Ripple’s Victory in SEC Lawsuit: Explained
On July 13, 2023, Ripple scored a partial victory after a court ruled in its favor following a lawsuit filed against the crypto company by the U.S. Securities and Exchange Commission (SEC) in December 2020.
In this guide, we’ll explore the lawsuit filed by the SEC against Ripple, the recent ruling, and what the future may hold for XRP and, possibly, the crypto industry.
What Is the SEC Lawsuit Against Ripple?
Ripple Labs is a US-based provider of crypto solutions for businesses. It’s also the creator of the XRP Ledger and its native cryptocurrency called XRP.
In December 2020, the SEC filed a lawsuit against Ripple and two of its executives at a U.S. Southern District Court of New York. The SEC’s complaint alleged that Ripple, its Co-Founder and former CEO, Christian Larsen, and its current CEO, Bradley Garlinghouse, had raised over $1.3 billion via an unregistered digital asset securities offering. The capital was raised through an initial coin offering (ICO) geared towards helping the firm to finance its business.
The case lodged against Ripple sent shockwaves across the crypto sector because fears arose that all crypto tokens could become classified as securities. In addition, leading crypto exchanges like Coinbase suspended XRP trading, adding to the negative sentiments around the XRP token. While blockchain companies had anticipated future regulations, the SEC vs. Ripple case became an apparent example of a regulatory body targeting a crypto company. The ongoing case was anticipated by many to affect the future of digital asset regulations and decide how crypto assets will be classified. This is because the digital asset space has been largely unregulated for over a decade, despite continuous calls to establish a regulatory framework for the crypto industry.
While this article is aimed at providing readers with the facts of the Ripple case, it’s in no way financial advice. Should you wish to invest in XRP after reviewing the facts, please remember to do your own research (DYOR) first.
What Is XRP?
Before we take an in-depth look at what XRP is, we’ll start by mentioning that the XRP token and Ripple don’t mean the same thing. However, they have always been used interchangeably, as the XRP token was initially called Ripple.
XRP is the native token used by the Ripple network and was launched in 2012 alongside the XRP Ledger (XRPL). The XRPL is an open-source, decentralized blockchain. Ripple, on the other hand, is a technology company behind the creation of the XRP token.
XRP was created to boost international transfers and the exchange of multiple currencies. The XRP token is pre-mined and has a maximum supply of 100 billion tokens. It is also used to expedite transactions in the Ripple ecosystem with all the transactions being recorded on the XRP Ledger. The token is considered successful by many as it has ranked among the top ten digital currencies by market capitalization so far. You can buy XRP in Trust Wallet and use it to process global payments, benefitting from high transaction speeds, low energy consumption, high uptime, scalability, and lower network costs when compared to blockchains like Ethereum.
In its lawsuit against Ripple which has been ongoing for nearly three years, the SEC argued that the XRP token is a security, a financial instrument used to raise capital in private and public markets. This meant that the SEC saw XRP as a form of financial instrument that Ripple used to raise money and that it could be classified as other securities like bonds, stocks, shares and more.
However, this lawsuit against Ripple isn’t unique. So far, the SEC has filed over 100 charges against various crypto firms claiming certain digital assets like Cardano, Polygon, and Solana, among others, are securities. Currently, various lawmakers have introduced a bill seeking to have the SEC chair removed following what is considered a witchhunt of various crypto companies.
Below, we take a closer look at exactly what the SEC’s case against Ripple entails.
The SEC's Case Against Ripple
The Securities and Exchange Commission filed a case against Ripple Labs and two of its executives. The allegations against Ripple, Larsen, and Garlinghouse stated that Ripple raised more than $1.3 billion through its 2013 ICO. The funds were later used to finance the creation of the Ripple platform.
According to the SEC, the company sold the XRP tokens, an unregistered security offering, globally and to U.S. investors. The class action lawsuit alleges that the defendants didn’t register the offer and sale of the XRP tokens, nor did they fulfill any indemnity from registration. As such, the defendants allegedly violated the registration provisions per federal securities regulations.
Ripple also reportedly issued billions of XRP tokens in exchange for non-cash activities like market-making services and labour. Moreover, besides designing and promoting the sale of the XRP tokens, the two executives were accused of personally engineering the sales of XRP tokens amounting to roughly $600 million.
To win the case, the SEC cited the Howey Test in its argument against Ripple and its CEOs. The Howey test relates to the SEC vs. W.J. Howey Co. case from 1946, which was heard and determined by the U.S. Supreme Court. According to the case, Howey sold parcels of citrus groves to various buyers in Florida. The buyers would again lease the land back to Howey even though they didn't need to cater to the groves.
Howey’s employees would take care of the groves and sell them on behalf of the owners. In turn, the revenue generated would be shared between the two parties. Given the arrangement, Howey failed to register its transactions leading to the SEC intervening. The Supreme Court’s final ruling established that the leaseback agreement passed for an investment contract.
In its ruling, the court established that an investment contract exists if funds are invested in an ordinary enterprise with an assurance of profit that would be derived from other people’s efforts.
By quoting the Howey test, the SEC argued that the ICO qualified as an ‘investment contract’ as Ripple raised funds directly from the public. Therefore, the XRP token should be considered as a security and its sales should have been registered with the SEC.
Following the case, Ripple filed a response to the allegations the SEC had lodged against it. In its response, the technology company provided five major arguments to support that its XRP token doesn’t meet the securities criteria.
First, Ripple argued that their token is a fully operational currency that’s a preferable alternative to BTC. Ripple said that its token had achieved widespread adoption thanks to its use of an open-source blockchain. Besides ranking among the top ten cryptocurrencies, the token had also been trading alongside BTC and ETH, two tokens the SEC previously said weren’t securities. Ripple also mentioned that the token has been trading in major secondary markets since 2013.
Ripple’s second argument stated that the company is a transparent and responsible actor. It has banked on expert advice and laws that had stated that the token is a digital currency and not a security. Ripple also touched on the fact that 90% of its XRP holdings are in an inaccessible escrow that they voluntarily proposed and can’t single-handedly terminate. They also stated that their On Demand Liquidity (ODL) product utilizes XRP as a crossover currency that addresses the inefficiencies of the current traditional cross-border payment solutions.
In its third argument, the company showed that its token sales were a tiny fraction of the entire XRP trading. Currently, Ripple’s sales have been restricted to sales to ODL (On Demand Liquidity) clients only.
The fourth argument cited that the XRP is a currency that is used by over 150 third-party consumer and commercial applications for various purposes.
In their last proof of why the XRP isn’t a security, Ripple stated that from the expansive data analysis conducted, the price of its token corresponds to that of alternative leading crypto assets.
The company further reiterated that their token does not in any way fulfill the Howey test, a response to SEC’s argument on why the XRP is a security. According to Ripple, “XRP is not an investment contract because there is no “contract” underlying any “investment contract”.
On July 13, 2023, Judge Torres gave a ruling that saw Ripple emerge somewhat victorious. The judge ruled that the sale of XRP tokens on a public crypto exchange cannot be considered as offers of securities. This was because buyers didn’t have any expectations of earning profits linked to the efforts made by Ripple to sell the tokens as people buying securities would.
Instead, the XRP sales were mainly blind bids as purchasers couldn’t establish who, between Ripple and the crypto exchanges, was the recipient of the money. In addition, the XRP sales on various crypto exchanges, including as compensation to staff, didn’t involve offering and selling of investment contracts. Hence, the sale of the tokens doesn’t fulfill the Howey test.
However, while Ripple had a victorious win in the ruling, there was a partial victory for the U.S. SEC. Torres noted that the sale of $728.9 million XRP tokens to hedge funds and other institutional investors constituted the sale of unregistered securities.
In addition, Torres acknowledged that the firm’s marketing, geared toward institutional investors, demonstrated that the company was promoting an abstract value proposition for its token that relied on the company’s efforts to build the underlying blockchain technology for its cryptocurrency. As part of her ruling, Torres mentioned that a jury will have to determine whether Ripple’s executives helped the company violate the law.
Furthermore, she said that the defendants can’t argue that they didn’t have fair notice that the XRP token was a digital currency at trial. This ruling is unique because, in the past, judges have always sided with the SEC in the cases it has filed against crypto-related companies with a majority of cases ending in settlements. Some of these companies have had to pay fines and agree to either follow the U.S. securities laws or exit the U.S. market.
We’ll have to wait and see whether this will be the case for Ripple.
The final outcome of this ruling could have a huge impact on both the U.S. regulator and the wider crypto industry. Considering how hard the SEC has been going against crypto companies, it’s very clear that the regulator wants to control and regulate the crypto industry. For now, Larsen and Garlinghouse will have to await the final decision from the jury on whether they aided the company to violate U.S. financial security laws.
What Happens Next?
Currently, the SEC hasn’t authoritatively stated what its next move will be following the ruling earlier this month. However, speculations are that the U.S. regulator will likely file an appeal at the Second Circuit Court, according to Marc Fagel, a former SEC representative.
Ripple’s CEO, Garlinghouse, has nonetheless stated that filing an appeal would take the SEC years. While calling the SEC a “bully,” he said the ruling confirmed that the XRP isn’t a security and it would, therefore, take the regulator years to ‘prove’ the security claims.
In addition, he also said this was the first time that the U.S. regulator was losing a crypto case and called them out for going after crypto players that aren’t able to build a good defence and would instead opt to settle.
The SEC vs Ripple case is expected to positively impact other cryptocurrency cases. The ruling could potentially change the outlook of the SEC’s regulatory enforcement efforts in the crypto industry. In addition, some crypto experts also believe the case will set a positive precedent for other crypto players like Binance and Coinbase in their ongoing lawsuits filed by the SEC.
While Ripple has been able to defend and get a ruling that confirms its XRP token isn’t a security, it’s still not yet out of the woods as there’s still a chance that the SEC could appeal the ruling. Further, there is still a pending decision being determined by the jury on Larsen and Garlinghouse role in aiding Ripple to violate security laws.
However, there is optimism in the crypto market that the nearly three-year-long lawsuit will come to an end. The ruling has also reignited calls asking for the development of regulations and laws around cryptocurrencies. In addition, crypto exchanges that had suspended the trading of XRP are now looking at “lifting the ban,” thus allowing people to trade widely again.
As always, if you are considering investing in the XRP token, ensure that you do your own research, and be sure to use a safe wallet like Trust Wallet to help you buy and manage your XRP.