crypto exchanges as vehicles for reform, modeling know-your-customer (KYC) and anti-money laundering (AML) best practices from a U.S. perspective.
It’s time to simply do what the SEC alumni and big law alumni working in the crypto space have been asking the SEC to do for years: create a basic adaptive framework for crypto asset disclosure in the same way the SEC has adapted regulations in the past for asset-backed securities, master limited partnerships, and a host of other hybrid assets and hybrid vehicles.
If the SEC reaches out to the practicing crypto bar in good faith, their Washington headquarters will be met with a line of practicing lawyers coming with good ideas that will make F Street look like the front doors of a Taylor Swift concert.
The SEC should embrace this opportunity to foster innovation and growth in the crypto industry, rather than stifle it with outdated and ill-fitting rules. It should recognize that crypto is not a threat, but an opportunity for America to lead the world in financial technology and inclusion. The SEC should act now, before it’s too late.
J.W. Verret is an associate professor at the George Mason Law School. He is a practicing crypto forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Financial Accounting Standards Board’s Advisory Council and a former member of the SEC Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting for policy change to preserve freedom and privacy for crypto developers and users.
