Blockchain Company
Cryptocurrency
- Officially Determined to Constitute a Security?
- In the Affirmative: Redemption Right is Triggered in Favor of Series C Preferred Stock’s Holder, According to Stockholders’ Agreement
Wells Notice and the SEC’s Filing of an Enforcement Action
Contract Drafting
Meaning of the Term “Determination”
Delaware Law
In this expedited contractual dispute, defendant Ripple Labs, Inc. (“Ripple”) has moved for summary judgment (the “Motion”). Granted.
Ripple is an enterprise blockchain company. It uses a cryptocurrency called XRP in its payment network, and hosts a platform, RippleNet, to facilitate transactions. Plaintiff Tetragon Financial Group Limited is an investment company. Plaintiff, through its affiliates (collectively, “Tetragon”), holds a majority of Ripple’s Series C preferred stock. Ripple and Tetragon executed a stockholders’ agreement dated December 20, 2019 (the “Stockholders’ Agreement”) memorializing Tetragon’s investment and status as « Lead Purchaser. » Pursuant to that agreement, Tetragon has a redemption right that is triggered upon a “Securities Default” as defined in Section 5.4: A “Securities Default” means if XRP is determined on an official basis (including without limitation by settlement) by the U.S. Securities and Exchange Commission (or (1) another governmental authority or (2) a governmental agency of similar stature and standing) to constitute a security on a current and going forward basis (and not, for the avoidance of doubt, a determination that XRP was a security in the past). If a Securities Default occurs, Tetragon may demand redemption of its shares via a « Redemption Request. » Following receipt of a valid Redemption Request, the Stockholders’ Agreement requires Ripple to redeem Tetragon’s shares within sixty days and apply all of its legally available cash and other assets to the redemption. At issue in this case is whether certain actions by the Securities and Exchange Commission (the “SEC” or the “Commission”)—in particular, a “Wells Notice” and the filing of an enforcement action—constitute a “Securities Default” under Section 5.4. Some brief background on these processes provides helpful context.
Wells Notices And Enforcement Actions Generally
SEC investigations are usually initiated when a potential violation of securities law is identified. If the matter escalates, the SEC will issue a Formal Order of Investigation, which identifies the nature of the investigation, grants power to the SEC’s staff (the “Staff”) to investigate, and allows the SEC and its officers to issue subpoenas and compel sworn witness testimony. If the Staff finds that further action is warranted, the Staff may recommend that the SEC file an enforcement action or institute other enforcement proceedings.
Prior to doing so, the Staff may send potential defendants a Wells Notice, which allows potential defendants the chance “to provide a written submission” in defense of their actions. At this stage, the Staff must obtain an Associate or Regional Director’s approval. Once a potential defendant submits a written response to a Wells Notice, that submission must be sent to the Commission with a staff memorandum.
Based on the Action Memorandum and the potential defendant’s written submissions, the Commission votes to approve or reject the recommendation.
An enforcement action begins when the SEC files suit in federal court. After the Commissioners vote to bring an enforcement action, they are minimally involved in the litigation. Once the SEC decides to file in federal court, the SEC’s role pivots to that of advocate for its position; barring settlement, the Court—not the Commission—decides whether the instrument in question is ultimately a security.
(…) In line with “Delaware’s well-understood principles of contract interpretation,” I find that the Stockholders’ Agreement’s plain language is susceptible to only one meaning: a determination “on an official basis” that XRP “constitutes a security on a current and going forward basis” answers the question of whether XRP is a security in the affirmative and with finality. Applying that meaning to the undisputed facts, I conclude that a Securities Default has not occurred.
(…) Neither party here meaningfully contends that the definition of Securities Default is ambiguous, so I do not reach the parties’ arguments about their negotiation history or other extrinsic evidence of their intent.
Instead, I turn directly to the language in question, and apply it to the Wells Notice and the SEC’s filing of the Enforcement Action.
“Under well-settled case law, Delaware courts look to dictionaries for assistance in determining the plain meaning of terms which are not defined in a contract,” as “dictionaries are the customary reference source that a reasonable person in the position of a party to a contract would use to ascertain the ordinary meaning of words not defined in the contract.” And so, I look to contemporary dictionaries to help understand Section 5.4’s undefined terms.
By its plain meaning, a “determination” has finality. According to Merriam- Webster’s Dictionary, to “determine” something means “to fix conclusively or authoritatively,” as in to “determine national policy,” or “to settle or decide by choice of alternatives or possibilities,” as in to “determine the best time to go.” The Oxford Learner’s Dictionary similarly states that a “determination” is “the process of deciding something officially.” The “official” nature of a determination is echoed in definitions in the legal arena. In those definitions, a determination comes from an authoritative source, such as a court. Black’s Law Dictionary tells us that a “determination” is “the act of deciding something officially; especially, a final decision by a court or administrative agency.” Merriam-Webster’s definition suggests that a legal determination has finality, « a judicial decision settling and ending a controversy ».
(…) Applying this plain meaning to the SEC’s decision to file the Enforcement Action and issue a Wells Notice, it is clear that neither constitutes a Securities Default.
(…) Tetragon’s arguments regarding the Wells Notice present an even weaker case for a Securities Default. A Wells Notice precedes an enforcement action, giving potential defendants notice of the SEC investigation and providing them the opportunity to explain to the SEC why an enforcement action is unnecessary. As the parties’ experts explained, a Wells Notice indicates that the Staff might recommend an enforcement action to the SEC Commissioners, but the Commission itself is free to reject this recommendation. SEC Commissioners, who lead the SEC, are simply not involved in the Wells process. Further, a Wells Notice invites the potential defendant to convince the Staff that such a recommendation would be improper. Wells Notice from Staff is a far cry from the type of official, final decision contemplated by Section 5.4.
My conclusion that the SEC actions at issue fall short of “determinations” does not gut Section 5.4 of its meaning. It is undisputed that the SEC can make “determinations on an official basis” in three other ways: (1) an administrative proceeding, (2) a report pursuant to the Securities Exchange Act of 1934 (the “’34 Act”), and (3) rulemaking.
(Court of Chancery of the State of Delaware, March 19, 2021, Tetragon Financial Group Limited v. Ripple Labs Inc., Docket C.A. No. 2021-0007-MTZ)
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