Uncertainty around cryptocurrency regulation increased when a federal judge in New York disagreed with another judge who had earlier this month determined that a Ripple Labs coin was not a security when sold to the general public on secondary markets.
On Monday, Judge Jed Rakoff of the US District Court granted the Securities and Exchange Commission’s (SEC) request to proceed with their investigation into Terraform Labs Pte. Ltd. and its founder, Do Kwon. Rakoff asserted that his decision disregarded the differentiation made in the Ripple case regarding sales to the public and institutional entities.
Most coins rose sharply in the wake of the July 13 Ripple verdict, which had been largely heralded as a victory for the cryptocurrency sector. The Ripple ruling is unaffected by Rakoff’s decision, but it does highlight how unresolved the issue of whether a digital asset qualifies as a security is. The uncertainty might support the case for new legislation to address the problem.
The SEC had asked Rakoff in court documents not to agree with US District Judge Analisa Torres’ conclusions in the Ripple case. The regulator has stated that it is thinking about appealing the Ripple judgement.
The XRP coin from Ripple is a security when offered directly to institutional investors but not when sold to the general public on exchanges, according to Torres, who sits one floor above Rakoff in the federal courthouse in Manhattan.
In the Terra case, Judge Rakoff declared that the court would not differentiate between these cryptocurrencies based on their method of sale. Thus, coins sold directly to institutional investors would be treated as securities, and those sold through secondary market transactions to retail investors would not be exempt. The court explicitly rejected a similar approach adopted by another judge in a related case within the same district.
Security Check
The SEC had contended that XRP must be treated as a security in order for the so-called Howey test—named after a 1946 Supreme Court decision—to be applied. As per the examination, a security exists when there is an “investment of funds in a shared venture with a realistic anticipation of profits arising from the efforts made by others.”
The crypto firm’s sales of its XRP token to knowledgeable investors met the test for an investment contract, according to Torres, who applied the test in finding that institutional sales of the token fell under securities laws. He asserted that purchasers “would have comprehended that Ripple was promoting a speculative value proposition for XRP, offering the possibility of making profits.”
She observed that a significant number of such sales occurred through automated trading algorithms on exchanges, known as blind transactions. However, she contended that the sales of XRP to the general public did not meet the criteria mentioned in the test since there was no evidence to suggest that those buyers expected to share in the company’s profits.
In February, the SEC filed a lawsuit against Terraform Labs and Kwon on the grounds that they issued and sold unregistered securities as part of a scam that destroyed at least $40 billion in market value. Kwon, who had managed to avoid punishment in South Korea before being apprehended in March for using a fake passport, is also being prosecuted in the US.
Rakoff claimed that both institutional and ordinary investors were subject to the SEC’s accusations against Terraform and Kwon. The judge said the defendants were charged with extolling the tokens’ viability and saying that money from token sales will be reinvested in the Terraform blockchain to produce even more money.
Simply put, secondary-market buyers had just as much reason to think that the defendants would use their capital contributions to make money on their behalf, according to Rakoff.
Terraform Labs Pte. v. Securities and Exchange Commission, 23-cv-01346, US District Court, Southern District of New York (Manhattan), is the case at hand.
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