On Tuesday (July 12), Sarah Netburn, a U.S. Magistrate Judge for the U.S. District Court for the Southern District of New York, denied an important motion by the United States Securities and Exchange Commission (SEC) in their lawsuit against Ripple.
As you may remember, on 22 December 2020, the SEC announced that it had “filed an action against Ripple Labs Inc. and two of its executives, who are also significant security holders, alleging that they raised over $1.3 billion through an unregistered, ongoing digital asset securities offering.” Essentially, the SEC is arguing that XRP is a security under U.S. federal securities laws.
In its letter motion, the SEC argued that “internal documents” related to June 2018 speech by William Hinman are protected by “attorney – client privilege”.
On 14 June 2018, William Hinman, then director of the Division of Corporation Finance at the SEC, made a speech at Yahoo Finance’s “All Markets Summit: Crypto” one-day event in San Francisco, California. The speech was about how the SEC plans to use the “Howey Test” to determine whether a digital asset should be considered a security or not. The only two cryptocurrencies Hinman mentioned by name were Bitcoin (BTC) and Ether (ETH), neither of which he said should be considered as securities:
“And so, when I look at Bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise. The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.
“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.“
Hinman’s remarks brought great relief to the crypto space, which had been uncertain about the status of Ether ever since 22 April 2018, when a New York Times interview with a former chairman of the U.S. Commodity Futures Trading Commission (CFTC), Gary Gensler, revealed that he was planning to say during a speech at MIT on 23 April 2018 that Ether and XRP had been issued and traded in violation of U.S. federal securities law:
“There is a strong case for both of them — but particularly Ripple [XRP] — that they are noncompliant securities.”
This is what Magistrate Judge Hon. Sarah Netburn said about the attorney-client relationship in her ruling:
“Defendants argue that Hinman is not a ‘client’ of the SEC’s lawyers for purposes of advice related to an outside activity such as the Speech. The SEC retorts that the Speech had to have been developed as part of Hinman’s official duties because the SEC staff who provided edits and feedback to the Speech were prohibited from using agency time and resources to provide input on a ‘purely personal errand.’ …
“At oral argument, the SEC emphasized that the information Hinman received from SEC staff while drafting and editing the Speech would not have been available to him as a private citizen; it was only in the context of his employment that he was able to solicit the edits and feedback he did.
“This question is made unnecessarily complicated by the SEC’ s litigation tactics . 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 his Speech, suggests that the SEC is adopting its litigation positions to further its desired goal, and not out of a faithful allegiance to the law.
“The Court, however, need not resolve whether Hinman was a ‘client’ of the SEC lawyers because the evidence establishes that the predominant purpose of the communications was not to provide legal advice.“