I watch the ripples change their size
But never leave the stream of warm impermanence
And so the days float through my eyes
But still the days seem the same
And these children that you spit on
As they try to change their worlds
Are immune to your consultations
They’re quite aware of what they’re goin’ through
—DAVID BOWIE, Changes
The Ripple saga1 has finally come to an end.
On August 7, 2024, the U.S. District Court for the Southern District of New York permanently enjoined Ripple from future violations of Section 5 of the Securities Act of 1933—that is, from the unregistered offer and sale of securities—and imposed a civil penalty of $125,035,150.
This was not the outcome the SEC had wanted. The SEC had asked the Court to make Ripple pay more than $1.95 billion in monetary sanctions comprised of (a) $876,308,712 in disgorgement, (b) $198,150,940 in prejudgment interest on the disgorgement amount, and (c) an $876,308,712 penalty.
The headline is the Court’s decision to deny the SEC’s disgorgement request. Citing Liu v. SEC, 140 S. Ct. 1936 (2020), the Court wrote: “Disgorgement is an equitable remedy, permissible only where it does not exceed a wrongdoer’s net profits and is awarded for victims.” The Court then found there were no victims here.
“Victim” for purposes of disgorgement under the federal securities laws, the Court explained, is one who suffers pecuniary harm from the violation.2 The purpose of disgorgement is to restore the status quo, not confer a windfall on investors who received the benefit of their bargain and suffered no pecuniary harm. Here, the Court concluded, the investors had not suffered pecuniary harm as a result of Ripple’s conduct.
The Court arrived at the $125,035,150 penalty by multiplying the number of unregistered transactions by the statutory amount for first tier penalties.3 It was less than 15% of the amount the SEC sought but more than twelve times the amount Ripple had argued was appropriate.
Finally, the kind of injunction imposed by the Court is often referred to as an “obey-the-law” injunction, because the Court simply says do not violate the same law again. In imposing it, the Court discussed Ripple’s continuing unregistered XRP sales to institutional buyers: “To be clear, the Court does not today hold that Ripple’s post-Complaint sales have violated Section 5. Rather, the Court finds that Ripple’s willingness to push the boundaries…evinces a likelihood that it will eventually (if it has not already) cross the line.” Yet, the Court denied the SEC’s request for a more specific injunction, prohibiting Ripple from further institutional sales of XRP.
This Court’s decision follows a mixed ruling on summary judgment,4 in which it held that Ripple’s sales of XRP to institutional investors constituted offers and sales of investment contracts, under the Howey test, but Ripple’s sales on digital asset exchanges and other distributions of the token—and individual sales by Larsen and Garlinghouse—did not. Soon thereafter, the SEC trimmed its case, dismissing its charges against the executives to obviate the need for a trial.
S&K OBSERVATIONS
There are no winners here, but the SEC definitely did not win.
The SEC poured an enormous amount of resources into this case, sending one staffer after the next into the breach. At the end of the day, the Court found there were no victims, the investors got the benefit of their bargain, they knew what they were getting into. And the Court’s decision affirmed precedent from which one can only conclude it will be difficult for the SEC to obtain disgorgement in pure registration cases going forward.
We are confident the zero in disgorgement, taken together with the penalty the Court imposed, was far south of anything the SEC would have accepted in settlement. The lesson for token issuers in registration cases may be to litigate rather than accept an untenable settlement, assuming they too have the resources for the fight. And the SEC did not obtain a judgment against the individuals, long a stated priority of its enforcement program.
It’s unfortunate that smaller crypto entrepreneurs and token issuers are generally not in a position to litigate against the SEC, like Ripple, because it creates an uneven playing field. It’s unfortunate also that—nearly four years after this case was filed—substantial uncertainty remains for the industry and investors when it comes to the securities law status of many token offerings as well as secondary market sales of tokens initially sold in ICOs or similar offerings.
Which raises the question: Was leading with enforcement in the non-fraud cases the right approach?
In seeking the specific injunction against further institutional sales, the SEC essentially argued Ripple is still engaged in the unregistered offer and sale of securities. So do we do it all over again? In declining that request, the Court seemed to be saying it did not want to.
1 On December 22, 2020, the SEC filed its complaint against Ripple Labs, Inc., company co-founder Christian Larsen, and its CEO Bradley Garlinghouse in the U.S. District Court for the Southern District of New York alleging Ripple engaged in unregistered sales of XRP in violation of §§ 5(a) and 5(c) of the Securities Act of 1933, including sales to institutional investors, programmatic sales on digital asset exchanges, and other distributions of XRP under written contracts for consideration other than cash. The compliant also alleged the executives engaged in unregistered individual sales and aided and abetted Ripple’s violations. It was a pure registration case; no fraud was alleged.
2 In the authority relied on by the Court, SEC v. Govil, 86 F.4th 89 (2d Cir. 2023), the Second Circuit held that it was not enough that investors were lied to and thus deprived of the right to make an informed investment decision because “offending that right” does not result in pecuniary harm. If the Second Circuit will not permit disgorgement in a fraud case where there was no pecuniary harm, it is unlikely it will permit it in a registration case.
3 In SEC injunctive actions, courts may impose penalties not to exceed the greater of the gross pecuniary gain to a defendant as a result of the violation (as sought by the SEC here) or a specified amount per violation, depending on whether the violation falls within the first, second, or third penalty tier. First tier penalties are for any violation of the federal securities laws; a second tier penalty, for any violation involving fraud, deceit, or manipulation, or a reckless disregard for a regulatory requirement; and a third-tier penalty, if in addition to meeting the requirements of a second-tier penalty, the violation resulted in substantial losses or created a significant risk of substantial losses to other persons. The Court found that first-tier penalties were appropriate because Ripple’s conduct did not involve fraud, deceit, or manipulation, or a reckless disregard for a regulatory requirement.
4 SKrypto discussed the summary judgment decision here.
