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US regulators faced a setback in their campaign to limit the sale of cryptocurrencies on Thursday, as a judge ruled that Ripple Labs did not violate securities law by selling digital tokens to the public.
The Securities and Exchange Commission (SEC) filed a lawsuit against Ripple in December 2020, accusing the cryptocurrency pioneer of selling $1.38 billion worth of XRP tokens without filing the necessary registrations under securities laws.
Judge Analisa Torres dismissed part of the SEC’s case, stating that the registration requirements did not apply to approximately $757 million of tokens sold on digital asset exchanges. This was because retail investors did not purchase XRP tokens with the expectation of profiting from Ripple’s business activities. However, the judge ruled that tokens sold to institutional investors were indeed securities.
The case revolves around a debated provision of US securities law that prohibits the sale of “investment contracts” unless they are registered as securities with federal regulators.
This law, created during the Great Depression to prevent stock promotion scams, has become a vital tool in SEC Chair Gary Gensler’s crackdown on the cryptocurrency industry, which he claims is teeming with fraud and abuse.
Recently, the SEC expanded its crackdown by suing major cryptocurrency exchanges Binance and Coinbase for alleged violations of registration requirements. Both companies deny the allegations and intend to defend themselves in court.
The outcome of these lawsuits will depend on whether the SEC can convince judges that cryptocurrencies, a 21st-century financial technology, fit the vague definition of an “investment contract” from a 1933 law.
Judge Torres’ ruling on Thursday offered some hope to both sides. She agreed with the SEC that sophisticated institutional investors who bought $729 million worth of XRP tokens understood Ripple’s pitch and the potential profits tied to the company’s efforts. These tokens were classified as investment contracts, and Ripple was found to have violated securities law by not registering them.
However, Torres also stated that “less sophisticated” retail investors who bought the same tokens on exchanges were either unaware of Ripple’s pitch or did not fully comprehend it. As a result, these tokens were not considered investment contracts and did not require registration.
Ripple CEO Brian Garlinghouse celebrated the ruling on Twitter, expressing confidence that his company has been operating within the confines of the law. Following the ruling, the price of XRP on Coinbase surged by 30%.
Nevertheless, Torres ordered that a jury must determine whether Garlinghouse and former CEO Christian Larsen knowingly participated in selling unregistered securities to institutional investors.
While the decisions of US district courts are not typically binding on other judges, the ruling in the Ripple case provides an early indication of the challenges that the SEC will likely face as it pursues enforcement actions against other cryptocurrencies.
Paul Grewal, Chief Legal Officer of Coinbase, stated last month that the SEC’s entire case is based on their interpretation of what constitutes an “investment contract.”
“We firmly believe that this interpretation does not cover the tokens listed on our platform or the products and services we offer,” he said.
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