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Ripple, its CEO Brad Garlinghouse, and its founder Christian Larsen are being sued by the SEC for falsely unlawfully trading 14.6 billion units of XRP, Ripple’s native currency, for 1.3 billion USD.
Why is the SEC afraid that XRP sales are illegal? According to the SEC, XRP tokens are securities (similar to business bonds), and if a company raises funds in the US by selling shares, those shares must be disclosed to the regulatory body. As a result, the SEC claims that Ripple violated the law by accumulating money from the sale of XRP without disclosing those tokens.
The following is an excerpt from its complaint, in which the SEC describes Ripple’s alleged violations:
By engaging in the conduct set forth in this Complaint, Defendants engaged in and are currently engaging in the unlawful offer and sale of securities in violation of Sections 5(a) and 5(c) of the Securities Act… and Larsen and Garlinghouse also aided and abetted Ripple’s violations of those provisions. Unless Defendants are permanently restrained and enjoined, they will continue to engage in the acts, practices, and courses of business set forth in this Complaint and in acts, practices, and courses of business of similar type and object.
To put it simply, the SEC’s rules (and US securities law) mandate that someone or organisation collecting funds from investors by selling assets (usually stocks) report those assets with the SEC. Registration includes a thorough overview of the asset on sale, which the SEC believes buyers need before parting with money to buy it. The SEC needs accurate financial data or a summary of a new venture’s business strategy and sales model when a firm offers equity, so investors can help determine whether the $100 they pay for an asset now can increase in value in the future.
The Key to the Case
The case hinges on whether or not XRP tokens can be classified as shares. The SEC said in its lawsuit that it warned Ripple in 2012 that XRP tokens were most likely securities and should be registered. According to the court filing, “Ripple and Larsen disregarded this guidance and instead chose to take the gamble of launching a large-scale XRP delivery without registration.”
The heart of this case would be if the SEC will persuade US courts to accept its position that XRP is a defence. The result of this case (and the subsequent appeals that would be filed regardless of the court’s decision) will have repercussions for the entire crypto room.
How the SEC Defines a Security
The SEC believes that XRP tokens fell into a special category of protection, as stated in its complaint:
The definition of a ‘security’ under the Securities Act includes a wide range of investment vehicles, including “investment contracts.” Investment contracts are instruments…through which a person invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others… … As the United States Supreme Court noted in SEC v. W.J. Howey Co., Congress defined ‘security’ broadly to embody a ‘flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.
The regulator claims Ripple, Larsen, and Garlinghouse have been marketing XRP unlawfully for more than eight years, and it includes the following table of revenue totals in its lawsuit.
According to the lawsuit, the selling of XRP allowed the organisation to fund its activities while also enriching Larsen and Garlinghouse as they found a use case for the XRP tokens.
The SEC concludes that the vast majority of XRP purchasers purchased the digital asset as an investment after reviewing defendants’ actions surrounding the bid, selling, and delivery of XRP. According to the SEC, anyone who purchased XRP did so because they thought they could benefit from selling it at a better price in the future (as opposed to buying XRP to use it as a currency).
What Does the SEC Want?
The SEC has asked the court to determine how to “correct” what it considers criminal activity.
- Stop defendants (Ripple, Larsen, and Garlinghouse) from selling XRP or all other non-registered properties indefinitely;
- require defendants to forfeit any proceeds made from selling XRP;
- bar defendants from engaging in any sale of digital asset securities;
- place additional monetary penalties on defendants
What Is Ripple’s Defense?
One of the key points in Ripple’s defence is that XRP performs a number of roles that differ from the legal definition of a “safe.” XRP is a virtual currency that acts as a means of trade for local and international transactions.
Furthermore, the company states that XRP is not considered a “security” anywhere in the world, citing interpretations by regulators in the United Kingdom, Singapore, and Japan, where it has been described as a virtual currency beyond the control of securities regulation.
…Securities authorities in the United Kingdom, Japan, and Singapore have already concluded that XRP is a virtual currency that is not controlled by securities laws. According to the UK Treasury, “well-known cryptoassets such as Bitcoin, Ether, and XRP” are not shares, but rather “[e]xchange tokens” that “are mainly used as a medium of trade.”
When applying a strict understanding of the word “protection,” it is obvious that certain aspects of the concept are absent in the case of XRP. However, emerging technology and investing approaches often necessitate judges reading laws that were never meant to handle these developments.
For the time being, US courts must adapt current law to emerging technology and economic conditions. It remains to be seen if the SEC will be able to reassure the courts that the supply, selling, and delivery of XRP are investments that must be controlled.
Although we cannot foresee whether the US judge would determine, it is evident that this case will set a precedent, signalling the beginning and end of a time in the framework of cryptocurrency law in the United States.