Yesterday, a day of no particular importance during the depths of a brutal bear market when crypto has been kicked around by seemingly everyone, the steeple bells peeled in goblin town.
On Thursday, the news spread quickly across Crypto Twitter, Slack, Discord and Telegram that a federal judge of the vaunted United States District Court for the Southern District of New York had reviewed the U.S. Security and Exchange Commission’s (SEC) years-long case against Ripple Labs and determined that it fell short in many respects.
Bill Hughes is the director of global regulatory matters at ConsenSys.
When the SEC publicly commented on the historic decision, it put on the bravest face it could muster. The agency puffed that the court agreed with its claim that heavily negotiated contracts for XRP tokens between Ripple and various institutional investors were securities under the “Howey test,” and that Ripple had fair notice that those contracts needed to be registered with the SEC to be lawful. Ripple’s interpretation of Howey was also expressly rejected by the court, the SEC sniffed, and the agency would “continue to review the decision.”
This carefully drafted pat-on-the-back contained so much spin that the SEC’s public affairs office must remain nauseous even today.
The SEC, tellingly, elided everything in the decision that is clearly damaging to the SEC’s current approach to crypto. The SEC undoubtedly knew immediately how big a debacle this decision is for them, and what a boon it is to not just the legal position but also spirit of an industry that the SEC has sought to crush under its well-polished wingtip since the condemnable implosion of FTX.
One wonders how surprised the SEC Division of Enforcement and chairman were at this decision, and what their first thoughts were. Was it possibly remorse about choosing to drop years-long discussions with the industry in favor of scorched earth litigation? About not pursuing a legislative or rulemaking approach? About actually litigating a strategically critical case to the end rather than doing whatever it takes to settle?
Whatever their thoughts might have been, their surprise was surely no less than that of the broader crypto space, which other than a few strident voices expected Ripple to lose – and lose huge – with potentially calamitous implications for other crypto market players.
This was so surprising in part because this was supposed to be an easy case for the SEC. Ripple raised funds by selling tokens to the public via crypto exchanges, and got people to accept XRP in payment for services, all the while touting that XRP would go up in value.
[W]e are unlikely to see the SEC change its hard charging tactics, despite growing discomfort among SEC staff.
If Ripple did not run afoul of the Securities Act of 1933 in its dealings, and the XRP token was not proven to be a security, then what’s the likelihood the SEC will be successful convincing other courts that other tokens are securities, or that secondary market crypto trading is regulated activity? The chances are now far worse than they were two days ago.
There are many things that this decision is not. It is not a blanket repudiation of the SEC’s legal theories about crypto. It does not toll the end of the Gensler chairmanship. It is not controlling precedent for other cases. This is but one district court, and its conclusions and reasoning are to some extent limited to the specific dispute before it. Other judges in the same courthouse, let alone federal judges across the country, can disagree with or ignore this decision.
It does not even permanently resolve the specific legal issues on which the judge ruled, because the SEC can at some point appeal. Whether there will be an appeal is to be seen. The SEC may wish to set the Ripple case, a long, exhausting and expensive litigation, aside in favor of a new cohort of cases that this chairman and his staff actually had a hand in building. That may be the more politically shrewd course of action, but it is more likely the SEC will try to immediately appeal this decision to the nationally influential Second Circuit, where the agency has an impressive track record of wins.
This decision is already the subject of legal criticism from many sides, including some who applaud the result. But even if the case is appealed and the Second Circuit reverses some if not all of the district judge’s findings in favor of Ripple, we are talking about months if not years of additional litigation at both the district and appellate levels, all of which holds profound risk for the SEC.
During that time, the SEC will find that its regulation-by-enforcement strategy has gotten palpably more difficult to execute. Every token issuer, exchange and (eventually) software developer that it hauls on to the carpet to make a public example of should now, if they did not before, have the sand to fight back.
And that’s perhaps the biggest impact of the Ripple decision. It is the boost of confidence the crypto community needed to stick to its guns that the SEC’s legal theory is wrong and its tactics improper.
It also boosts the confidence of the community in its public policy work that the SEC and its benefactors on Capitol Hill seem so committed to undermining. What is the Ripple case but a clarion call for Congress to act? It is time to end the interagency bickering and market uncertainty by finally establishing a regulatory framework that is on all fours with the technology, precisely as other countries are doing. This has failed to happen to date in no small part because some lawmakers accepted the SEC’s assurances that it has things handled.
The Ripple decision shows just how hollow those assurances are. Capitol Hill can no longer escape this question: might the crypto industry and 2021-era Gary Gensler be correct that there is a regulatory gap that needs to be filled through legislation?
Legislation is needed to define the SEC’s mandate. No one seriously believes the SEC should not have a productive regulatory role in U.S. crypto markets. Far from it. The SEC should play a vital role, as it does in the digital asset market structure proposal currently under consideration in Congress. But that role must be one that Congress fashions, not the Commission itself. The Ripple decision thankfully increases the possibility that such legislation is achievable if not this calendar year, then soon. Only then can valid worries about the next FTX be properly put to bed.
I expect the SEC not to go gentle into that good night on the policy fight that the chairman chose (or was politically forced, perhaps) to take up in the weeks after the FTX collapse. I do not think that a district judge swatting the SEC on the nose with this decision will engender any introspection or change in character.
Gensler’s tough cop routine, which to some extent is precisely the point of this crusade against crypto, cannot be abandoned. That would signal weakness, and weakness is political death. The more likely play of a masterful political operator, which the chair undoubtedly is, is to double down on enforcement and, by doing so, demonstrate strength to all those who might otherwise question whether his strategy and style might be the problem.
For those reasons, I suspect we are unlikely to see the SEC change its hard charging tactics, despite growing discomfort among SEC staff. They will continue to litigate cases against big exchanges, including Coinbase, explaining that the Ripple decision changes nothing about the merits of their theory. They will undoubtedly go after projects in DeFi, and perhaps the time table for doing so has moved up.
And they will hope for as many settlements as they can get. With Ripple’s win, the SEC may find far fewer willing to undermine the future of crypto in the U.S. by taking a sweetheart deal.
