The same day that the U.S. District Court for the Southern District of New York (SDNY) in SEC v. Ripple Labs, Inc. denied the SEC's request for an interlocutory appeal of the bombshell summary judgment ruling in the case, the SEC filed a legal brief in a separate matter providing insight into how it will adjust its legal theories in light of the court's ruling. Not to be lost in the midst of the "Is it a security?" battle taking place in this matter and others, the Ripple matter had another noteworthy – and rare – development as the SEC stipulated to dismissing the remaining claims against Ripple's executives. How significant is this setback for the agency? Are there any silver linings for the SEC in Judge Analisa Torres's denial? In today's post, we cover each of these developments and offer some key takeaways.

SEC's Interlocutory Appeal Denied

On Oct. 3, 2023, Judge Torres thwarted the SEC's attempts to appeal the court's critical summary judgment rulings to the U.S. Court of Appeals for the Second Circuit (Second Circuit). We previously covered the SEC's notice to the court of its intent to file an interlocutory appeal of the summary judgment rulings that found various transactions of Ripple did not involve a "security" for which a registration statement would have been required prior to the transaction based on the U.S. Supreme Court's investment contract in SEC v. W.J. Howey Co. (Howey test): 1) algorithmic sales of XRP on digital asset trading platforms (Programmatic Sales), 2) XRP distributions to Ripple employees and third parties (Other Distributions), and 3) sales of XRP by two Ripple executives on various digital asset trading platforms. Judge Torres did find, however, that Ripple's direct sales to institutional investors (Institutional Sales) satisfied the Howey test and thus constituted sales of "securities" that should have been registered beforehand.

The SEC asked Judge Torres to certify for interlocutory appeal to the Second Circuit her rulings that the Programmatic Sales and Other Distributions did not involve a "security." Generally, a district court may certify an order for interlocutory appeal where: 1) the order involves a controlling question of law, 2) there is substantial ground for difference of opinion and 3) an immediate appeal from the order may materially advance the ultimate termination of the litigation.

In her Oct. 3 decision, Judge Torres rejected the request. She emphasized that her summary judgment rulings were rendered after much consideration of the "heavily disputed factual record and detailed expert reports" and that she considered "the totality of circumstances surrounding Defendants' different transactions and schemes involving the sale and distribution of XRP." Judge Torres noted that the SEC does not suggest that the court applied the wrong standard; in fact, the court applied the SEC's standard (the Howey test) and rejected the defendants' standard (the proposed "essential ingredients" test). The SEC simply argued that the court misapplied the Howey standard to the facts in the record. But that is not enough to demonstrate an "issue of pure law" to satisfy part of the interlocutory appeal standard.

Importantly, Judge Torres went further and rejected the SEC's suggestion that her rulings are "controlling" and have "precedential value for a large number of cases." She faulted the SEC for "misconstru[ing]" her rulings in so far as they suggested that she held that "offers and sales on crypto asset trading platforms [can never] create a reasonable expectation of profits based on the efforts of others." Judge Torres made clear that her rulings applied only in the Ripple case because they were based on "the totality of the circumstances …, including an examination of the facts, circumstances, and economic realities of the transactions." Judge Torres was clear that "[t]he Court's holding did not turn on the fact that Ripple's 'offers and sales [were] on crypto asset trading platforms.'"

Additionally, Judge Torres rejected the SEC's attempt to put her decisions in Ripple at odds with other decisions, such as the Terraform Labs decision by SDNY's Judge Jed Rakoff.¹ Judge Torres noted that the Terraform Labs decision did not "engage with" her rulings and that nonetheless, Terraform Labs was decided at the motion to dismiss stage, where a court must accept as true the well-pleaded allegations. Judge Torres also rejected the other cases cited by the SEC and insisted that those cases used the same standard she did (the Howey test), but that they applied it "to the facts and circumstances of that particular case."

Finally, Judge Torres found that the final factor for granting an interlocutory appeal – whether the certification will materially advance the termination of the case – was also not satisfied because even "if the Second Circuit were to reverse the [rulings] and remand the case, the Court would be in the position of considering many complicated legal and factual issues in the first instance, such as whether Ripple's Programmatic Sales satisfy Howey's second prong that there exists a common enterprise or Defendants' fair notice defenses as to the Programmatic Sales and Other Distributions." And those decisions would also be subject to an interlocutory appeal motion regardless.

Rare Stipulated Dismissal of Individual Aiding and Abetting Claims

Judge Torres's denial of the SEC's request was not the only setback for the agency. On Oct. 19, 2023, the SEC stipulated and agreed with defendants Bradley Garlinghouse and Christian A. Larsen that the agency would dismiss its claims against them for aiding and abetting Ripple's violations of Section 5 of the Securities Act of 1933 (Securities Act) with respect to Ripple's Institutional Sales.

The SEC moved for summary judgment against both Garlinghouse and Larsen as part of the cross motions for summary judgment. The court denied the SEC's motion. Using the established framework for aiding and abetting liability – 1) existence of a securities law violation, 2) knowledge of this violation by the alleged aider and abettor, and 3) substantial assistance by the aider and abettor in the primary violation – Judge Torres found Garlinghouse and Larsen raised genuine issues of material fact as to the second element.²

Concerning No. 2 – knowledge of the violation – the SEC was required to show that the defendants "knew or recklessly disregarded the facts that made Ripple's transactions and schemes illegal under statutory and case law." The court found genuine issues of material fact based on, among other things, the defendants' testimony that they did not believe XRP was a security because "multiple foreign regulators … had determined that XRP was not a security" and the U.S. Department of Justice (DOJ) and the Financial Crimes Enforcement Network (FinCEN) labeled XRP a "virtual currency." The court also highlighted Larsen's testimony about former SEC Division of Corporation Finance Director Bill Hinman's 2018 speech – one of the subjects of the intense discovery battles between the parties – as a factor in favor of finding a genuine issue of material fact.

Now weeks after Judge Torres's denial of the SEC's interlocutory appeal request, the SEC acknowledged defeat on the remaining claims against the Ripple executives.

SEC Attempts to Pivot and Distinguish

On the same day as Judge Torres's denial of the SEC's request for an interlocutory appeal, the SEC filed an opposition to a crypto exchange defendant's motion for judgment on the pleadings under Federal Rule of Civil Procedure 12(c) in one of the largest unregistered exchange cases recently filed by the agency. The defendant's motion argued, among other things, that the SEC did not adequately allege the presence of investment contract securities.³ On this point, the defendant argued, among other things, that the SEC does not sufficiently allege that the tokens at issue grant the purchaser a contractual right to the profits, income or assets of a business enterprise.⁴ The exchange argued that if the crypto asset and the hope for an increase in value of that asset are the only items transferred, there is no investment contract. And, as expected, the defendant pointed the court to Judge Torres's summary judgment ruling, arguing "[t]he Ripple court found no investment contract based on facts substantially identical to those alleged here."

In response, the SEC argued that under the Howey test, the trading platform engaged in transactions involving investment contracts, which do not require contractual privity. The SEC hit back that the exchange's own internal compliance assessment involved an assessment of the Howey factors and argued that no case had held that contractual privity is necessary to find an investment contract. Moreover – and not surprisingly – the SEC countered the exchange's multiple arguments rooted in Judge Torres's Ripple opinion with several arguments rooted in several favorable crypto decisions for the agency, such as SEC v. Kik Interactive, Inc.,⁵ SEC v. Telegram Group, Inc.⁶ and Judge Rakoff's opinion in Terraform Labs.⁷ The SEC leaned hard into the argument – similar in substance to Judge Rakoff's ruling – that there is nothing in controlling precedent or statute that suggests the nature of the instrument changes based on the medium of the transaction. "There is, accordingly, no reason to apply anything other than Howey's test to both primary offerings and transactions on the secondary market."

With the defendants having recently filed their reply, we will be closely monitoring the docket for an opinion from the court.

Takeaways

• Significant Defeat for SEC …: Even with the SEC salvaging one aspect of its case against Ripple involving the Institutional Sales, there's little question that this matter is a significant setback for the SEC. A sizable portion of XRP activity involved Programmatic Sales, leaving the agency with a much smaller case (albeit one where the SEC still alleges hundreds of millions of dollars raised in USD equivalent). Furthermore, the SEC was forced to admit defeat in its charges against the executives where it sought liability premised on a heightened mental state (aiding and abetting liability). Following the dismissal of the claims against Garlinghouse and Larsen, Ripple's Chief Legal Officer touted that this is "surrender by the SEC." Of course, the expectation is that the SEC will appeal at the conclusion of the matter, but for the time being it is hard to classify the result as anything other than a big loss for the agency.
• … but with a Silver Lining?: Although Judge Torres rejected the SEC's request for interlocutory appeal, a closer read of the opinion reveals some footholds for the SEC to leverage going forward. Judge Torres made clear that her decision came from "a direct application of Howey to the unique facts and circumstances of this case." Judge Torres distinguished the other enforcement actions referenced by the SEC, noting they "involve different digital assets and different companies, which offered and sold those digital assets under different factual circumstances and economic realities." Furthermore, she was clear that the court "did not hold that offers and sales on a digital asset exchange cannot create a reasonable expectation of profits based on the efforts of others. The court held that based on the totality of the circumstances in this case …" Although they reinforce the court's firm holding in the Ripple matter, the SEC has already used this aspect of the court's holding to minimize the application of the holding to other matters. Although the defeat is a significant one (for now), this language may give the agency an opportunity to limit the damage.
• Discovery Rulings Played Significant Role, Particularly for Individual Defendants: Not to be lost in the back-and-forth concerning whether XRP is a security is the basis for the court finding genuine issues of material fact for the aiding and abetting claims against Garlinghouse and Larsen. As detailed above, the court focused in part on materials the defendants were able to obtain from the SEC in discovery. The January 2022 opinion from Magistrate Judge Sarah Netburn comes back into focus here where the court ruled, among other things, that documents peripheral to actual policy formation did not satisfy the deliberative process privilege, certain notes from staff members are not per se protected from disclosure and personal views of agency employees are not protected by privilege unless they bear on the formulation or exercise of policy-oriented judgment. Even though the SEC is now armed with the benefit of the opinion in this matter going forward and the Ripple facts are relatively unique compared to other tokens at issue in SEC investigations and enforcement actions, the defendants' effective use of the discovery process and the court's reliance on at least some of these documents to conclude a genuine issue of material fact likely means other, well-funded defendants will take a similarly aggressive discovery posture going forward.

The SECond Opinions Blog will continue monitoring this litigation and others in the SEC and crypto enforcement space. 

Notes

¹ SEC v. Terraform Labs Pte. Ltd., 2023 WL 4858299 (S.D.N.Y. July 31, 2023).

² As noted above, the court found the Institutional Sales violated Section 5 of the Securities Act, thus satisfying the first element. However, in addition to the genuine issues of material fact concerning the second element detailed above, the court also found that Larsen, Ripple's CEO prior to 2017, also raised a genuine issue of material fact concerning the third element on substantial assistance given he moved away from day-to-day operational duties.

³ The defendant also raised similar arguments advanced by other defendants in SEC crypto enforcement matters, arguing that the Major Questions Doctrine precludes SEC enforcement in this area.

⁴ Notably, the defendant petitioner sought to distinguish this argument from the one advanced by the Ripple defendants concerning the "essential ingredients" test by noting that a contractual right to profits, incomes or assets is a direct prong of Howey.

⁵ 492 F. Supp. 3d 169, 174-76 (S.D.N.Y. 2020).

⁶ 448 F. Supp. 3d 352, 358-59 (S.D.N.Y. 2020).

⁷ The SEC also heavily leveraged two non-SEC enforcement opinions: Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340, 347 (S.D.N.Y. Mar. 31, 2019) and United States v. Zaslavskiy, 2018 WL 4346339, at *2 (E.D.N.Y. Sept. 11, 2018).