Challenging Precedents in the SDNY Point to Ongoing Ambiguity for Crypto Assets in 2024
The end of 2023 saw several new developments in key crypto cases. Last year, we discussed conflicting decisions in two Southern District of New York (“SDNY”) cases testing the SEC’s authority to regulate the crypto asset industry. In SEC v. Ripple Labs, which was generally considered a victory for Ripple, Judge Analisa Torres granted partial summary judgment in favor of Ripple on the issue of whether certain sales of Ripple’s XRP digital tokens were considered “investment contracts” and thus “securities” under securities laws. In SEC v. Terraform Labs Pte. Ltd. and Do Hyeong Kwon, Judge Jed Rakoff delivered a decision viewed as an SEC victory, rejecting the approach of Judge Torres and ruling that the manner of sale of crypto asset securities has no impact on whether an asset is a security.
Analytical Divergence in the SDNY
The current divergence in SDNY precedent focuses on application of the so-called Howey test to determine the existence of an “investment contract.” An investment contract is a type of “security” regulated by the SEC. Judge Torres and Judge Rakoff agree that the first two prongs of the Howey test are met in their respective cases. Their views appear to diverge on whether both of the following groups of people can establish a reasonable expectation of profits derived from the efforts of others:
Judge Torres’ decisions have essentially found based on the factual record in Ripple Labs, that public statements by Ripple and its representatives regarding future proceeds did not create a reasonable expectation of profits for investors who acquired XRP on crypto exchanges. Judge Rakoff’s decisions argue that public statements by an issuer and its representatives regarding future proceeds can create an investment contract, regardless of the manner in which the crypto assets are acquired.
Ripple Labs Updates
Two significant developments took place in the Ripple Labs case. First, in October 2023, Judge Torres denied the SEC’s bid for interlocutory appeal of her decision on summary judgment. Second, shortly after Judge Torres denied the SEC’s petition for interlocutory appeal, the SEC voluntarily dismissed its claims against two Ripple executives alleging that they aided and abetted Ripple’s securities law violations with respect to the direct institutional sales of Ripple’s XRP tokens that did not occur on a crypto exchange.
Terraform Updates
Over two months after Judge Torres characterized Judge Rakoff’s decision in Terraform Labs as “not engaging with the Court’s reasoning” in Ripple Labs, Judge Rakoff issued a decision on cross-motions for summary judgment in Terraform Labs. His decision largely upheld his earlier reasoning in the motion to dismiss, in determining that Terraform (and its founder, Do Kwon) violated the federal securities laws by failing to register Terraform’s UST, LUNA, wLUNA, and MIR crypto asset tokens.
Final Thoughts
Looking ahead to 2024, we expect further significant legal decisions in Ripple Labs and Terraform Labs. Despite recent advancements in the Ripple Labs and Terraform cases, the industry likely remains many years away from judicial resolutions of which crypto assets are “securities” under applicable law. Legislative action clarifying the SEC’s jurisdiction over crypto assets remains highly sought after by the industry, but Congressional action remains unlikely in 2024 due to the current political environment.
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