SEC Drops Charges Against Ripple Executives
Commentary by Steven Lofchie
The SEC entered into a Stipulation of Partial Dismissal, approved by the District Court of the Southern District of New York, to dismiss in their entirety, charges filed by the SEC against two of the Ripple defendants for engaging in unregistered distribution of securities in violation of Securities Act Section 5 ("Prohibitions relating to interstate commerce and the mails").
As previously covered, the charges against the defendants were premised on the SEC's assertion that sales of XRP, the cryptocurrency associated with the Ripple blockchain, was a sale of a "security" for purposes of the Securities Act.
Commentary
While the dropping of the charges is certainly a victory for the individual defendants and perhaps for the crypto industry, it does not reflect well on the SEC.
The SEC has taken the view that all sales of cryptocurrencies (except Bitcoin and possibly Ether) are sales of securities on the basis that they constitute investment contracts. The SEC has taken this view without a meaningful attempt to analyze what is it about any individual sale that constitutes the investment contract, how that contract is manifest, and the possibility that the asset (meaning the cryptocurrency) is not the same as the investment contract. (For a compelling takedown of the view that a cryptocurrency as an asset is indistinguishable from an investment contract, see Lewis Cohen's article "The Ineluctable Modality of the Securities Laws.")
Perhaps to avoid taking on the hard legal challenges that would come with defining the application of the securities laws to cryptocurrencies, the SEC has brought numerous cases in situations where there was outright fraud or where the defendants did not have adequate resources or incentive to take on the SEC. The SEC's case against Ripple was different: there was no outright fraud and the defendants had both resources and motivation.
As it turned out, Judge Torres in the Ripple case took seriously the question of whether an "investment contract" could be identified as to all sales of the underlying cryptocurrency. She decided that it could not be, and so Judge Torres dismissed certain of the SEC's charges. That decision was criticized by another judge in the same District, and then very well defended by Judge Torres in a subsequent ruling in the Ripple case.
Had the SEC chosen to appeal the Ripple case, it would have been the first serious test by the SEC as to whether its application of the securities laws to cryptocurrencies was legally supported or overbroad. Instead of attempting to defend its views before the Second Circuit, the SEC gave up.
That outcome takes us back to square one, whether cryptocurrencies are securities or not. As previously described, this is about as meaningful as quarrelling over whether tomatoes are fruits or vegetables (see "The Solomonic Solution"). Ultimately, there must be some regulation of cryptocurrencies because they are a financial product sold to retail investors and there is significant fraud in the market.
Acknowledging that a regulatory scheme is needed is where the difficult questions begin. What does that scheme of regulation look like? SEC Chair Gensler's response is to say, "Like must be regulated as like." But that is not only an insufficient answer, it is at odds with the securities laws which do not regulate all securities identically. There are some twenty different variations of investment funds alone and it would not be hard to come up with a hundred different variations of how the securities laws apply to different products. Repeating "like must be regulated as like" is simply not a sufficient answer when a cryptocurrency is not just like an equity security, not just like a debt security, not just like an asset-backed security.
But for now, its just déjà vu all over again.