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Although the defendants could have acquired an advantage in pre-trial decisions in SEC v. Ripple Labs, are Ripple’s legal difficulties over?
When the US Securities and Exchange Commission brought legal proceedings against Ripple Labs and its top-two executives in December, charging that its XRP coin was a security and that the company had earned over $1.38 billion in an unregistered securities offering in 2013, many questioned whether XRP would ever succeed.
XRP was delisted by some exchanges, and some fund managers sold their XRP tokens. XRP had fallen out of the top three currencies in terms of market capitalisation and was on the verge of dropping out of the top ten. However, rumours of Ripple’s death were greatly inflated.
As of mid-April, XRP had increased 532% over the previous 12 months, and things also took a favorable turn recently in the SEC lawsuit, with the defendants prevailing in two discovery rulings — even turning the tables on the regulatory agency by winning access to the SEC’s internal memos and minutes with regard to crypto discussions. “The SEC Is Now On Trial – And Knows It,” sounded Forbes.
However, the case is still ongoing and, according to Daniel Payne, partner in the fintech and blockchain group at law firm Murphy & McGonigle, has the ability to set legal precedents in a variety of ways, including:
“The application of the statute of limitations to token sales; the extraterritorial reach of the securities laws to token sales on worldwide blockchains; the application of the securities laws to digital assets that FinCEN has regulated as a virtual currency [e.g., BTC]; and whether courts will use Bitcoin and Ether as models of non-security digital assets in their legal analysis.”
Therefore, while the defendants may have gained an edge in pre-trial rulings in SEC v. Ripple Labs, can one really say that Ripple’s legal troubles are over?
Not over till it’s over
Carol Goforth, Clayton N. Little professor of law at the University of Arkansas (Fayetteville), said, “Not by a long shot.” Ripple made a compelling argument for gaining access to the SEC’s internal opinions on cryptocurrency — i.e., the first discovery decision. In the second competition:
“[Ripple executives] Garlinghouse and Larsen made a plausible argument that the SEC was over-reaching with its request for eight years of their personal bank records. As the insiders argued, why does the SEC need to know household expenditures in order to make its case?”
“However, while Ripple may learn information that will aid its defence as a result of that ‘win,’ the extent to which this will matter in the long run is far from certain,” Goforth said. “The two recent pre-trial discovery rulings have shifted the case’s playing field,” Payne said. “The defendants gained traction with some key arguments, but that does not mean they have won the case.”
“It would be extremely premature to draw any conclusions from these interim rulings,” David Chase, a securities specialist and retired SEC compliance officer, agreed. He described these as “discovery skirmishes” that do not get to the heart of the matter.
“A different kind of case”
In SEC v. Ripple Labs, a new report in The National Law Review stated that “the SEC’s case rests on the proposition that XRP is a security — if it is not, the SEC lacks jurisdiction,” although Payne stated that “there are a handful of district court rulings that specific digital assets are securities: Telegram, Kik, ATBCoin, and so on.” These cases established significant precedents on which the SEC now depends to monitor new token issuances that it claims are securities offerings. Payne went on:
“But Ripple is a different kind of case. XRP was first sold over eight years ago, and over that time, the XRP ledger has become decentralized, while Ripple has, in large part, decoupled from XRP. But the SEC is alleging that XRP was and remains a security.”
According to John Wagster, an attorney at Frost Brown Todd, the claims against Ripple, like almost any SEC action in the cryptocurrency room, “will be analysed by market participants looking for a pathway to compliant token offerings,” adding: “A healthy market requires regulatory consistency, and the most meaningful outcome of the Ripple enforcement action would be one that provides such a pathway.”
According to Yuliya Guseva, a law professor at Rutgers Law School, “the Ripple case is extremely important.” Despite similarities to the Kik and Telegram cases, the details in SEC v. Ripple Labs are distinct. “The outcome of Ripple could have a significant impact on the cryptocurrency market. For starters, the final decision should offer more clarity to developers and the crypto community.” She continued, saying:
“The decision may reveal if we have transitioned from the bygone era of ICOs and related enforcement to a more mature market phase with a more nuanced doctrinal approach to cryptocurrencies.”
In terms of the discovery decision, Chase is hoping to see the SEC’s internal conversations regarding XRP and cryptocurrency among the cache of documents that is now set to appear. “It usually runs only one way,” referring to businesses supplying papers to the case. However, in this situation, it is the SEC who must deliver the goods — not a “typical” turn of events for the department, according to Chase.
What is propelling XRP price upward?
But what does one make of the recent surge in the stock price of XRP — even before the discovery rulings? “Considering the ongoing Securities and Exchange Commission lawsuit against Ripple, which was initiated in December 2020, the XRP price’s journey to $1 this year has been nothing short of spectacular,” commented Cointelegraph Markets columnist Marcel Pechman. XRP gained more than 40% over the weekend after the pre-trial rulings, hitting about $1.3 on April 18 and almost reaching $2 on April 14.
Wagster said that the rise in XRP’s share price over the past year is due to general bullishness in crypto markets rather than something unique to XRP, while Chase said, “Maybe what we’re seeing is the free market in action.” The SEC’s lawsuit “is just another data point to consider” in evaluating XRP; investors might also be jeopardising an eventual settlement with the government.
There may be another interpretation: Maybe the SEC’s decisions just don’t matter that much anymore when it comes to globally traded cryptocurrencies. Goforth disagrees. The SEC still plays a large role in regulating U.S. exchanges and other businesses, she said, while Payne noted that “if a cryptocurrency has a touchpoint within the U.S., the SEC has an argument that it can assert jurisdiction.”
He did allow, however, “that XRP is traded worldwide, where many purchasers may be unaware of the SEC’s case,” which may have something to do with XRP’s price resilience. The price may also be affected by “purchasers who are betting that Ripple will win [the SEC case] and are trying to buy low.”
In SEC v. Howey Co., the United States Supreme Court established the framework for determining if an asset is a defence. According to The National Law Review, “the Court explained that an asset is a security if it represents an investment in a common enterprise with the expectation of profits derived solely from the efforts of others.” Since then, the SEC has applied the 71-year-old Howey Test, and in its Ripple Labs lawsuit, the department stated that XRP should be considered a defence — as outlined by the journal — because:
“Investors who purchased XRP anticipated that profits would be dependent upon Ripple’s efforts to manage and develop the market for XRP. Ripple has disputed the SEC’s allegations, arguing that XRP is a ‘fully functioning currency that offers a better alternative to Bitcoin.’”
Goforth went on to say, “If the cryptoasset is truly decentralised, with no ‘other’ on whom purchasers rely, the Howey Test is not met.” That is, unlike Bitcoin (BTC) and Ether, the coin or token will not be considered a defence (ETH). “It is easy to see how purchasers could rely on the creator/issuer in the case of an asset like XRP, where the creator/issuer owns the majority of the asset, controls its distribution, and is primarily responsible for its utility and potential profitability.”
Typically, SEC enforcement actions target issuers who are engaging in obviously fraudulent or corrupt behavior or target a specific activity they are hoping to dissuade, noted Wagster, adding: “The action against Ripple appears to target the promotional activity Ripple undertook when selling its tokens.”
“Ripple does not want to face the regulatory burdens of registering XRP as a security when Bitcoin and Ether appear to have escaped that fate,” said Payne, adding: “The question of how similar XRP is to Bitcoin and Ether today — as opposed to when they were first created — and whether the court even views that comparison as the right one could make or break this case.”
Meanwhile, even though the court rules that XRP, unlike Bitcoin and Ether, must be registered as a security in the United States, “that does not necessarily make the XRP token worthless,” Goforth suggested. “The real question is what kind of final order the SEC might accept if it is clear that the court will find that XRP was sold as an investment and thus a security. If we draw an analogy with SEC v. Kik” (another case in which a company issued tokens [e.g., Kin]), then:
“Ripple might be permitted to continue operating with limitations on the right of the company and its founders to sell additional tokens. Just as Kik is required to notify the SEC of trades, a similar obligation might be imposed on Ripple and its current and former CEO.”
“On the other hand, if the SEC insists on registration, Ripple will have to decide whether it makes financial sense. If it does, a signed token would have more liquidity and be more easily exchanged, which could be a big gain for investors,” Goforth said.
What happens if the SEC loses? “Regardless of the outcome of the SEC’s complaint against Ripple, the SEC will continue to be one of the primary regulators of cryptocurrency in the United States,” Wagster said.
The wheel of fortune rises and falls
And if Ripple wins round one, it has not won the series. “The recent U.S. District Court rulings are certainly favourable to Ripple,” Wagster told Cointelegraph, “but the game is far from over.” The SEC selects its cryptocurrency goals with care.” Furthermore, he stated:
“Once the SEC decides to move forward with a high-profile enforcement action, it would be embarrassing for them to back down without some sort of victory. I expect them to continue to pursue their claims against Ripple with zeal.”
There was a time when it was expected that Ripple Labs, rather than Coinbase, would be the first crypto-native company to be listed on a major U.S. stock exchange. Coinbase went live on the Nasdaq market this week, with a well-subscribed deal that attracted parallels to Facebook and Airbnb’s public debuts. Perhaps Ripple’s destiny is to make monumental waves in the courts, rather than on Wall Street, by helping to articulate the laws that will govern the evolving cryptoverse.