PROTECTIONS FOR MILLIONS OF AMERICANS AGAINST FRAUD AND ABUSE IN THE CRYPTO MARKETS ARE ON THE LINE IN THE RIPPLE CASE. SEC v. Ripple Labs, Inc., No. 24-648(L) (2d Cir.)
On January 22, 2025, Better Markets filed an amicus brief in support of the SEC’s effort to close a massive loophole in the securities laws, one that threatens to expose millions of everyday investors to greater fraud and abuse in the crypto markets and beyond. The district court dramatically narrowed the definition of an “investment contract” by holding that crypto tokens were not securities simply because investors acquired them on trading platforms or exchanges instead of directly from Ripple. The decision strips investors of protections under the securities laws where they need it most. The crypto markets have long been rife with fraud and abuse and the securities laws provide the only meaningful protections for the increasing number of everyday investors who are lured with promises of huge and lightning-fast profits. Those laws require full disclosure about crypto investments, strict bans on fraud and manipulation, and important remedies for those who have been ripped off. The lower court’s decision in this case deprives millions of retail investors of those protections. The SEC is rightly challenging that aspect of the district court’s decision in the Second Circuit, and Better Markets fully supports the appeal.
The SEC filed an enforcement action against Ripple and its principals for the sale of unregistered securities in the form of the XRP crypto token issued by Ripple. Ripple promoted the token far and wide to institutional and retail investors as an investment opportunity that would produce huge returns as the promoters worked to find practical applications for the token in the financial system. Yet the district court held that the sales of the tokens on trading platforms to retail investors did not involve securities in the form of “investment contracts” because, in the court’s view, investors weren’t sophisticated enough to understand how they would profit from the efforts of Ripple. Yet the court also held that direct sales to institutional investors were securities.
As we explained in our amicus brief, the court’s decision has no support in the securities laws or the facts of the case. First, the court erred in holding that investment contract status hinges on an investor’s purchase of the investment directly from the issuer. This position finds no support in the securities laws; it disregards the Supreme Court’s firmly established axioms calling for a broad, flexible, and realistic application of the investment contract definition (known as the Howey test); and it starkly deviates from the growing body of modern case law appropriately finding that crypto offerings are investment contracts regardless of whether they are sold directly to investors or through secondary trading platforms.
Second, the court erred in concluding that retail investors were not sophisticated enough to grasp the link between their expected profits and Ripple’s claimed efforts to find valuable commercial applications for its token. As a threshold matter, investor sophistication is not an element of the Howey test, and if it were, it would clearly militate in favor of investment contract status so investors most in need of protection would be safeguarded. In any event, the court offered no basis for its conjecture, and the court’s estimation of investor sophistication actually conflicts with the economic realities surrounding today’s retail investors. They are bombarded with online promotions that clearly tout issuers’ ability to pursue business strategies and applications that will generate huge profits for investors. Ripple took full advantage of this in its widespread appeal to retail investors.
Finally, the court erred by applying Howey in a way that will dramatically undermine the investor protection purposes of the securities laws. It thus violated the cardinal rule embodied in Howey: “The statutory policy of affording broad protection to investors is not to be thwarted by unrealistic and irrelevant formulae.” Howey, 328 U.S. at 301. The unfortunate reality is that the court’s decision deprives millions of retail investors of critical protections under the securities laws in an investment arena where they need it most, one that is rapidly expanding yet full of fraud, abuse, and market manipulation. Countless everyday investors, enticed by earnest sales pitches but deprived of full and accurate disclosures and meaningful remedies, will suffer financial losses. And the harm is likely to spread to investment offerings well beyond crypto, as a wide variety of investment contracts based on other types of assets stand to evade securities regulation simply by virtue of the channels through which they are sold to investors and investors’ level of sophistication.
