Federal Court Declines to Order SEC Disclosure of Employee Trade Preclearance Decisions

On September 21, 2021, in the much-watched and hotly contested enforcement action filed by the US Securities and Exchange Commission (SEC) against Ripple Labs Inc. (Ripple), SDNY Magistrate Judge Sarah Netburn denied Ripple’s motion to compel the SEC to disclose records concerning its preclearance of SEC employees’ personal cryptocurrency transactions. Sec. & Exch. Comm'n v. Ripple Labs, Inc., No. 1:20-cv-10832 (SDNY).

As background, the SEC alleges Ripple’s use of blockchain innovation, including the cryptocurrency token XRP, amounted to an unregistered securities offering, which Ripple denies. Given the underdeveloped regulatory scheme associated with cryptocurrencies, Ripple is setting the stage, through various discovery requests, to argue that the SEC did not view XRP as a security until recently, in an apparent attempt to undermine the SEC’s position and assert defenses such as lack of fair notice and scienter.

As described in a previous post, significant discovery disputes in this action have been decided in Ripple’s favor. In April 2021, Ripple successfully obtained discovery from the SEC concerning the SEC’s communications with third parties about whether XRP and comparable cryptocurrencies were securities. And in a June 23, 2021 order, the SEC was directed to produce documents reflecting the SEC’s ethics rules for its employees’ trading of digital assets.

But this time, Judge Netburn ruled in favor of the SEC and denied access to employees’ preclearance records. In its most recent motion to compel, Ripple argued that the SEC’s pre-2018 ethics rules did not require employees to obtain preclearance before trading digital assets. Because the SEC generally requires its employees to seek preclearance before trading securities, Ripple claimed that the SEC’s failure to require preclearance before trading digital assets is “strong corroboration” of Ripple’s assertion that the SEC had not “viewed digital assets as securities.”

According to Ripple’s motion, the SEC revised its ethics policy in January 2018 to state that digital assets could be subject to restrictions and that specific restrictions would be adjudicated on a case-by-case basis during the trade preclearance process. Ripple further asserted that counsel for the SEC represented that XRP trading has been banned for SEC employees since March 9, 2019 (the date the SEC issued a formal order of investigation in this matter), but would not confirm if such restrictions had been put in place earlier than that. In its motion, Ripple sought discovery concerning implementation of this policy. To avoid employee privacy concerns, Ripple offered that the SEC could produce aggregated information or redacted copies of individual documentation, which the SEC declined to do.

In response, the SEC argued that the ethics policy makes clear that it is not intended to determine whether employees’ proposed trades comport with the securities laws, only whether they pose conflict-of-interest concerns. Moreover, relying on certain federal privacy laws, the SEC asserted that the trading activities of its personnel are confidential.

In denying Ripple’s motion, the court found that employee privacy concerns outweighed the relevance of Ripple’s request for specific examples regarding the operation and implementation of a general policy the SEC previously produced. In her ruling, Judge Netburn distinguished between general trading policies—which she had previously ordered produced because they were relevant to Ripple’s fair notice and scienter defenses — and discrete decisions in the preclearance process for individual employees—which she found would demonstrate only how an individual ethics counsel viewed an individual trading decision. Judge Netburn reasoned that producing the latter was more likely to create confusion or collateral litigation disputes. Judge Netburn further held that Ripple did not present sufficient justification for even an anonymous intrusion into the personal financial affairs of SEC employees. While the privacy laws applicable to these documents allow for disclosure pursuant to court order, the court held that Ripple had not met the applicable burden.

In our previous post, we analyzed the broad implications of Ripple’s success in convincing the court to compel discovery into the views the SEC articulated to third parties—implications that extend beyond enforcement in the cryptocurrency space. Though last week’s decision did not go Ripple’s way, it does not alter the significance of the prior discovery rulings, which found that the SEC’s statements and actions in the non-enforcement context could be relevant to litigation defenses.

Continue to follow Enforcement Edge as we track this key case and its implications both for the crypto space and the securities enforcement world more broadly.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.