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(Reuters) - The blockchain company Ripple Labs Inc is not the first crypto defendant in a Securities and Exchange Commission enforcement action to blame the SEC for failing to provide adequate guidance about when digital assets should be considered securities under federal law.
But as I read Ripple’s latest discovery brief, which calls for the SEC to disclose its internal policies on whether employees can trade digital assets and to hand over certain emails the SEC had received from crypto investors and issuers, it occurred to me that Ripple has actually managed to force the SEC to play defense – at least in discovery disputes.
In discovery orders in April and May, U.S. Magistrate Judge Sarah Netburn of Manhattan gave Ripple significant latitude to develop its argument that it can’t be liable for selling $1.3 billion in unregistered XRP because the SEC sent garbled messages about whether digital assets are subject to the Securities Act.
Under Netburn’s orders, Ripple’s lawyers from Kellogg, Hansen, Todd, Figel & Frederick and Debevoise & Plimpton can’t see the SEC’s privileged materials (though the SEC must produce a privilege log) and are not entitled to informal emails or other communications among SEC officials. But the magistrate otherwise ordered the SEC to search its relevant repositories and turn over to Ripple all communications between the SEC and third parties, including crypto exchanges and other market participants, about XRP, bitcoin and ether.
Ripple’s demand in Friday’s letter brief for documents addressing whether SEC employees are permitted to trade digital assets demonstrates how broadly the company is interpreting Netburn’s orders.
Presumably, some of those SEC documents will become public when Ripple files its promised motion for summary judgment. Those revelations, in turn, could be helpful to future crypto defendants asserting that the SEC’s hands-off approach to bitcoin and ether led the market to assume that the agency similarly regarded other digital assets as currencies not subject to the Securities Act.
I’m making a lot of logical leaps, of course, and the SEC didn’t respond to my email query on the implications of Netburn’s discovery rulings. But it could turn out that Ripple’s victories in these discovery skirmishes undermine the SEC’s policy of using litigation, rather than formal rulemaking, to police the blockchain industry. (Ripple declined to comment.)
The agency has for years cited its robust litigation against crypto fraudsters to rebut blockchain industry arguments that it is not providing fair notice about selling unregistered digital assets. And why not litigate if you’re the SEC? As a regulator, the agency has vast leverage over potential defendants. Ripple, for instance, was under investigation for more than two years before the SEC sued the company last December for violating the Securities Act. Ripple surrendered thousands of documents, including key memos from its lawyers, in an ultimately futile attempt to ward off the SEC’s case, only to see the agency cite those documents in its complaint.
Before the Ripple case, blockchain defendants were stymied when they tried to invoke bitcoin and ether to argue that the SEC deprived them of fair notice that their digital tokens were subject to federal securities laws. The agency described its string of victories against crypto companies’ fair notice defenses in a March 15 letter brief to Netburn, opposing Ripple’s first formal demand for discovery of bitcoin and ether documents.
In one of the agency’s highest-profile cases, for instance, U.S. District Judge Alvin Hellerstein of Manhattan denied Kik Interactive Inc’s demand for discovery on the SEC’s bitcoin and ether policies in 2019, noting that the agency’s view of those cryptocurrencies had no bearing on whether Kik’s digital tokens qualified as securities under the U.S. Supreme Court’s 1946 "Howey test." Hellerstein subsequently granted summary judgment to the SEC in October 2020. The judge’s opinion, which concluded that Kik’s tokens qualify as securities under the Howey test, made no mention of bitcoin.
In another closely watched case, the blockchain developer Telegram Group Inc also tried to argue that its planned digital tokens were not subject to SEC enforcement because they were akin to bitcoin and ether. U.S. District Judge Kevin Castel of Manhattan did not rule specifically on Telegram’s fair notice defense but in March 2020 granted the SEC’s motion to enjoin the launch of Telegram’s crypto platform.
Obviously, Ripple’s argument for discovery from the SEC on bitcoin and ether resonated with Netburn despite the rulings against Kik and Telegram. (Those companies, I should point out, both had top-tier defense counsel – Skadden, Arps, Slate, Meagher & Flom for Telegram; Cooley and Kirkland & Ellis for Kik.) The judge has not explained her reasoning in detail, though, as I’ve reported, she said in a May 31 decision rejecting the SEC’s bid for privileged Ripple documents that the company’s fair notice defense turns on “the commission’s state of mind as to whether XRP qualified as a security.”
The eventual disposition of the Ripple case will fall to U.S. District Judge Analisa Torres of Manhattan, not to the magistrate overseeing discovery. The SEC has asked Torres to strike Ripple’s fair notice defense, arguing among other things that because its case against Ripple alleges a statutory violation of the Securities Act, the SEC’s actions and interpretations are irrelevant. “It is for this court to determine whether Ripple offered and sold what the Securities Act defines as a ‘security,’” the SEC said.
Maybe Netburn will turn out to be an outlier when it comes to relevance of the SEC’s internal discussions of the differences between cryptocurrencies and digital assets encompassed by the Securities Act. Or maybe not. When you live by litigation, as the SEC has in regulating the blockchain industry, you can also die by it.
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