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Ripple-SEC Lawsuit
Gary Gensler, Chairman of the SEC, has repeatedly been on the record that he believes most cryptocurrencies outside of Bitcoin are securities. In September, Gensler was quoted, “the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities… the investing public is buying or selling crypto security tokens because they’re expecting profits derived from the efforts of others in a common enterprise.” While the SEC has levied successful lawsuits against several minor crypto projects from the 2017 ICO days, none can compare to the lawsuit filed against Ripple Labs and its XRP token in 2020.
Founded in 2012, The Ripple network is a protocol to provide liquidity to global markets for fast, cross-border payments with minimal fees. XRP tokens are the accounting units used within the XRP Ledger open-source database and serve as a bridge currency between banks. The ledger stores and preserves XRP transactions and account balances. Ripple Labs, Inc. is a private, for-profit company that sells the closed-source banking software RippleNet, which was previously split into three separate products: xCurrent, xRapid, and xVia.
According to the SEC, Ripple Labs raised at least $1.3 billion “over a years-long unregistered offering of securities. Ripple used this money to fund its operations without disclosing how it was doing so, or the full extent of its payments to others to assist in its efforts to develop a ‘use’ for XRP and maintain XRP secondary trading markets.” In December 2020, the SEC sued Ripple Labs for selling unregistered securities, an allegation Ripple Labs refutes on the basis that XRP is not a security and the sale of XRP never included an investment contract.
It is expected that the SEC will make its case for XRP to be deemed a security based on the common definition and interpretation of the Howey Test, the most common legal test applied to securities. The four-component questions of the test are listed below:
- Is there an investment of money?
- Is there an expectation of future profits?
- Is the investment of money in a common enterprise?
- Do any profits come from the efforts of a promoter or third party?
When examined through the lens of the Howey Test, the second point, an expectation of profit, creates issues. As stated, XRP is a bridge currency used between banks for fiat money conversions. If this is truly the case, Ripple Labs must defend why it would sell XRP to average retail users.
The second critical disagreement with XRP involves aspects three and four of the Howey Test. The SEC interprets Ripple Labs as the “common enterprise” and “third-party” that has control over XRP and potential profits. The connection between the activities of Ripple Labs Inc. and the market price of its native token has been put under question.
Since late 2018, Ripple has tried to distance the company from the XRP token, although, in the early years of Ripple’s development, they appeared to state clearly that Ripple Labs created XRP. More recently, the Ripple website has changed that language from its original statement and now claims that Ripple did not create XRP.
Over the past several months, Ripple has been slowly putting more and more pressure on the SEC in this case. While Ripple and the SEC have been engaged in a heated legal battle, recent rulings from an overseeing judge have backed the SEC up against a figurative wall. U.S.Magistrate Judge Sarah Netburn called the SEC hypocritical as the organization tried to distance itself from comments made by formal official Bill Hinman that Ethereum (ETH) was not a security. This comment was made based on the advice and guidance from the SEC itself.
The SEC has tried to argue that the speech was irrelevant, but the judge has declined. This places a pivotal victory in Ripple’s column because if Hinman’s comments are legally deemed relevant, Ripple may be given the upper hand and help confirm XRP is not a security either. This would deal a great blow to the SEC’s ability to regulate other similar assets within the cryptocurrency space. This also comes after the SEC attempted to keep its ‘key experts’ in the case confidential - a move Ripple has challenged outright.
In Q1 2022, a judge ruled to unseal previously private communications sent to Ripple from its outside counsel dating back to 2012, before the XRP sale. Perkins Coie LLP attorneys “advised Ripple not to sell the proposed coins, as various conditions could subject them to being regulated as securities or commodities. A second memo… suggested that XRP may not be considered a security under federal law, but cautioned there was a risk the Securities and Exchange Commission would see things differently.”
In late September 2022, Ripple and the SEC requested a summary judgment to possibly finally bring the two-year legal battle to a close. The summary judgment forgoes a full trial and enables the judge to make the ultimate ruling. Should the summary judgment come to fruition, a ruling could be expected in H1 2023.
