Key Takeaways

• The court denied Ripple’s senior executives’ motions to dismiss, finding that the SEC had met its pleading burden.
• The court also denied the SEC’s motion to strike Ripple’s fair-notice affirmative defense.
• The Ripple case will continue to move toward trial.

Overview

The two individual defendants in the Ripple case, Bradley Garlinghouse and Christian A. Larsen, suffered a setback this week when the court denied their motions to dismiss. Judge Analisa Torres, District Court judge for the Southern District of New York, ruled that the United States Securities and Exchange Commission (SEC) had adequately pleaded that the two senior executives of the crypto platform had aided and abetted Ripple’s alleged violations of Section 5 of the Securities Act of 1933 (Securities Act). On the same day, the court also denied the SEC’s motion to strike Ripple’s affirmative defense that the SEC violated Ripple’s due process rights for failure to provide fair notice that its conduct was illegal.

Background

Ripple Labs, Inc. (Ripple) was founded in 2012 as a privately held payments technology company that uses blockchain technology to enable money to be sent around the world more efficiently than through traditional means of money transmission. XRP is the native digital asset (aka token or cryptocurrency) that is transacted on the Ripple blockchain. In December 2020, the SEC brought suit against Ripple and two of its senior executives, alleging that Ripple violated Section 5 of the Securities Act through the offering and sale of Ripple’s native digital asset XRP, beginning in at least 2013. The SEC argues that XRP is an investment contract, subject to federal securities laws. The individual defendants, Garlinghouse, Ripple’s CEO, and Larsen, one of Ripple’s co-founders, are alleged to have aided and abetted Ripple’s Section 5 violations.

The Defendants’ Motions to Dismiss

In April 2021, both individual defendants moved to dismiss the SEC’s complaint. In order to survive a motion to dismiss, the SEC’s complaint must “contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’”[1] Specifically, the SEC needed to establish for the court that it sufficiently alleged that Ripple violated securities law, that the individual defendants had knowledge of the violations, and that the individual defendants provided substantial assistance in Ripple’s alleged violations of securities law. The defendants’ motions to dismiss rested on three major arguments: (1) that the SEC failed to plead that the defendants had the requisite knowledge of Ripple’s alleged securities violations, (2) that the individual sales were not domestic and therefore fell outside the scope of Section 5, and (3) that the SEC’s claims were time-barred.

(1) Knowledge

The defendants both argued that the SEC failed to adequately plead that they had knowledge of Ripple’s alleged violations of Section 5. They asserted that in order for the SEC to properly allege this claim, it would have to plead that it was obvious to the two defendants that Ripple’s offers or sales of XRP were improper. That was impossible, the defendants argued, given the regulatory uncertainty about cryptocurrencies and whether they constitute securities under federal law. In his motion to dismiss, Larsen argued that the SEC did not properly allege that he provided substantial assistance in furtherance of the alleged Section 5 violations.

The court rejected both the knowledge argument and Larsen’s substantial assistance argument. With regard to knowledge, the court found that the SEC need show only that Garlinghouse and Larsen had a “general awareness of their overall role in Ripple’s illegal scheme.”[2] The court emphasized that “the SEC need not demonstrate that the Individual Defendants were aware that Ripple’s scheme was illegal.  . . . Rather, the SEC must show that the Individual Defendants knew, or recklessly disregarded, the facts that made Ripple’s scheme illegal.”[3] The court further concluded that the SEC sufficiently alleged that both Garlinghouse and Larsen knew that Ripple had taken actions to make unregistered sales of XRP and that they provided substantial assistance for the same.

(2) Domestic Sales

The defendants also argued that the SEC failed to plead that the individual sales were domestic and therefore within the jurisdictional reach of Section 5 of the Securities Act. The court rejected the argument and concluded that the SEC’s complaint adequately alleged that Garlinghouse and Larsen made domestic offers and sales of XRP. In addition to showing that offers and sales took place on U.S.-based platforms, the court noted that the SEC alleged that the defendants resided in the U.S. when they made these offers. The court held that “it is the location of the offerors – here Larsen and Garlinghouse – that is relevant” to determining the domesticity of the sales.[4]

The court also disagreed with the defendants’ argument that such domestic sales should fall outside the scope of Section 5 because they were “predominantly foreign.” Rather, the court noted, “[t]hese offers and sales were made by U.S. residents, involved alleged securities issued by a U.S. company, concerned at least some offers and sales made on U.S.-based platforms, and included at least some offers and sales made to U.S. purchasers.”[5] Accordingly, the court rejected the defendants’ argument that the individual sales were outside the scope of Section 5.

(3) Timeliness

Last, the court found that the SEC’s claim was timely. Larsen argued that the SEC’s claims should be time-barred under 28 U.S.C. § 2462 because the amended complaint alleges that the offering of unregistered securities dated back to 2013. The court dismissed this argument, noting that Larsen cited “no cases in which a court has applied his interpretation of 28 U.S.C. § 2462 to claims under Section 5, or any other provision of securities laws.”[6]

The SEC’s Motion to Strike

In a separate decision, the court also addressed and denied one of the SEC’s main motions.[7] Ripple had pleaded that the SEC had failed to provide fair notice that its conduct was in violation of law, in contravention of Ripple’s due process rights. On April 22, 2021, the SEC moved to strike Ripple’s affirmative defense, arguing that it was legally insufficient and that Ripple could not prevail on it. The court disagreed. Although acknowledging that courts generally apply a lower plausibility threshold when evaluating motions to strike affirmative defenses (as opposed to motions to dismiss), the court nevertheless denied the SEC’s motion. The court instead found that the SEC’s and Ripple’s arguments on this point depended on questions of fact or law that could not be determined at this stage of the litigation. The court further found that the SEC would not be prejudiced by litigating the issue.

Conclusion

The court’s decision means that the battle continues in what has become the most heavily litigated crypto case to date. Unless the case settles, the court will now have the opportunity not only to decide the claims at issue in the above motions but also to address the fundamental issue at bar – whether XRP is a “security” under federal securities law. That decision will have major consequences in not only this case but also the crypto industry at large.

Alexandra Karambelas assisted in the preparation of this alert.

[1] SEC v. Ripple Labs, Inc., No. 1:20-cv-10832, Dkt. No. 441 at 13 (S.D.N.Y. Mar. 11, 2022) (citation omitted).

[2] Id. at 15.

[3] Id. (emphasis in original).

[4] Id. at 27.

[5] Id. at 29.

[6] Id. at 30.

[7] SEC v. Ripple Labs, Inc., No. 1:20-cv-10832, Dkt. No. 440 (S.D.N.Y. Mar. 11, 2022).

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