Paradigm Files Amicus Brief in SEC’s Lawsuit Against Ripple
TLDR: Last week, Paradigm filed an amicus brief in the SEC’s lawsuit against Ripple Labs, Inc. Our goal is to help the Court avoid the unintended consequences of casually endorsing the SEC’s position in this case, which conflates an investment scheme with the crypto asset sold in that scheme. Our brief is backed by a comprehensive analysis of every relevant appellate and Supreme Court case to have applied the Howey test, which confirms no legal precedent exists for treating the object of an investment contract itself as a security (nor has the SEC cited any such authority). While this distinction may seem subtle, it is of monumental importance, and if ignored, it could displace Congress’s role in deciding how crypto assets will be regulated.
The orange groves in Howey were not securities, neither are tokens
Since the seminal Howey case1 in 1946, federal courts have found a wide range of transactions to constitute investment contracts, including examples dealing with whiskey warehouse receipts2, beavers3, cattle embryos4, and chinchillas5, among others. However, in each of those cases, the investment contract (i.e., the set of formal or informal arrangements between the issuer and purchaser) is clearly distinguishable from the object of the scheme itself (e.g., the orange groves, whiskey warehouse receipts, etc.).
The same logic has been applied to transactions and schemes involving crypto assets. For example, in a carefully worded opinion, the Telegram court held that “While helpful as a shorthand reference, the security in this case is not simply the Gram, which is little more than alphanumeric cryptographic sequence… This case presents a “scheme” to be evaluated under Howey that consists of the full set of contracts, expectations, and understandings centered on the sales and distributions of the Gram.”6
By claiming that digital assets themselves are securities, the SEC is attempting to bypass the role of Congress
Nevertheless, in an attempt to expand its authority past the bounds set by Congress, the SEC has repeatedly referred to the XRP token itself as a security. If the Ripple court takes the SEC’s flimsy bait, it risks straying outside the bounds of all existing appellate precedent and statutory guidance and opening their decision to potential reversal. The result would be pointless and unnecessary chaos for markets, investors, and even the government’s efforts to comprehensively address this industry.
Markets for digital assets raise important investor protection and other policy concerns. But that is all the more reason for judicial restraint, particularly given Congress’ active desire to pass comprehensive legislation on crypto, including ongoing consideration of various bills intended to address this. As the Supreme Court explained just this past term, “Congress intends to make major policy decisions itself, not leave those decisions to agencies.”7 For these reasons, our amicus brief asks the court to decline to adopt the SEC’s unsupported position that the XRP token itself is a security and in so doing restrain the SEC from jumping ahead of Congress.
In SEC v. W.J. Howey Co., 328 U.S. 293 (1946), the Supreme Court held that an offering of units of a citrus grove development, coupled with a contract for cultivating, marketing, and remitting the net proceeds to the investor, was an offering of an “investment contract” and therefore a “security” offering within the meaning of § 2(1) of the Securities Act of 1933. The Court also set forth a four part test that looks to whether the circumstances of a given contract, transaction or scheme involves: (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits to come, (4) solely from the efforts of the promoter or a third party (opinions available here, see wikipedia for more background). ↩
Glen-Arden Commodities, Inc. v. Costantino, 493 F.2d 1027 (2d Cir.1974) ↩
Kemmerer v. Weaver, 445 F.2d 76 (7th Cir. 1971) ↩
Bailey v. J.W.K. Props., Inc., 904 F.2d 918 (4th Cir. 1990) ↩
Miller v. Cent. Chinchilla Grp., Inc., 494 F.2d 414 (8th Cir. 1974). ↩
SEC v. Telegram Group, Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020) at 379. ↩
West Virginia v. EPA, 142 S. Ct. 2587 (2022) ↩