A Ripple of Doubt

In an Aug. 9, 2023, letter to Judge Analisa Torres, the SEC alerted the U.S. District Court for the Southern District of New York (SDNY) – and the crypto industry writ large – of its intent to seek leave to file an interlocutory appeal of the court's recent grant of summary judgment in favor of defendant Ripple Labs Inc.

Specifically, the SEC wants a change to persuade the U.S. Court of Appeals for the Second Circuit – now, not later – of its view that Torres got it wrong when she determined that the company's offer and sale of its XRP token over crypto trading platforms, and distributions of XRP in exchange for labor and services, did not involve investment contract securities under the Howey doctrine.¹ And the SEC now has a new opinion at its disposal to support its argument.

Procedural Status of the Case

As we've discussed in other posts, SEC v. Ripple Labs, Inc., et al. is one of the most closely watched crypto cases to date given its key question of whether XRP tokens, or the transactions through which they are offered and sold, constitute securities and thus come within the SEC's enforcement reach. Filed in December 2020, the case has made headlines for a number of reasons, including the defendants' unsuccessful efforts to secure early dismissal of the case and the parties' discovery fights thereafter.

Most recently, following the close of discovery, the parties filed, and on July 13, 2023, the Southern District of New York decided, cross motions for summary judgment. In her ruling, Torres delivered partial victories – and partial losses – to both sides. For its part, the SEC has alleged that all of the various transactions by which XRP tokens were distributed constituted securities transactions. Not so, concluded the court when it granted summary judgment in the company's favor, determining that the XRP token is not, in and of itself, a security, and that sales over trading platforms and distributions of the token as consideration for labor and services did not involve investment contracts under Howey. Following the court's decisions on the parties' respective summary judgment motions, it directed the clerk to set the case for trial.

Purpose of an Interlocutory Appeal

The SEC's letter seeking leave to move for an interlocutory appeal followed soon after the court ruled on the summary judgment motions. Simply put, an interlocutory appeal occurs when litigation is still ongoing and no final judgment has been entered, but one or more parties want to challenge and reverse an order from the trial court deciding an issue in the case. The SEC's challenge would focus on whether platform-based transactions and other distributions of XRP were securities transactions.

Parties are not guaranteed the right to an interlocutory appeal and must persuade the court why such a step is necessary. Here, the SEC argues that such an appeal is necessary and appropriate because:

• the two determinations it seeks to appeal involve "controlling questions of law on which there is substantial ground for differences of opinion, as reflected by an intra-district split that has already developed" between the Ripple Labs decision and a decision just 18 days later by Judge Jed Rakoff – also of the SDNY – deciding in SEC v. Terraform Labs Pte. Ltd.² that platform-based sales did comprise securities (and "reject[ing] the approach recently adopted" in Ripple Labs)
• there are numerous actions currently pending and "the Order's rulings are of particular consequence to an issue of programmatic concern to the SEC's enforcement of the securities laws and potentially to a large number of pending litigations"
• interlocutory review would permit the court and the parties to avoid piecemeal litigation and the possibility of two trials and two remedies phases (assuming the SEC prevailed)

An Intra-District Split

Perhaps chief among its bases for arguing why an appeal is needed now, the SEC points to a decision from another SDNY court expressly rejecting, in part, the finding in Ripple Labs – a possibility we predicted could occur following the original ruling.

In Terraform Labs, the SEC charged the company and its founder Do Keyong Kwon with five counts of securities fraud relating to sales of a stablecoin called the UST coin, a companion coin called LUNA and three other related crypto assets. The charges included fraud under Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, control person liability under Section 20(a) of the Exchange Act, and the unregistered sale of securities and security-based swaps under Section 5 of the Securities Act.

In his July 31, 2023, opinion, Rakoff denied the defendants' motion to dismiss, a dispositive motion that occurs before fact discovery, whereas summary judgment motions seek a ruling after fact discovery concludes. The court found that the allegations in the SEC's amended complaint, which the court was required to accept as true at the motion dismiss stage, were sufficient to survive dismissal and that the SEC alleged sufficient facts that, if later proven to be true, would demonstrate the digital assets sold by Terraform qualified as "investment contracts" under Howey.³ Notably, the court cited and rejected Torres' approach that distinguished sales to institutional purchasers from sales through the secondary market to anonymous purchasers, declining "to draw a distinction between these coins based on their manner of sale." Instead, Rakoff found that:

Howey makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary resale transaction has no impact on whether a reasonable individual would objectively view the defendants' actions and statements as evincing a promise of profits based on their efforts.⁴

More to Come

The SEC needs the court's permission to file a motion for leave to file an interlocutory appeal. Per the court's practices, the defendants have until Aug. 16, 2023, to submit a letter in opposition to the SEC's Aug. 9, 2023, pre-motion letter. If the court grants the SEC's request to file a motion, the SEC has proposed a briefing schedule whereby it would file its motion on Aug. 18, 2023, then the defendants' opposition brief would be due on Sept. 1, 2023, and the SEC's reply brief would be due on Sept. 8, 2023. The court may accept (or reject) that schedule or impose its own.

The SECond Opinions Blog will be watching and provide updates. If you need additional information on this topic – or any topic related to securities enforcement or investigations – please contact the authors or other members of Holland & Knight's Securities Enforcement Defense Team.

Notes

¹ SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

² No. 23-cv-1346, 2023 WL 4858299 (S.D.N.Y. July 31, 2023).

³ The court also rejected the defendants' other arguments. First, the defendants relied on the Major Questions Doctrine, which the court found did not apply because "the cryptocurrency industry – though certainly important – falls far short of being a portion of the American economy bearing vast economic and political significance." Terraform, 2023 WL 4858299, at *8. Next, the court rejected the defendants' fair notice argument under the Due Process Clause, finding that a reasonable person operating within the crypto industry would have fair notice that their conduct might prompt an SEC enforcement action due to the SEC's activities in the crypto space to date, including written guidance and other enforcement actions and litigation. Id. at *9. Finally, the court declined to credit the defendants' argument under the Administrative Procedures Act (APA), finding that the SEC simply was enforcing its existing views that certain digital assets are securities and not imposing any new policy such that the APA was not triggered. Id. at *10.

⁴ Terraform, 2023 WL 4858299, at *15.