Securities and Exchange Commission v. Ripple Labs Inc.

Background

The Securities and Exchange Commission (SEC) sued Ripple Labs Inc., Bradley Garlinghouse, and Christian A. Larsen under Section 5 of the Securities Act of 1933. The SEC alleged that the defendants offered and sold XRP as securities without filing a registration statement. It also alleged that Garlinghouse and Larsen aided and abetted Ripple’s violations.

The parties filed cross-motions for summary judgment. Summary judgment is a decision without a trial when the record shows that no genuine dispute about an important fact requires a jury’s decision. The central legal question was whether the defendants’ XRP transactions were “investment contracts,” a type of security under the Securities Act. The court applied the Supreme Court’s Howey test, which generally asks whether money was invested in a common enterprise with a reasonable expectation of profits from the efforts of others.

The court’s analysis of XRP transactions

The court rejected the defendants’ proposed additional “essential ingredients” test. It held that an investment contract does not necessarily require post-sale obligations by the promoter or a right for the investor to share in profits. Instead, the court examined the economic reality and total circumstances of each category of transaction.

Institutional sales. Ripple sold XRP directly to institutional buyers under written contracts. The court held that these sales were investment contracts. The buyers paid money, Ripple pooled and used the proceeds to fund its operations and develop uses for XRP and the XRP Ledger, and the buyers reasonably expected XRP’s value to increase through Ripple’s managerial and entrepreneurial efforts. Ripple’s marketing materials, public statements, and contract restrictions supported that conclusion. The court therefore held that Ripple’s institutional sales were unregistered offers and sales of investment contracts violating Section 5.

Programmatic sales. Ripple sold XRP through trading algorithms on digital-asset exchanges in blind transactions. Buyers did not know whether they were purchasing from Ripple, and Ripple did not know who was buying. The court held that the record did not establish that these buyers reasonably expected profits from Ripple’s efforts. It therefore held that Ripple’s programmatic sales were not offers or sales of investment contracts. The court did not decide whether the first two Howey factors were satisfied for these sales.

Other distributions. Ripple distributed XRP to employees as compensation and to third parties through its Xpring initiative. The court held that these transactions did not satisfy Howey’s requirement that an investor provide money or other tangible, defined consideration. The court therefore held that these distributions were not offers or sales of investment contracts. It did not decide the other Howey factors for these transactions.

Larsen’s and Garlinghouse’s sales. Larsen and Garlinghouse sold XRP programmatically through digital-asset exchanges. Because the transactions were blind bid-and-ask sales, the court held that the record could not establish the third Howey factor—an expectation of profits from the efforts of others. The court therefore held that their exchange sales did not amount to offers or sales of investment contracts.

Due-process defenses

The defendants argued that the SEC had not given them fair notice that their conduct violated the securities laws, and Larsen and Garlinghouse also raised a vagueness defense. The court rejected those defenses as to the institutional sales. It held that the Howey test and related case law gave a person of ordinary intelligence sufficient notice that the institutional sales could be treated as investment contracts. The court did not address the defenses as to the other transactions because it held that those transactions were not investment contracts.

Aiding-and-abetting claim

The SEC also sought summary judgment against Larsen and Garlinghouse on its claim that they aided and abetted Ripple’s Section 5 violation. The SEC had to show a primary securities violation, the defendants’ knowledge of facts making the conduct unlawful, and substantial assistance in carrying it out.

The court recognized that Ripple’s institutional sales constituted a primary violation. But it found genuine factual disputes about whether Larsen and Garlinghouse knew or recklessly disregarded the facts making the sales unlawful, including whether they understood that the securities laws applied to XRP and whether the Howey elements were satisfied. The court also found a factual dispute about whether Larsen provided substantial assistance after he stepped down as Ripple’s CEO and became Executive Chairman. Because a reasonable jury could resolve those disputes for the defendants, the court denied the SEC’s motion for summary judgment on the aiding-and-abetting claim against both men.

Disposition

The SEC’s motion for summary judgment was granted as to the institutional sales and otherwise denied. The defendants’ motion for summary judgment was granted as to the programmatic sales, the other distributions, and Larsen’s and Garlinghouse’s sales, and denied as to the institutional sales. The SEC’s motion for summary judgment on the aiding-and-abetting claim against Larsen and Garlinghouse was denied. The court stated that it would issue a separate order setting a trial date and related deadlines. It also denied as untimely two requests to file amicus briefs.