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Enforcement Edge
March 19, 2021

SEC Enforcement Action Is Not a "Final Resolution" that Ripple's Cryptocurrency Token Is a Security

Enforcement Edge: Shining Light on Government Enforcement

On March 5, 2021, payments technology company Ripple Labs Inc. (Ripple) achieved a big win in Delaware Chancery Court bearing on whether a cryptocurrency token qualifies as a security under the US securities laws. Ripple uses blockchain innovation, including the cryptocurrency token "XRP," to send money around the world. Tetragon Financial Group Ltd. (Tetragon), an investment company and majority shareholder of Ripple's Series C preferred stock, sought a preliminary injunction to force a $175 million stock redemption by Ripple. Tetragon Fin. Grp. Ltd. v. Ripple Labs, Inc., No. 20201-007 (Del. Ch., filed Jan. 4, 2021). Tetragon argued that a securities default occurred under the parties' stockholders' agreement, triggering Ripple's redemption obligations. Ripple, for its part, took the position that no securities default had happened because the Securities and Exchange Commission (SEC) has not yet issued a final decision that the token qualifies as a security. Vice Chancellor Morgan T. Zurn rejected Tetragon's arguments.

The ruling addressed a central issue in Tetragon's suit: whether recent actions brought by the SEC effectively determined that XRP qualifies as a security, a determination that would have sweeping implications for the cryptocurrency market as a whole. Tetragon argued that the SEC has officially determined that XRP qualifies as a security when it issued a Wells notice and then filed an enforcement action against Ripple and two of its executives in December 2020 in the US District Court for the Southern District of New York. In the New York suit, the SEC alleged that XRP is a security and that Ripple sold 14.6 billion XRP tokens since 2013 without filing a registration statement. Securities and Exchange Commission v. Ripple Labs, Inc. et al., 1:20-cv-10832-AT-SN (filed Dec. 22, 2020). In that lawsuit, Ripple maintains that XRP is not a security.

Vice Chancellor Zurn disagreed with Tetragon, concluding that neither the Wells notice nor the SEC's lawsuit qualified as a final and authoritative SEC determination that XRP is a security. Vice Chancellor Zurn reasoned that the mere act of filing an enforcement action "is not itself the act of deciding something officially" like a "final decision by a court or administrative agency." Rather, the SEC's filing of a lawsuit "initiates a process by which the Court will ultimately determine whether XRP is a security on a current and going forward basis." While the SEC can take the litigation position that XRP is a security, the SEC "left the final resolution of whether it is a security to the Court." As a result, Vice Chancellor Zurn concluded that "XRP is no more a security after the SEC filed the enforcement action than it was before it" because "[a] determination . . . resolves the question of whether XRP is a security" and the "enforcement action, by contrast, asks that question."

Following the ruling, Tetragon immediately sought to have the question certified for interlocutory appeal. Vice Chancellor Zurn denied that request on March 11, noting that the court had already expedited the case—Ripple sought summary judgment and dismissal on March 9, and if that motion is denied, trial is currently scheduled for March 25 and 26.

Though it occurred in the context of private litigation, this ruling further highlights the gray area in the regulatory framework for cryptocurrencies. Commentators and market participants—including Ripple—have called for regulatory clarity for the cryptocurrency market, arguing that this would drive more entrepreneurial activity. In a similar vein, XRP holders moved to intervene in the enforcement action in the Southern District of New York on March 14, arguing that, because XRP had previously been regulated as a currency, not a security, the SEC's lawsuit is devaluing their investment, with the mere filing of that action leading to a $15 billion drop in XRP's aggregate value. Against this backdrop, Gary Gensler, President Biden's nominee for Chair of the SEC, expressed an openness to further regulatory activity in this arena during his recent confirmation hearing. Gensler's nomination was recently advanced out of committee to the full Senate for a vote, and his likely confirmation is on the horizon.

Continue to monitor the Enforcement Edge blog for cryptocurrency regulatory updates as they develop.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.