Security or not, that is the question
For over a year now, the legal battle between Ripple and the U.S. Securities and Exchange Commission (SEC) has been going on, involving nothing less than a directional decision for the entire crypto space, in addition to an estimated $1.3 billion. Now there is a ray of hope for Ripple: the judge in charge denied two crucial motions. But from the beginning: On December 22, 2020, Ripple Labs received an indictment from the U.S. Securities and Exchange Commission (SEC) alleging “unauthorized trading in unregistered securities.” Since then, the authorities have been engaged in a dispute with Ripple Labs, in which two more decisions have now been made.
On the one hand, the “fair notice” defense of the crypto company is granted, and on the other hand, the request of Brad Garlinghouse, the CEO of Ripple Labs, and Chris Larsen, the former CEO, to drop the charges against them as individuals was rejected. What does this mean? For that, let’s take a look at Ripple’s founding history: when it was founded in 2012, Ripple was considering the extent to which they could place the so-called “NewCoin” in the American market. To do so, they sought legal advice to help the developers determine whether and to what extent the design of the coin and Ripple’s business model could result in the “NewCoin” being a security as defined by the SEC. The result: the business model was changed and XRP was launched. Legally, this cryptocurrency would have had only a marginal risk of being classified as problematic by the SEC.
According to various sources, Ripple is said to have had contact with SEC staff on several occasions through 2018 (i.e., for 6 years). Some SEC officials also invested in XRP themselves, as reported by BTC-ECHO, which is significant in that they would not have been allowed to do so if XRP had been classified as a security. Finally, the classification of XRPs as securities followed in early 2018, albeit conditionally, with the SEC’s official indictment alleging unauthorized securities trading following in late 2020.
Billions at stake
If the indictment is upheld, it could cost Ripple billions. That’s why it wants to get its head out of the noose by means of a “fair notice” defense. The question is why Ripple did not receive a “fair notice” from the SEC about the agency’s concerns in the years between 2012 and 2020. It could have raised concerns at any time and at any meeting – but it didn’t. Moreover, Ripple emphasizes its willingness to conform to applicable regulations. The SEC sees this differently and requested that this line of defense not be pursued. This has now been rejected by Antalisa Torres. Now the SEC has to justify why it had not informed Ripple Labs about the concerns earlier.
This dispute also involves the question of whether cryptocurrencies are securities. The answer to this question is tied to the jurisdiction of the SEC, which only has jurisdiction over securities! As the basis for her decision, Judge Torres applied the criteria from the Howey test, according to which a security involves a so-called “participation contract.” A participation contract is defined by the U.S. Supreme Court as an “investment in the form of money in a known enterprise, with the credible expectation of future profits to be derived from the entrepreneurial or managerial efforts of others.”
Ergo, securities lending presupposes a central authority that is responsible for the venture and helps determine the price through its actions. As a result, investors can expect to earn a profit on their investment in the future. An SEC expert report concludes that there is a correlation between the announcements at Ripple Labs and the price of XRP, whereas there is a consensus in the crypto community that the XRP price is predominantly correlated with the bitcoin price. One can be curious about the outcome of the proceedings….