On January 21, 2022, we reported that the Court presiding over the SEC’s enforcement action against Ripple Labs, Inc., and its founders Bradley Garlinghouse and Christian Larson, ruled that the SEC was required to turn over a prepublication draft and internal SEC communications related to the influential June 2018 speech by then Director of the Division of Corporation Finance, William Hinman, entitled Digital Asset Transactions: When Howey Met Gary (Plastic).
In the speech, Hinman famously concluded, “And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value.”
The defendants sought these internal SEC communications to challenge the Commission’s allegations that Larsen and Garlinghouse were objectively reckless in believing XRP was not a security, and that Ripple was on fair notice that XRP was a security.
At first, the SEC had sought to protect these materials from disclosure under the “deliberative process privilege,” which shields communications reflecting government decision and policy making processes, but the Court rejected the argument on the ground that the speech reflected Hinman’s personal views, not the view of the Commission.
Then the SEC took another run at it, this time arguing the materials were protected by the attorney-client privilege. The Court was having none of it:
The SEC has distanced itself from the Speech to avoid discovery and sought to preclude Hinman’s deposition on the grounds that whatever he said in the Speech, it had nothing to do with the SEC’s position. The hypocrisy in arguing to the Court, on the one hand, that the Speech is not relevant to the market’s understanding of how or whether the SEC will regulate cryptocurrency, and on the other hand, that Hinman sought and obtained legal advice from SEC counsel in drafting the Speech, suggests that the SEC is adopting its litigation positions to further its desired goal, and not out of faithful allegiance to the law.
One reason the Hinman speech has been so important to the cryptocurrency industry and investors is because, at the time, it was the first statement by anyone from the SEC concerning the securities law status of Ether. In the years that have passed since the 2017-2018 ICO craze – short of an enforcement action like the one it brought against Ripple – neither the SEC nor members of SEC’s senior management have made similar statements concerning any other digital assets, even those with market capitalizations in the billions, held by millions of investors.
In other words, the Hinman speech is one of the few bits of concrete guidance we have from the SEC. On April 3, 2021, the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub) published its Framework for “Investment Contract” Analysis of Digital Assets as a guide for analyzing whether a digital asset is offered or sold as an investment contract and, therefore, is a security. The Framework remains a useful tool for analyzing digital assets in the abstract. However, the SEC has never published a report on the securities law status of any other widely held digital assets. We cannot know the SEC’s programmatic reasons for bringing the enforcement action against Ripple and its co-founders, but it is clearly consuming a tremendous amount of resources. It is unfortunate the SEC continues to send its staff to die on that hill instead of redirecting their energies to something that might provide more comprehensive guidance to investors, the markets, and the industry.