In a significant decision for the digital (crypto) asset industry, on July 13, 2023, the United States District Court in the Southern District of New York (the Court) in the matter of the Securities and Exchange Commission (SEC) vs. Ripple Labs, Inc. (Ripple) found (in part) in favour of Ripple, granting summary judgment allowing that the digital asset known as "XRP", created and distributed by Ripple in what were referred to as "programmatic sales", did not constitute sales of investment contracts (i.e. securities) under the oft-cited "Howey Test".
The lawsuit, brought initially by the SEC in December 2020, aimed to constrain Ripple's sales of XRP, casting XRP as a security for which sales would require compliance with additional securities law and regulations. The lawsuit had a general chilling effect on sales of XRP including in secondary markets through registered and unregistered crypto-asset trading platforms both in Canada and globally.
The Court considered the three primary methods of distribution of XRP by Ripple at issue: (i) "institutional sales", being sales directly to certain counterparties, primarily hedge funds and other institutional buyers, through written contracts; (ii) "programmatic sales", or sales on digital asset exchanges through the use of trading algorithms (described as "blind bid/ask transactions") where Ripple did not know the buyer and purchasers did not know the seller; and (iii) "other distributions", being distributions to employees as compensation or to third party developers as incentives. Distributions of traditional equity securities in similar fashion would typically be captured by applicable U.S. securities laws, generally requiring registration, public disclosure and/or regulatory filings with the SEC.
While the Court ruled that Ripple's institutional sales did constitute the unregistered offer and sale of investment contracts under the U.S. Securities Act, the Court went on to hold that programmatic sales and other distributions in question did not. Notably, with respect to programmatic sales, the Court examined the third prong of the Howey Test, finding that while it may have been the case that programmatic buyers purchased XRP with an expectation of profit, they did not derive that expectation from the efforts of Ripple as opposed to other factors like trends in digital asset markets, including as none of the programmatic buyers knew they were buying XRP from Ripple. The Court further stated that a speculative motive itself does not evidence the existence of an investment contract alone, and cited that the test for whether a digital asset is a security is not a search for the precise motivation of each individual market participant. The Court looked at the economic realities of the sales and distributions themselves, finding there were no promises or offers from Ripple that would lead a reasonable purchaser in programmatic sales to expect profits derived from Ripple`s efforts. With respect to other distributions, the Court found these did not involve an investment of money by the acquirors and thus the distributions did not meet the first prong of the Howey Test.
In Canada, the provincial securities commissions which form the Canadian Securities Administrators (CSA) generally require registered crypto-asset trading platforms to apply policies and procedures to determine whether a crypto asset available to be bought and sold is a security and/or derivative, and if so whether it is being offered in compliance with securities and derivatives laws, taking into consideration statements made by regulators or authorities with the most significant connection to a particular asset. On its release, the decision in Ripple has been generally well received by digital asset market participants, as evidenced by trading platforms listing and (re-listing) XRP concurrently and a corresponding spike in XRP trading price and volumes.