SEC v Ripple
The issue of whether cryptocurrency is a security in the United States is far from settled despite the decision in Ripple’s case.
In 2020, the United States Securities and Exchange Commission (SEC) took action against Ripple, alleging that it raised more than $1.3 billion in 2013 by selling XRP in an unregistered security offering to investors. Ripple had argued that XRP should not be treated as a security and hence fell outside the regulatory scope of the SEC.
The issue before New York District Court hinges on whether the sale of XRP falls within the meaning of an investment contract in the definition of a “security” under the United States securities laws.
The XRP were sold under 3 circumstances, namely, to institutional investors, on digital asset exchanges through the use of trading algorithms and distributed as a form for payment of services. Proceeds from these sales were used to fund Ripple’s operations.
The District Court concluded that the sale of XRP to institutional investors were investment contracts and violated section 5 of the Securities Act as it constituted an unregistered offer and sale of investment contracts. The sale of XRP on digital asset exchanges and the distribution of XRP as payment for services on the other hand, did not fall within the meaning on investment contracts and therefore did not violate the Securities Act.
It should be noted that the court was examining the nature of the transaction rather than the nature of the underlining instrument. In this case an investment contract has been defined by the Supreme Court in SEC v W. J. Howey Co as a “contract, transaction or scheme whereby a person invests his monies in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
The court held that while the institutional investors’ expected returns hinges on Ripples’ efforts as a result of the pooling of the investments made, the same cannot be said of the sales on exchanges and the distribution. Those who purchase XRP on the exchanges could not be said to have the expectation of profits from the managerial efforts of others (or from Ripple’s efforts).
In Malaysia, the issue of whether a digital token or digital currency is a security was resolved with the coming into force of the Capital Markets and Services (Prescription of Securities) [Digital Currency and Digital Token] Order 2019 on 15 January 2019. Under this Order, digital currency and digital token when sold or traded under the circumstances specified in the Order have been prescribed as securities under securities laws and falls within the regulatory purview of the Securities Commission Malaysia.