Legally speaking, what are cryptocurrency tokens for sale to the public?
Continue Thursday’s shocking split decision Southern District of New York (SDNY) Judge Analisa Torres in the SEC v. Ripple Labs et al case says XRP is an illegally sold investment contract when sold to VCs and institutional investors, but is perfectly legal. The answer seems to be that it is. , “something else” when sold anonymously via a virtual currency exchange or distributed by an employee or insider.
Therefore, the ruling guarantees cryptocurrency issuers only an ongoing uncertainty in the cryptocurrency market, an uncertainty that Congress, and only Congress, can intervene to correct.
Preston Byrne, an occasional columnist at CoinDesk, is a corporate partner in Braun Rudnick’s Digital Commerce Group.
At issue in the lawsuit is that Ripple Labs’ 10-year token distribution was in a transaction that is an “investment contract,” a term defined in the SEC v. WJ Howie’s “Howie Test.” whether it is a sale of securities based on. 328 US 293 (1946, clarified by subsequent case law).
This test, in simple terms, consists of (1) investments of money, (2) in public enterprises, and (3) contracts, transactions, or The scheme says it falls under the law. This is known as an “investment contract” and is regulated by the Federal Securities Act of 1933 in exactly the same way as securities.
For the purpose of conducting the Howey analysis, the Ripple Labs court divided Ripple’s token sale into three categories: (1) Institutional sales to hedge funds, VCs, etc. (2) programmatic sales to retail directly on digital asset exchanges; (3) “as a form of payment for services” to employees and other service providers, such as restricted token purchase agreements and option agreements;
In the first category, institutional sales, Ripple lost out. Few, if any, legal commentators I have seen argue that the courts do not.
For the second category of sales, programmatic sales, the court ruled in Ripple’s favor, arguing that Howie’s third “profit expectation” was not met. The court stated that “Ripple’s programmatic sale was a blind bid/ask deal,” and that “programmatic buyers were asked whether their payments were sent to Ripple or to other sellers of XRP.” “We couldn’t know if the programmatic buyers were in the market,” he said. It was the same shoe as the secondary market buyer who didn’t know who or what he was paying. “
As a result, the court ruled that “programmatic buyers purchased XRP with the expectation of making a profit, but did not derive that expectation from Ripple’s efforts (as opposed to other factors such as general cryptocurrency market trends). Not because programmatic buyers in particular don’t expect profits.” Buyers knew they were buying XRP from Ripple. “
The court here is clearly wrong for a simple reason. The expectation of profit prongs does not require the expectation of profit as a result of the effort of the seller, but rather the effort of another person. According to Howey, “the efforts of promoters or third parties.” As anyone active in the industry should know, Ripple Labs was and still is the primary promoter of XRP, whether or not buyers were aware they were buying tokens from Ripple Labs. .
For more on why SDNY is wrong, see the 2020 decision granting the SEC’s preliminary injunction motion in a large lawsuit. Win Telegram messenger app and its blockchain development subsidiary. There, there is Judge Kevin P. Castell (who recently became famous for lashing out at several lawyers who wrote the following petition): ChatGPThallucination) buyers’ profit expectations are “based on Telegram’s intrinsic entrepreneurial and managerial efforts”[,]It is not due to the entrepreneurial spirit and management efforts of the intermediaries who were selling Telegram SAFT contracts to everyone at the time.
It was “Telegram’s efforts to develop the project” rather than the intermediary seller’s reselling efforts, which the court found to be “necessary efforts of others” for purposes of the Howey case. For this reason, I expect Ripple’s victory on this point to be overturned on appeal.
Finally, and most bizarrely, Ripple won because “other distributions” to employees and others did not meet Howie’s first part – the “funds invested” part. This is a very thorny issue. For it is clear enough from precedent that “investment of money” for Howie purposes need not actually involve the transfer of funds. All that is required is for the purchaser to give up “some tangible and definable amount of money.” Consideration in exchange for interest that is substantially in the nature of a security. “
However, after stating that Ripple’s “other distributions” include “distributions to employees as rewards … and distributions for the development of new applications of XRP,” in virtually any commercial environment, this relationship does not exist. is deemed to have the necessary two-way movement of contractual consideration to satisfy the conditions. Notwithstanding this aspect (employees providing services and employers providing tokens), the court ruled that the required contractual consideration did not exist and that “specific or definable consideration” was not provided to Ripple. We concluded that we were not paid.
Given that employees who provide services and third parties who develop applications for use with the Protocol are routinely paid large sums of money and cryptographic tokens, it is very specific to me as a commercial law attorney. It feels measurable.
For these reasons, the findings are likely erroneous and may be challenged on appeal.
Therefore, the legal status of XRP appears to have some kind of quantized duality: Schrödinger’s shitcoin. that isA security when sold to institutional investors in a primary sale, but a security when sold using the anonymity of a virtual currency exchange or in exchange for services to insiders not.
I find this position highly unsatisfactory from a regulatory consistency perspective. Other securities do not magically change from a security to a non-security after being sold multiple times. Also, when considering the whole reason why XRP buyers buy XRP tokens, this is clearly a false application of the set of precedents related to the first and third Howey prongs (see above).
Issuers in the US market are therefore presented with two major avenues for further development. Much like SEC’s Bill Hinman recklessly invented a “well-diversified” test for token issuance in 2017 and launched 1,000 ICOs (which were then bench-slapped by districts). courts across the United States).
The first pathway is that, assuming that the ill-fits-for-purpose regulations remain unchanged, and that new token issuers take advantage of this narrow (and possibly erroneous ruling) to launch new programmatic token schemes, the SEC will Enforcement action will be taken on two occasions. Over three years, it will hurt the American economy, investors, and innovation more broadly.
Startups on this first road should pay close attention – says my colleague Steven Paley says yes“That order in the Ripple case is a partial summary judgment by a single district court judge. While persuasive, it does not bind precedent in other courts and is therefore likely to be appealed and overturned.” Don’t base your decision on that.”
The second path would be for the US Congress to recognize that it doesn’t make sense for a security to be a security in one transaction but not a security in another, and to normalize cryptocurrency investments, as the UK is doing now. to pass a law to This gives all token trading a well-defined legal status, requires an active disclosure regime, and regulates tokens without contractual promises in the same way as contractual instruments, as in 1933. Securities law requirements are repealed.
Ripple’s token sale business should be legal within regulations in the United States. Not currently.
In my view, Judge Torres’s decision to do so is likely to be overturned on appeal. My hope is that Congress concludes legislation and decides it is time for crypto tokens and crypto exchanges to receive their own purpose-based disclosure and oversight framework. This frees cryptocurrency regulation from the hands of slow and inconsistent courts. This is in the hands of the politically motivated SEC to allow the US cryptocurrency business to proceed in a more laissez-faire manner as allowed in jurisdictions such as the UK.
But my expectations of Congress are pretty low. I hope to be proven wrong on that point.
