In 280 and 279 BC, King Pyrrhus of Epirus defeated the Romans in the Battles of Heracles and Asculum but suffered insurmountable casualties that resulted in the eventual loss of the military campaign. Hence the reference to a Pyrrhic Victory in which the battle was won but the war was lost.
That fate may befall Ripple Labs, Inc. and the larger crypto community after a decision by the U.S. District Court for the Northern District of California throwing out federal and state law class claims but declining to follow another federal court that held that Ripple’s digital asset, XRP, was not a security under federal law. The ruling at summary judgment by Judge Phyllis Hamilton in In re Ripple Labs, Inc. Litigation, No. 18-cv-06753-PJH (N.D. Cal. June 20, 2024), allowed a single claim under California law concerning one statement by Ripple CEO Brad Garlinghouse to go to trial. However, Judge Hamilton’s decision undermines the determination by a court in the Southern District of New York that a certain category of XRP sales did not satisfy the definition of a security under federal law.
Background
Ripple, based in San Francisco, promotes a global payment protocol and exchange system. Ripple developed the XRP digital asset that could be used as a “bridge asset” to make a bridge transfer between two fiat currencies. Ripple asserts that the XRP functions as a currency and therefore is not a security that needs to be registered with the Securities and Exchange Commission. The SEC, however, begs to differ and filed an action, pending in the Southern District of New York, arguing that XRP is a security.
In the Ripple securities litigation, plaintiff Bradley Sostack brought a class action under federal and state law on behalf of all purchasers of XRP from May 3, 2017, to the present and who either retained the XRP and/or sold XRP at a loss. The plaintiff alleged that defendants Ripple Labs, XRP II (a subsidiary of Ripple), and Bradley Garlinghouse, Ripple’s CEO, violated Section 12(1) of the Securities Act of 1933 by the offer and sale of unregistered securities and California Corporations Code Section25503 for the primary violation of Code Section 25110’s restriction on the offer and sale of unregistered securities. The plaintiff also brought control person liability claims against Ripple and Garlinghouse under Section 15 of the Securities Act and California Corporations Code Section 25504.
Further, Sostack brought a claim only in his individual capacity (and not as a class claim) for a violation of California Corporations Code Section 25501 against Ripple and XRP II, and a parallel material assistance claim under Code Section 25504.1 against Ripple and Garlinghouse. These allegations arose out of a single allegedly misleading statement by Garlinghouse in a December 14, 2017, televised interview in which he asserted that he was “very, very, very long [on] XRP” when he supposedly sold millions of XRP during 2017.
Dismissal of Class Claims
Defendants asserted that the federal claims had to be dismissed under the statute of repose in Section 13 of the Securities Act, which bars claims brought “more than three years after the security was bona fide offered to the public.” The court held that the evidence showed that XRP was offered to the public before July 3, 2015, more than three years before the lawsuit was filed. Thus, summary judgment had to be granted on the federal class claims.
Defendants asserted that the claims under California Corporations Code Section 25503 for failing to register a security required the plaintiff to prove that he was in privity with the defendant – i.e., that they had a direct contractual relationship with each other – concerning the purchase of XRP. The court agreed that privity was required and that the plaintiff had failed to raise a triable issue that he or any class members were in privity with defendants or their agents in connection with the purchases of XRP, mandating summary judgment on the state law class claims.
Remaining Claim and the Definition of a Security
The dismissal of the class claims left only the allegation concerning the single alleged misleading statement by Garlinghouse brought by the plaintiff in his individual capacity. Whether summary judgment was granted on that claim turned on whether the XRP satisfied the definition of a security under federal law.
The U.S. Supreme Court established the definition of a security in SEC v. W. J. Howey Co., 328 U.S. 293 (1946). The Ninth Circuit defines the “Howey” test as 1) an investment of money; 2) in a common enterprise; 3) with an expectation of profits produced by the efforts of others. Warfield v. Alaniz, 569 F. 3d 1015 (2009). Judge Hamilton found that the XRP plainly satisfied the first two prongs of the Howey test.
But defendants argued that Judge Hamilton should follow the analysis of the court in the SEC’s action against Ripple, where Judge Analisa Torres distinguished between institutional buyers of XRP under a written contract and so-called programmatic buyers of XRP on digital asset exchanges. SEC v. Ripple Labs, Inc., 682 F. Supp. 3d 308 (S.D.N.Y. 2023). Judge Torres held that the institutional purchasers relied on Ripple’s managerial and entrepreneurial efforts for an expectation of profit, while the programmatic purchasers relied more on cryptocurrency market trends given that such buyers presumably were not aware of the company’s promises and representations.
But Judge Hamilton disagreed with this analysis (as did another court in the Southern District of New York; see SEC v. Terraform Labs Pte. Ltd., 684 F. Supp. 3d 170 (S.D. N.Y. 2023)). Judge Hamilton found that defendants had numerous publicly-disseminated statements concerning Ripple’s efforts with regard to the cross-border payments industry, which defendants acknowledged that they had targeted. Further, Ripple worked with a marketing agency to answer questions directly by XRP purchasers. The court stated that: “[G]iven the relative novelty of cryptocurrency, and given the lack of any controlling law regarding the motivation of a reasonable cryptocurrency investor, the court declines to find as a matter of law that a reasonable investor would have derived any expectation of profit from general cryptocurrency market trends, as opposed to Ripple’s efforts to facilitate XRP’s use in cross-border payments.” The court therefore denied summary judgment and permitted the individual claim to proceed to trial.
While Ripple understandably hailed the dismissal of the class claims, Judge Hamilton’s decision is a defeat in the efforts by Ripple and the crypto industry to argue that crypto assets are not a security under the Howey standard. The resolution of this dispute must come from the appellate courts and/or Congress.
For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.
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