The SEC vs. Ripple saga continues
By: Yannik Karl Pieper
Tags: Cryptocurrency, Cryptocurrency News, Ripple, Xrp, Crypto

CEO of Ripple Brad Garlinghouse said on Monday that he expects the SEC to file a lawsuit against the company claiming that Ripple sold unregistered securities to investors. The debate is about the nature of XRP and the next chapter of what seems to be an endless story. Is it a currency or security?

Before we dive into the claim’s details, let’s take a look at the circumstances and motivation behind the filing. There are a few things worth noting that might change the perspective on the issue.

Setting the stage

First of all, the content of the lawsuit is nothing new. Ripple was sued several times over the last few years regarding the same problem without a clear decision from the SEC. The difference this time is that the lawsuit is coming from Jay Clayton, the Chairman of the SEC itself.

Brad Garlinghouse’s comment on Monday highlights the timing of the decision. He’s also pointing to the failure of “providing a clear regulatory framework for crypto in the U.S,” which seems to be at the core of the issue.

“The SEC has permitted XRP to function as a currency for over eight years, and we question the motivation for bringing this action just days before the change in administration. Instead of providing a clear regulatory framework for crypto in the U.S., (SEC Chairman) Jay Clayton inexplicably decided to sue Ripple — leaving the actual legal work to the next Administration.”

It’s also worth mentioning that the US Financial Crimes Enforcement Network (FinCEN) accused Ripple of violating the Bank Secrecy Act in 2015 by selling XRP without prior registration. Ripple had to pay a fine of 450,000$ but could continue trading the token after the agreement was reached.

Ripple’s CEO referred to that decision in another part of his comment.

“In fact, the Justice Department and the Treasury’s FinCEN already determined that XRP is a virtual currency in 2015 and other G20 regulators have done the same. No other country has classified XRP as a security.”

Alright, now that we know about the circumstances of the recent news, let’s get to the meat of the argument.

Currency or security?

The SEC’s complaint boils down to the nature of an “investment contract” and if XRP can be considered such. The following quotes are from the summary section of the 71 pages long document released by the Security and Exchange Commission on Tuesday.

From at least 2013 through the present, Defendants sold over 14.6 billion units of a digital asset security called “XRP,” in return for cash or other consideration worth over $1.38 billion U.S. Dollars (“USD”), to fund Ripple’s operations and enrich Larsen and Garlinghouse. Defendants undertook this distribution without registering their offers and sales of XRP with the SEC as required by the federal securities laws, and no exemption from this requirement applied. Ripple engaged in this illegal securities offering from 2013 to the present, even though Ripple received legal advice as early as 2012 that under certain circumstances XRP could be considered an “investment contract” and therefore a security under the federal securities laws.

The Howey Test

The Howey Test determines that a transaction represents an investment contract if “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party,” The Howey case goes back more than 70 years. In 1946, the Howey company (a citrus farm in Florida) leased half of its property to “finance an additional development.” The lawsuit ended up in the supreme court, which decided in favor of the plaintiff.

“The transactions in this case clearly involve investment contracts, as so defined. The respondent companies are offering something more than fee simple interests in land…they are offering an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise.”

Ripples response

Ripple released a summary of its Wells submission in which it explains why XRP can’t be considered an “investment contract.” The quotes below are from that document and point to the fact that XRP is decentralized and independent of Ripple. Even though the company initially founded the network, it will continue to exist without it. The document also emphasizes that XRP is used by most as a currency (unit of account/store of value/medium of exchange).

XRP transactions take place on the XRP Ledger (“XRPL”), a decentralized, cryptographic ledger powered by a network that is not controlled or owned by any one party. The XRPL has successfully recorded hundreds of millions of transactions for over eight years without error or dispute. XRP is used as a currency by as many as 150 third party commercial and consumer applications for a variety of purposes. XRP’s functional characteristics and longstanding utility as a replacement for fiat currency require that it be categorized as a currency and not a security. XRP trades in a robust currency market, with massive volumes of traders, the vast majority of whom have never transacted with Ripple. In any event, there is no vertical commonality here where the fortunes of XRP holders are demonstrably not intertwined with Ripple and its efforts, but instead hinge on independent market forces as it does here, which is overwhelmingly supported by the data.

In response to the Howey test, Ripple stated that they were never leading investors to believe that their work would increase the price of XRP. Speculation was always part of the crypto market but never the companies intent and outside of their control. XRP as a digital currency was simply a product, a utility token to ease global money transfer.

Ripple does not and has not promised to increase XRP’s prices in public statements. Ripple’s overall messaging regarding XRP has been entirely consistent with that of a company that uses a currency for payment solutions. Ripple has made clear that its efforts relate to increasing the liquidity of the XRP market for ODL’s benefit and not to increase the price of XRP. Ripple’s sales to its customers for use in ODL do not, and cannot, violate Section 5. When a purchaser is not “‘attracted solely by the prospects of a return’ on his investment . . . [but] is motivated by a desire to use or consume the item purchased . . . the securities laws do not apply.”

I’m not a legal expert by any stretch of the imagination, so I can’t comment on these arguments’ validity. I just thought I would collect the ones that seemed the most important so you can decide for yourself.

Missing regulatory clarity and the bigger picture

XRP’s price plummeted almost 50% the days after the news came out. Other Altcoins followed the negative trend, and it seemed like the entire market was shaken by the early Christmas present from the SEC. Only Bitcoin remained pretty much unphased at the top.

The community response to the lawsuit was mixed. XRP has been at the center of controversy since its creation, mainly because of the coin’s concept of decentralization or lack thereof. Ripple, holding more than 50% of the max supply in an escrow, wasn’t in the spirit of the cypherpunk movement. In many ways, it ran contrary to the core idea behind Bitcoin. This lawsuit (valid or not) certainly highlights why a cryptocurrency built by a for-profit organization is often seen as problematic. It’s the same reason Bitcoin is untouchable in a legal sense.

The lawsuit also shows how early we still are in the history of the entire industry. Many questions remain unanswered, and with a wave of institutional money on the horizon, 2021 will be an exciting and crucial year for crypto regulation.

So what now? The lawsuit will definitely take many months, if not years, to settle. Legal processes are slow, but there’s light at the end of the tunnel. The new chairman of the SEC, Elad Roisman, was announced two days ago and is widely considered “pro-crypto.” And once the case is closed, we’ll at least finally have a clear regulatory answer. In some sense, crypto’s very own “Howey Test.”