Ex-SEC Official Comments on Ripple Ruling, Says Howey Test Wasn’t Designed to Address Secondary Market Sales

Former SEC official Daniel Michael and a group of legal experts comment on the Ripple ruling, emphasizing that the Howey test was not designed to address secondary market trades between anonymous buyers and sellers.

Daniel Michael, former chief of SEC’s Enforcement Division’s Complex Financial Instruments Unit (CFI), recently commented on the commission’s case against Ripple.

Howey Is Ill-Fitted to Secondary Market Sales

In a recent article, Michael and a group of legal experts said the “Ripple decision demonstrates that the Howey Test is ill-fitted to secondary market transactions between anonymous buyers and sellers.”

According to the authors, the facts in the Ripple case complicate any form of assessment as to whether a common enterprise exists between secondary market traders and the initial sellers.

Per the analysts, the Howey test is satisfied when there is an investment of money in a common enterprise, with profits expected to be obtained from the efforts of others.

Furthermore, they argued that the Ripple ruling also makes it difficult to ascertain whether secondary market traders can reasonably expect profit from the efforts of the initial sellers, with whom they have no form of relationship.

SEC v. Ripple Summary Judgment

Recall that the court overseeing the Ripple case issued the highly anticipated summary judgment decision on July 13, 2023.

Applying the Howey test to the case’s facts, Judge Analisa Torres ruled that Ripple’s past institutional sales of XRP constituted an investment contract, while programmatic sales on secondary markets and other distributions did not.

Not satisfied with the ruling, the SEC attempted to certify an interlocutory appeal to challenge the court’s decision on Ripple’s secondary market sales of XRP.

However, Judge Torres denied the request, stating that the July 13 ruling did not pose a controlling question of law for which substantial grounds existed for difference of opinion.

Howey Wasn’t Designed to Address Secondary Market Sales

Michael, who joined the SEC in 2010, stated that it is unsurprising that the Ripple judge addressed the question of secondary market trading by relying on cases involving direct sales between buyers and issuers.

According to legal experts, the Howey test was not designed to address secondary market trades between anonymous buyers and sellers without the involvement of the asset’s issuer.

The legal experts argued that although the SEC claims the Howey test is flexible, the longstanding security test is not limitless. They added that applying the test to circumstances it was not designed to address could be testing those limits.

Furthermore, the analysts cited a few cases where the Howey Test was interpreted in secondary market trading. In Hocking v. Dubois, Michael and his colleagues pointed out that the 9th Circuit Court of Appeals found that the attributes of an asset alone do not make it an investment contract.

However, the asset’s promotion and its representations at the time of sale are important factors in considering whether the asset will be deemed a security.

“These cases reinforce the notion that the SEC appears to be taking the Howey test into unchartered waters,” the legal analysts noted.

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