On July 13, 2023, U.S. District Judge Analisa Torres issued a landmark ruling for the crypto community, holding that programmatic, or open market, sales of XRP tokens do not constitute investment contracts, and are thus not securities regulated by the U.S. Securities and Exchange Commission (“SEC”).  However, the ruling was not a complete win for the crypto industry, as Judge Torres split the baby in ruling that institutional sales of XRP did constitute the sale of unregistered securities.

The SEC commenced the underlying action against Ripple Labs (“Ripple”), the creator of the XRP token, and several of its executives back in December 2020, claiming that they raised over $1.3 billion through the sale of XRP in an unregistered securities offering. Ripple pushed back, ostensibly making itself a use case for the industry. While this highly anticipated decision sets some welcome guardrails for whether cryptocurrencies are securities subject to the regulatory ambit of the SEC, the order made clear in a footnote that this ruling was not addressing “whether secondary market sales of XRP constitute offers and sales of investment contracts.” The order further noted that the answer to this question would depend on the totality of circumstances and the economic reality of that specific contract, transaction, or scheme.  Notably, Judge Torres held that “XRP, as a digital token, is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract,” but “ordinary assets—like gold, silver, and sugar—may be sold as investment contracts, depending on the circumstances of those sales.”

Judge Torres found that XRP was a security for institutional buyers under the Howey Test. In SEC v. W.J. Howey Co., the Supreme Court held that under the Securities Act, an investment contract is “a contract, transaction[,] or scheme whereby a person [(1)] invests his money [(2)] in a common enterprise and [(3)] is led to expect profits solely from the efforts of the promoter or a third party.” 328 U.S. 293 (1946).

Defendants did not dispute that there was a payment of money; therefore the first element was established. With respect to the second Howey prong, the court found the existence of a common enterprise because the record demonstrates that there was a pooling of assets and that the fortunes of the Institutional Buyers were tied to the success of the enterprise as well as to the success of other Institutional Buyers.” And, finally, the third Howey prong was satisfied as the institutional investors “would have understood that Ripple was pitching a speculative value proposition for XRP with potential profits to be derived from Ripple’s entrepreneurial and managerial efforts.”

Conversely, in considering the economic reality of the programmatic sales, the court found that the third Howey prong was not satisfied, and thus did not address the other two prongs. Specifically, the court stated that “Ripple’s Programmatic Sales were blind bid/ask transactions, and Programmatic Buyers could not have known if their payments of money went to Ripple, or any other seller of XRP.” Therefore, the programmatic buyer “stood in the same shoes as a secondary market purchaser who did not know to whom or what it was paying its money.” Indeed, the court found no evidence that programmatic buyers had the ability to understand the multiple documents and statements that the SEC pointed to, which include inconsistent statements across multiple platforms from a variety of Ripple speakers over an extended eight-year period.