John Reed Stark, an expert on digital regulatory compliance with 15 years of experience as an SEC enforcement attorney, recently shared his detailed analysis on the recent partial victory for Ripple in the SEC vs Ripple lawsuit. Stark’s insights, published on LinkedIn on July 14, 2023, provide a comprehensive breakdown of the ruling and its implications for the crypto industry.
Stark begins by acknowledging the SEC’s loss in this case but cautions that the decision is on shaky ground and ripe for appeal. He then dissects the court’s ruling, which divided Ripple’s offering into three categories: Institutional Sales, Programmatic Sales, and Other Sales.
In the case of Institutional Sales, the court ruled that XRP was a security when sold to institutional investors, thereby constituting an unlawful sale of securities. Ripple is now required to pay a penalty for the violation, and these investors are entitled to rescission. Stark points out that the court also held that a jury would be needed to decide whether Ripple executives aided and abetted Ripple’s unregistered issuance.
Stark then delves into the court’s rejection of Ripple’s due process defense, stating that Ripple had fair notice that its offering without registration was illegal. However, he also notes that the court is taking seriously the crypto industry’s position that the SEC has sent mixed and inconsistent messages regarding the application of the Howey Test to tokens trading in the secondary market.
Stark mentioned that the court had rejected Ripple’s attempt to reinvent the Howey test with a new test called the “Essential Ingredients Test.”
Judge Torres stated:
“Indeed, in the more than seventy-five years of securities law jurisprudence after Howey, courts have found the existence of an investment contract even in the absence of Defendants’ “essential ingredients,” including in recent digital asset cases in this District . . . And this makes sense, given that the Howey test was intended to “embod[y] a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” 328 U.S. at 299. Put differently, the Howey test was intended to effectuate “[t]he statutory policy of affording broad protection to investors,” protection that is “not to be thwarted by unrealistic and irrelevant formulae.’”
Regarding Programmatic Sales, the court ruled that XRP was no longer a security when sold anonymously to exchanges due to the lack of actual privity between exchange customers and Ripple. Stark finds this troubling, arguing that the court’s presumption that programmatic buyers did not have an expectation of profit from the issuers’ efforts is inconsistent with basic notions of investing.
Stark also disagrees with the court’s ruling on the third category, Other Sales, stating that the court’s distinguishing of the tokens awarded to employees and third parties makes little sense. He argues that these distributions seem clearly to be receiving compensation in the form of tokens, just like employees or third parties who receive compensation in the form of restricted stock units or stock options.
As per Stark’s analysis, the most worrying aspect for XRP token holders seems to be the court’s ruling that XRP was a security when sold to institutional investors. This means that these sales were unlawful, and Ripple will have to pay a penalty for this violation. Furthermore, these institutional investors are entitled to rescission, which means they have the right to undo the transaction and get their money back. This could potentially lead to a significant amount of XRP being returned, which could impact the market and the value of XRP. Additionally, Stark’s belief that the decision is ripe for appeal adds another layer of uncertainty for XRP token holders.
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