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 Section 5 violations.

The parties filed cross-motions for summary judgment. Summary judgment is a decision without a trial when the record shows no genuine dispute about an important fact and the moving party is entitled to judgment as a matter of law.

Ripple’s XRP transactions fell into three categories identified by the SEC: institutional sales under written contracts; programmatic sales through trading algorithms on digital-asset exchanges; and other distributions, including XRP given to employees as compensation and to third parties through Ripple’s Xpring initiative. Larsen and Garlinghouse also sold XRP programmatically on digital-asset exchanges.

Legal standard

The court applied the Supreme Court’s test for an “investment contract.” Under that test, an investment contract is a contract, transaction, or scheme in which a person invests money in a common enterprise and reasonably expects profits from the managerial or entrepreneurial efforts of others. The court examined the economic reality and overall circumstances of each category of transaction.

The court rejected Defendants’ proposed additional requirements that every investment contract must include post-sale obligations by the promoter and a right for investors to share in profits. The court held that those requirements are not part of the Supreme Court’s test.

The court also held that XRP itself is not automatically an investment contract. Instead, whether a transaction involving XRP was an investment contract depended on the circumstances surrounding that transaction.

Institutional sales

The court granted the SEC’s motion for summary judgment as to Ripple’s institutional sales and denied Defendants’ motion as to those sales. The institutional buyers paid money for XRP, and Ripple pooled the proceeds and used them to fund its operations, develop uses for XRP and the XRP Ledger, and promote the XRP market. The court found that the buyers’ fortunes were tied to Ripple’s efforts and to the fortunes of other institutional buyers.

The court also found that reasonable institutional buyers would have expected profits from Ripple’s efforts. It relied on Ripple’s marketing materials, public statements, market reports, and the terms of some sales contracts, including resale restrictions and statements that buyers were purchasing XRP to resell or distribute it. The court concluded that Ripple’s institutional sales were unregistered offers and sales of investment contracts in violation of Section 5.

The court rejected Defendants’ fair-notice and vagueness defenses as to the institutional sales. It held that the investment-contract test and the decisions applying it gave reasonable notice that this conduct could be covered by the securities laws.

Programmatic sales and other distributions

The court granted Defendants’ motion for summary judgment as to Ripple’s programmatic sales and granted the SEC’s motion only in part, denying it as to those sales. The programmatic transactions were blind bid-and-ask transactions: Ripple did not know who purchased the XRP, and the purchasers did not know who sold it. The court concluded that the record did not establish that programmatic buyers reasonably expected profits from Ripple’s efforts, so the third part of the investment-contract test was not satisfied.

The court granted Defendants’ motion as to the other distributions and denied the SEC’s motion as to them. The recipients did not pay money or provide another tangible and identifiable form of consideration to Ripple; instead, Ripple transferred XRP to them. The court therefore found that the first part of the investment-contract test—an investment of money—was not satisfied.

The court also granted Defendants’ motion as to Larsen’s and Garlinghouse’s own XRP sales and denied the SEC’s motion as to those sales. Those transactions were programmatic sales through digital-asset exchanges, and the court found that the record could not establish that buyers reasonably expected profits from the efforts of Larsen or Garlinghouse.

Aiding and abetting claim

The court denied the SEC’s motion for summary judgment on its claim that Larsen and Garlinghouse aided and abetted Ripple’s violation. The court found that the record established a primary Section 5 violation concerning Ripple’s institutional sales and that Defendants conceded they provided substantial assistance during relevant periods. But the record presented genuine factual disputes about whether Larsen and Garlinghouse knew or recklessly disregarded the facts making Ripple’s conduct unlawful.

The court also found a factual dispute about whether Larsen provided substantial assistance after he stepped down as Ripple’s chief executive officer and became executive chair. A reasonable jury could find that he did not consciously assist Ripple’s violations in an active way during that period. Because these factual disputes remained, the aiding-and-abetting claim was not resolved on summary judgment.

Disposition

The court’s final rulings were:

- The SEC’s motion for summary judgment was granted as to the institutional sales and otherwise denied. - 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 pretrial deadlines.