Parts of the recent controversial ruling in SEC v. Ripple on crypto tokens were “wrongly decided,” the SEC said in a new filing in its enforcement action against Terraform Labs. The SEC urged the Terraform court not to follow the Ripple ruling that “programmatic” sales of tokens to retail investors were not “investment contracts” or securities under the federal securities laws (SEC v. Terraform Labs Pte Ltd., July 21, 2023).
The Ripple and Terraform actions both involve alleged sales of unregistered securities and are being litigated in the Southern District of New York. Ripple is being heard by Judge Analisa Torres, while Terraform is being heard by Judge Jed Rakoff.
The SEC’s filing was in response to a memorandum by Terraform regarding supplemental authority in SEC v. Ripple. Terraform argued that the Ripple ruling on programmatic token sales confirmed that the tokens at issue in the Terraform case were not securities.
The SEC also signaled a possible appeal of the Ripple ruling, saying staff intends to recommend that the SEC seek review.
Terraform: Ripple is “fatal” for SEC. In a July 18 memorandum regarding supplemental authority, Terraform argued:
- Ripple held that “programmatic sales” of the digital asset at issue in that case (XRP) by the defendants on exchanges were not “investment contracts” and that Howey would not be satisfied even if secondary market purchasers had speculative intent;
- The same reasoning applies to the tokens at issue in SEC v. Terraform Labs (UST, LUNA, wLUNA, MIR, and mAssets). The SEC does not allege that Defendants sold UST to anyone, directly or on a secondary market. All UST was created by operation of the Terra blockchain.
- Terraform’s Institutional sales of the Terraform tokens were different in key ways from Ripple’s institutional sales of XRP. These facts distinguish the Ripple holding that institutional sales of XRP were securities.
The SEC argued:
- Ripple rejected the defendants’ argument that all investment contracts must include post-sale obligations on the promoter and grant the investor a right to share in profits from the promoter’s efforts;
- Ripple rejected that the SEC did not “provide Defendants with fair notice of its retroactive interpretation of securities laws it now asserts in this case, finding that “Howey sets forth a clear test for determining what constitutes an investment contract.”
“Ripple creates an artificial distinction between the expectations of sophisticated institutional and retail investors, improperly transforms Howey’s reasonable investor inquiry into a subjective one and turns on its head the reasoning underlying Howey and other cases,” the SEC wrote.
The SEC argued:
- The promoter’s choice of using intermediaries to sell does not alter reasonable expectations—those who buy indirectly have the same reasonable expectations. Section 5 expressly proscribes “offer[s] to sell,” as well as sales made “directly or indirectly” through intermediaries, and courts have found Section 5 violations where unregistered securities transactions occur through the use of intermediaries, showing that Ripple’s direct purchase requirement does not exist.
- Ripple erroneously creates two different “reasonable investor” standards—one for institutional and another for retail investors. Creating any such subjective dichotomy is contrary to Howey.
- Ripple misconstrues and improperly adds elements to the Howey analysis of “efforts of others,” including that the seller have made promises directly to each investor, that each investor knows that her money was going directly to the promoter, that the expectations (as opposed to the profits) derive from the issuer’s efforts, and that the investor believes that her proceeds would be used directly to undertake the relevant efforts.
This is case No. 1:23-cv-01346-JSR (Docket).