XRP Security Or Not? Former SEC Official Reveals Shaky Ground

Key Points:

• The SEC sued Ripple Labs for an unregistered securities offering of over $1.3 billion in XRP.
• The Ripple decision categorized XRP sales into three categories and ruled XRP was a security when sold to institutional investors, but not to the public on exchanges.
• The decision has sparked controversy and raises questions about the classification of tokens as securities and SEC protection for retail investors.

The Ripple lawsuit has been a hot topic. The court ruled XRP was a security when sold to institutional investors, but not to the public on exchanges.

On December 22, 2020, the SEC sued Ripple Labs Inc. for conducting an unregistered securities offering of over $1.3 billion in XRP, Ripple’s native token. The lawsuit has been a hot topic in the cryptocurrency community, with many wondering whether XRP should be classified as a security.

Former SEC official John Reed Stark said that the XRP decision resides on shaky ground, the SEC is likely for appeal and will likely result in reversal. In the Ripple decision, the Court breaks down the Ripple offering into three categories and rules separately on each category: “Institutional sales,” “Programmatic sales,” and “Other Sales.”

With respect to category one, Ripple’s Institutional Sales of XRP to sophisticated individuals and entities pursuant to written contracts, the court held that XRP was a security when it was sold to institutional investors and thereby constituted an unlawful sale of securities. Those investors are therefore entitled to rescission, and Ripple must pay a penalty for the violation. The court also held that a jury will be needed to decide whether Ripple executives aided and abetted Ripple’s unregistered issuance.

With respect to category two, sales of XRP to the public (whom the Judge refers to as “programmatic buyers” on digital asset exchanges), the court held that XRP was no longer a security when the institutional investors or Ripple sold the XRP anonymously to exchanges because there was no actual privity between exchange customers and Ripple.

With respect to category three, “Other Distributions,” the Court concluded that Ripple’s Other Distributions did not constitute the offer and sale of investment contracts.

The Ripple decision is troubling on multiple fronts. The SEC’s position was that this was a traditional application of Howey, but the Ripple decision seems anathema to the SEC’s mission and authority. Moreover, the Ripple decision appears to declare that if any crypto-issuer sells their tokens through an exchange, then securities regulations do not apply because exchange customers are presumed to not know anything about the crypto-issuer.

The Ripple Court seems to hold that if an issuer does not know who is buying their token and the purchasers do not know who is selling the token, then the token is not a security, even though the issuer used the proceeds from the original, initial sales of the token to fund the issuer’s operations.

The Ripple decision grants full SEC protection and all remedies that go along with SEC violations to institutional investors, but retail investors are not granted any SEC protection at all. This seems backward to say the least. The Ripple Court appears to distinguish the IPO and trading of Apple from the ICO and trading of a token.

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