District Court Allows ‘Fair Notice’ Defense in SEC Cryptocurrency Case Against Ripple Labs, But Denies Motions to Dismiss | Skadden, Arps, Slate, Meagher & Flom LLP

In December 2020, the Securities and Exchange Commission (SEC) filed suit against Ripple Labs, Inc. and two of its executives, alleging they raised over $1.3 billion through an ongoing securities offering. unregistered of its digital currency XRP. The case, which has potentially far-reaching implications for digital asset markets, focuses primarily on whether XRP constitutes “security” under federal securities laws. Over the past year, the SEC and Ripple have sparred extensively over discovery and privilege issues.

On March 11, 2022, Judge Analisa Torres of the Southern District of New York issued two substantive rulings: (1) one denying the SEC’s motion to strike defendants’ “fair notice” defense and (2) the other rejecting the defense of the individual defendants. motions to dismiss.

Affirmative defense of “reasonable notice”. First, the court considered Ripple’s affirmative defense that it did not have “a fair opinion that its conduct was a violation of law, in violation of Ripple’s due process rights”. Claiming that the SEC had not clarified whether to label XRP as a security, Ripple argued that the SEC had now unfairly engaged in enforcement regulation by targeting Ripple for unregistered sales of XRP. Ripple’s assertion has significant implications for the industry as a whole.

Limiting itself to the facts set out in Ripple’s pleading – including that the price of XRP had no relation to Ripple’s business, that Ripple had not sold XRP as an investment, and that Ripple had no relationship with vast majority of XRP holders – court denied SEC strike motion. In doing so, the court noted:[a]At the very least, these facts, if true, would raise legal questions as to whether Ripple had been properly informed that the term “investment contract” covered its distribution of XRP, and the Court may need to consider these questions in more depth. »

While it is unclear whether Ripple will prevail on the merits of this affirmative defense or as a whole, the SEC’s denial of the motion allows Ripple to assert the affirmative defense of “fair notice”.

Requests for help and encouragement. Second, the court denied individual defendants’ motions to dismiss claims that they aided and abetted Ripple’s violation of Section 5 of the Securities Act of 1933 by aiding Ripple’s unregistered sales of XRP. The court held that, to succeed on an aiding and abetting theory, the SEC must plead and ultimately prove “(1) the existence of a violation of securities law by the principal party (per aiding and abetting); (2) knowledge of that breach on the part of the accomplice; and (3) substantial assistance on the part of the accomplice in carrying out the primary breach.”

In doing so, the court rejected defendants’ argument that aiding and abetting liability requires showing that defendants knew or recklessly ignored that Ripple’s actions were somehow “improper.” The court discredited this argument because to require “knowledge of ‘inappropriate’ activity would result in the imposition of a ‘will’ requirement that is absent” from the statute.

The court then determined that the SEC had discharged its burden of argument with respect to the two defendants, focusing on the SEC’s allegations that one or both individuals supervised the sale of XRP by Ripple; were directly involved in Ripple’s strategy to support the price of XRP; knew that XRP sales were funding Ripple’s operations; and understood that XRP would have been sold to “investors”. The SEC’s decision to charge individuals with aiding and abetting an unregistered offering was notable because it does not generally pursue charges of this nature against individuals.

Domestic offers versus foreign offers. Finally, the court also denied the individual defendants’ motion to dismiss the SEC’s Section 5 application based on the 2010 U.S. Supreme Court ruling in Morrison v. National Australia Bank. Specifically, the individuals argued that their alleged XRP offerings and sales were not “domestic,” or were “predominantly foreign,” so the SEC’s claims should be dismissed under morisson.

Judge Torres held that the defendants Sales of XRP took place domestically because, among other things, they sold XRP on embedded digital asset trading platforms and with major establishments in the United States. The court further held that because the defendants made the offers while in California, the offers were in fact domestic and within the scope of Section 5 liability.

The court then rejected the argument that the offers and sales were “predominantly foreign” because the offers and sales were made by US residents, involved securities allegedly issued by a US company, involved a platform based in the United States and included offers and sales to American Buyers.

The SEC-Ripple litigation has been closely watched as it presents critical issues involving the application of securities laws to digital assets. Justice Torres’ rulings address issues that may prove important in other digital asset litigation, including the viability of “fair notice” defenses, liability for complicity, and the application of Morisson in the context of section 5.

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