A pair of recent rulings from the Southern District of New York (SDNY) have potentially increased confusion around the regulatory status of crypto asset regulation—but may also provide some interesting signs of what’s to come. In a long-awaited decision, Judge Analisa Torres ruled that certain sales by Ripple Labs, Inc. (Ripple) of its XRP token did not constitute unregistered sales of securities, as alleged by the U.S. Securities and Exchange Commission (SEC). Weeks later, Judge Jed S. Rakoff denied Terraform Labs Pte. Ltd.’s (Terraform) and Do Hyeong Kwon’s motion to dismiss an SEC complaint alleging that Terraform and Kwon violated securities laws based in part on the assertion that various tokens developed and distributed by Terraform are securities.
Judge Rakoff explicitly disagreed with key elements of Judge Torres’s decision, including whether the nature of the counterparties in a particular transaction in a digital asset and whether the transaction is executed on an exchange should be determinative of whether a transaction involves a securities transaction. As we discuss below, the resolution of this split within the SDNY may be critical to future regulatory action by the SEC, and it was therefore almost inevitable that the SEC has sought leave to file an interlocutory appeal of the Ripple ruling.
This difference aside, Judge Torres and Judge Rakoff both rejected arguments that the defendants did not have adequate notice that transactions in the relevant crypto assets may have involved securities transactions. Judge Rakoff, while ruling that Terra’s UST stablecoins were securities, also suggested that at least some stablecoins (namely, those truly pegged to the dollar and used as units of value) may not be properly deemed securities.
This alert discusses the rulings and these implications in more depth.
The Ripple Ruling
In the Ripple case, Judge Torres addressed whether Ripple’s sales of XRP involved illegally unregistered offerings and sales of securities in violation of Section 5 of the Securities Act of 1933 (Securities Act), which requires that all offerings and sales of securities be registered with the SEC or comply with an exemption from registration.
Judge Torres found that Ripple’s sales of XRP to various hedge funds and other institutional buyers did involve offerings and sales of securities under the U.S. Supreme Court’s decision in SEC v. W.J. Howey.1 Judge Torres noted, among other reasons, that Ripple’s efforts in marketing XRP and touting its investment potential likely led these investors to expect that Ripple would promote XRP and protect its position in the market, which would be a primary driver of value. As a result, these investors would have expected their profit to derive primarily from Ripple’s efforts.
In contrast, Judge Torres found that three other types of transactions in XRP did not involve offerings and sales of securities:
The Terraform Ruling
A few weeks after the Ripple ruling, Judge Rakoff found that Terraform’s tokens potentially meet the definition of a security under Howey, and thus that Terraform and Kwon engaged in several violations of the securities laws, including Section 5 of the Securities Act. An important reason, among others cited by Judge Rakoff, was that Terraform and Kwon had engaged in extensive marketing efforts to build investor expectations of profit, including through investor meetings, marketing materials, and social media posts.
Importantly, Judge Rakoff disagreed with Judge Torres’s finding that the “manner of sale” of an asset, and in particular whether it is sold directly to institutional investors or on-exchange to retail purchasers, determines whether the asset is a security under Howey. Judge Rakoff took the position that Howey “makes no such distinction between purchasers,” irrespective of whether the purchaser bought the coins directly from the defendants or, instead, in a secondary resale transaction. Instead, Judge Rakoff noted, the question is whether a “reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts,” which he found occurred in the instant case.
A Few Takeaways
Further, Judge Torres’s ruling that certain blind, on-exchange transactions do not, by their nature, involve securities transactions potentially suggests that transactions in assets that are securities because they are “investment contracts” are not subject to regulation under part or all of the Securities Exchange Act of 1934 (Exchange Act), which (among other things) governs securities intermediaries such as exchanges and broker-dealers. Arguably, the Exchange Act does not make that distinction; like the Securities Act, the Exchange Act includes the term “investment contract” within its definition of what a “security” is.
If adopted, Judge Torres’s analysis could be viewed as a significant new reading of Howey and a change in interpretation of the securities laws and the SEC’s jurisdiction.
Due to significant uncertainty surrounding these two rulings, crypto industry market participants should be cautious in relying on either Ripple or Terraform as guidance. Neither appears to be moving to final resolution soon, and both were made in the context of specific assets and transactions.
 328 U.S. 293 (1946). Section 2(a)(1) of the Securities Act defines a “security” using a long list of instruments, including an “investment contract.” Courts have assessed whether an asset is an “investment contract” under Howey, in which the Supreme Court found that for an investment contract to exist, there must be 1) an investment of money, 2) in a common enterprise, 3) with an expectation of profit, 4) based primarily on the entrepreneurial or managerial efforts of others. In Howey, purchasers bought plots of land in an orange grove, along with a suite of management services provided by the sponsor of the offering, who would cultivate the land and harvest, market, and sell the fruit. While the plots of land alone were not securities, the overall scheme—the plots of land along with the services—constituted an investment contract.
 See, e.g., Sec. & Exch. Comm’n v. Telegram Grp. Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020) (granting a preliminary injunction on the basis that the SEC had a substantial likelihood of success in proving that contracts and understandings related to the sales of tokens were part of a larger scheme to distribute the tokens into a secondary public market in an unregistered offering of securities); U.S. Sec. & Exch. Comm’n v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020) (finding that company’s sales of cryptocurrency constituted illegally unregistered offerings of securities).
 See, e.g., Uselton v. Comm. Lovelace Motor Freight, Inc., 940 F.2d 564, 574 (10th Cir. 1991) (stating that for the purposes of an investment contract, the investor’s contribution may take the form of cash, goods and services, or any other exchange of value); Capital General Corporation, 54 SEC Docket 1714, 1728-29 (July 23, 1993) (stating that Capital General’s gifting of securities constituted a “sale” because it was a disposition for value “by virtue of the creation of a public market for the issuer’s securities”); see also Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, SEC Rel. No. 81207, available at https://www.sec.gov/litigation/investreport/34-81207.pdf, at 11.
 SEC v. Ripple Labs at 29.
 SEC v. Terraform Labs at 26.