Securities and Exchange Commission v. Ripple Labs Inc.

Background

The Securities and Exchange Commission brought the action against Ripple Labs Inc., Bradley Garlinghouse, and Christian A. Larsen. It alleged that the defendants engaged in unlawful offers and sales of securities in violation of Section 5 of the Securities Act of 1933.

Ripple asserted an affirmative defense based on fair notice. In substance, Ripple argued that it lacked adequate notice that its conduct violated the law, which it said would contravene its due-process rights. Ripple’s answer included allegations about XRP’s uses, its trading and distribution, Ripple’s relationship with XRP holders, and legal memoranda that Ripple obtained in 2012 concerning potential legal risks.

Motion and Legal Standard

The Commission moved under Federal Rule of Civil Procedure 12(f), which permits a court to strike an insufficient defense from a pleading. Motions to strike defenses are generally disfavored. The court explained that it must treat the nonmoving party’s well-pleaded facts as admitted for purposes of the motion, draw reasonable inferences in that party’s favor, and resolve doubts in favor of denying the motion.

To strike an affirmative defense, the Commission had to show that there was no factual question that could allow the defense to succeed, no legal question that could allow it to succeed, and prejudice from allowing the defense to remain. Ripple also had to plead enough facts to make the defense plausible, although courts generally apply a lower plausibility threshold to affirmative defenses at this stage than to claims challenged by a motion to dismiss.

Court’s Analysis

The court treated Ripple’s position as an as-applied fair-notice challenge. That type of challenge examines whether the law gave adequate notice that the particular conduct at issue was prohibited, rather than considering the law in the abstract.

At this stage, the court’s review was limited to facts pleaded in Ripple’s answer, undisputed facts in the amended complaint, and facts suitable for judicial notice. Ripple alleged, among other things, that XRP’s price was not determined by Ripple’s activities, that Ripple did not sell XRP as an investment, and that Ripple had no relationship with most XRP holders.

The court concluded that, if true, these allegations raised legal questions about whether Ripple had fair notice that the term “investment contract” covered its distribution of XRP. The court therefore held that the Commission had not shown that there were no factual or legal questions that might allow Ripple’s defense to succeed.

The court also rejected the Commission’s argument that allowing the defense would cause undue prejudice. The Commission did not contend that Ripple had filed the defense too late, and the court would not decide at this early stage that the defense was invalid merely because it could expand the litigation.

Disposition

The court denied the Commission’s motion to strike Ripple’s fair-notice affirmative defense. The order did not determine whether the defense will prevail, whether XRP was a security under the circumstances alleged, or whether any defendant is ultimately liable. The Clerk of Court was directed to terminate the motion at ECF No. 128.