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A Guide to XRP's Case with the SEC: A Proceeding Set to Shape the Future of Crypto

By Jinia Shawdagor | August 18, 2021

On December 22, 2020, the US Securities and Exchange Commission (SEC) dropped a lawsuit against Ripple Labs as well as the company’s CEO Brad Garlinghouse and co-founder Christian Larsen.

XRP and the SEC

According to the filed lawsuit, Ripple Labs had allegedly raised $14.6 billion from investors in the US and worldwide in an unregistered securities offering beginning in 2013 to the present time through the sale of XRP.

The lawsuit further alleged that Larsen and Garlinghouse “also made personal unregistered sales of XRP totaling approximately $600 million.”

In the United States, the securities act of 1933 requires that all offered securities be registered and qualified by the SEC. Companies that offer securities are required to disclose important financial information thus enabling investors to make informed judgments about the investment.

Although there is pending regulatory clarity in regards to what entails a security concerning cryptocurrencies, the SEC categorized any investment contracts issued to buyers and advertised as an investment to be a security. 

In a press release, the SEC said that “the defendant failed to register their offers and sales of XRP or satisfy any exemption from registration, in violation of the registration provisions of the federal securities laws.”

Ripple’s Reaction

Instead of quietly settling the case with the SEC as is custom with most companies that are entangled in legalities with government agencies, Ripple adopted an unusual strategy of a public fight with the regulator. 

From the start of the year, the lawsuit against Ripple cast a pall over the price of XRP as the cryptocurrency struggled to maintain its own amid a crypto-wide bull run. 

Although recent developments in the case have brought about growing optimism for Ripple’s co-founders and XRP holders, there is still a lot of uncertainty as to who between the SEC and Ripple will emerge on top.

In this article, we will provide a full guide into the Ripple vs SEC case and examine what the outcome of this proceeding will mean for cryptocurrencies in general. 

Where it all began: How Ripple fell under the scrutiny of the SEC

Ripple began as one of the earliest crypto and blockchain projects. It was named OpenCoin at the time and was the brainchild of a group of programmers including Jed McCaleb, who is also credited for creating Stellar and the infamous Mt.Gox (once the largest Bitcoin exchange that got hacked under a subsequent owner).

The team behind OpenCoin built the foundation for Ripple Labs which was created in 2012 after Chris Larsen (a business executive and angel investor) joined the project. 

Compared to other top cryptocurrencies, XRP stands out as it does not depend on mining. The entire supply of the cryptocurrency was produced in one fell swoop at the beginning of the project. This brought about a lot of criticism to Ripple Labs and their XRP cryptocurrencies especially from crypto enthusiasts who believe that decentralization is the driving ethos of crypto, to begin with.

The price of XRP grew either way on the backdrop of the 2017 ICO boom even as Ripple Labs’ struggled to partner with banks and establish XRP as a cross-border payment solution.

Despite holding its position as the number three biggest cryptocurrency in terms of market capitalization over the years, the fact that a bulk of the total supply of XRP was still held by Ripple Labs was a point of concern for most. 

Increasingly the XRP cryptocurrency was associated with the company albeit attempts by the company to rebrand and distinguish itself from the XRP platform. 

According to Ripple, XRP is an independent digital currency that is built to facilitate cross-border transactions on the Ripple Network. Ripple Labs on the other hand, is a privately owned company based in San Francisco in the US. 

A case against Ripple

While the move by the SEC may have baffled many, it was hardly a surprise given that the agency has been investigating Ripple since 2017. What’s more, Ripple’s executives were already subject to a litigation hold that required them to preserve emails and other documents for years. 

Several legal experts have opined that the move by the SEC was a reaction to Ripple’s refusal to accept the terms of a settlement proposed by the government agency.

Ripple accused of selling XRP to fund operations

In a 70 page complaint filed by the SEC in court, the agency alleged that Ripple’s corporate success is a disguise for a company selling highly speculative digital tokens to finance Ripple’s operations as well as enrich the lives of Larsen and Garlinghouse.

“While Ripple touted the potential future use of XRP by certain specialized institutions, Ripple sold XRP widely into the market, specifically to individuals who had no use for XRP as Ripple has described such potential uses and for the most part when no such uses even existed,” said the SEC in a filed complaint.

In regards to Ripple’s use of capital from the sale of XRP to fund operations, the SEC highlighted that Ripple lacked funds to pay for its general business expenses “which for 2013 and 2014 already exceeded $25 million.”

According to the SEC, Ripple was compelled to actively “seek to offer and sell XRP as widely as possible, while controlling supply and demand in the resale market to manage and control liquidity for an imagined, future “use” case.”

“In 2017, [Ripple] also began accelerating sales of XRP because while Ripple’s expenses continued to increase (reaching nearly $275 million for 2018), its revenue outside of XRP sales did not.” added the SEC. 

The government agency showcased that Ripple’s only products were two software suites xCurrent and xVia both of which did not use XRP and only managed to earn a paltry $23million through 2019.

Basically, the SEC’s case against Ripple argued that the overwhelming majority of Ripple’s revenue and business model was focused on funds acquired from the sale of XRP.

The SEC vs. Larsen and Garlinghouse

Further detailing how Ripple and other beneficiaries profited from the sale of XRP, the SEC mentioned that “Larsen and his wife netted at least $450 million” from the sale of XRP from 2015 when Larsen was Ripple’s CEO.

“From April 2017 through December 2019, while an affiliate of Ripple as CEO,” the SEC pointed out that “Garlinghouse sold over 321 million XRP he had received from Ripple to public investors in the market, generating approximately $150 million from those sales.” 

The SEC complaint stated further that Garlinghouse “frequently told investors that he was invested in XRP and that he was bullish on the investment” even while he was selling millions of XRP. 

In a responsive comment, Garlinghouse replied to the accusation saying that being long on a position doesn’t preclude one from selling a portion of their holdings.

Ripple and third-party middlemen

The SEC also pointed out that ripple organized and paid third parties to manage the sale of XRP, allegedly carrying out XRP sales programmatically so as not to exceed a certain percentage of XRP’s overall daily trading volume.

The SEC said that money transmitters such as MoneyGram are only using XRP as bridge money for cross-border payments because Ripple paid them to do so. 

Initially, Ripple completed the acquisition of the giant remittance platform (MoneyGram) with a $50 million stake in November 2019. According to reports, Ripple’s acquisition entitled it to about 10% of MooneyGram’s outstanding common stock “and approximately 15 percent on a fully diluted basis including non-voting warrants held by Ripple.”

According to a filling of the acquisition with the SEC, MoneyGram would use the capital flow to support its operations as well as expand its use of Ripple’s on-Demand Liquidity Product called xRapid.

xRapid is a product created by Ripple Labs that offers liquidity solutions for banks where the XRP cryptocurrency is used as a bridge currency for cross-border payments. According to Ripple, the product aims to lower cross-border transactional costs and eliminate delays in global payments. 

Although Garlinghouse told CNN in an interview aired in 2019 that, “there’s no special sweetheart deal” when MoneyGram is moving money from U.S dollars to other national currencies, the SEC insists that Ripple gave MoneyGram over 200 million XRPs most of which were dumped to the market by MoneyGram soon after. 

Ripple emulating central banks

In addition to the accusation about Ripple incentivizing trading platforms to list XRP, the SEC also accused Ripple of emulating the operations of a central bank by “timing the prices and amounts of XRP sales to achieve what Ripple viewed as desirable trading volume.”

The SEC’s complaint cited that, “Ripple sought to maximize the amount it could earn from the XRP market sales while minimizing volatility and any downward pressure on XRP’s market price caused by Ripple’s constant injection of new XRP into the market to raise operating funds.”

The SEC noted that Ripple aimed to deploy these strategies and maximize the number of funds that could be raised from the sale of XRP or achieve more “speculative volume” of XRP.

Other accusations

The SEC complaint went into further detail, showcasing how Ripple’s executives used buybacks to stabilize the price of XRP through a consistent buying method from accounts that were also known to be sellers. The Ripple execs were also accused of analyzing the market and making efforts to maintain synchrony of the XRP price with the rest of the crypto market. 

In addition, the SEC scrutinized Ripple’s decision to move most of its XRP holdings on May 16th, 2017 into escrow as nothing more than a guise that presented the XRP market as a decentralized and functional market. 

Loopholes in SEC’s case 

Although it has been the belief of many that the SEC has the upper hand in regards to the case against Ripple, the blockchain software company has refused to settle. 

For most onlookers, the sudden move by the SEC to attack Ripple after waiting for about 8 years while being a bystander through periods of ICO fuelled financial bubbles is suspicious of dubious intentions by the agency.

While commenting on the case, former SEC Chair Mary Jo White noted that “When it takes that long to figure out a case, you shouldn’t be bringing it. 

“It’s not something I would do walking out the door,” White adds. 

Besides, the SEC has demonstrated a great deal of inconsistency with senior officials at the agency, saying that Ethereum’s ETH did not constitute securities violation despite Ethereum launching as an ICO.

The agency also handled other high-profile blockchain offerings with a slap on the wrist as opposed to the harsh stance in the Ripple case. Examples include EOS, a blockchain project that raised $4billionin in its 2017-2018 ICO only to pay $24million in a settlement with the SEC.

The SEC’s Howey test will be crucial in determining the case with Ripple. The SEC uses the Howey test to determine whether an asset is a security or not. It was first used by the Supreme Court in 1946 and defines security as “any contract, transaction, or scheme whereby someone invests their money in a common enterprise and is led to expect profits solely from the efforts of others.”

Conclusion: Who will win?

Going forward, the case will go into fact discovery that will conclude on August 31st and Expert Discovery that will end on October 15th. Fact discovery mainly consists of document discovery, and deposition as the battle between the government agency and Ripple continues throughout the weeks. 

On the other hand, expert discovery will require each party to submit individuals they will rely on for more technical testimonies and opinions that support either side of the case. 

Considering the motion-filled by the SEC, expert lawyers predict that the SEC will steer the case away from the technical aspects that highlight XRPs decentralization and more towards how XRP was marketed as well as how Ripple manipulated XRPs price. Already the SEC has requested slack messages from Ripple’s marketing and finance team.

Ripple’s argument on the other hand is predicted by lawyers to steer more towards showcasing the SEC’s regulatory uncertainty in terms of determining whether or not digital assets generally should be subject to registration under federal securities laws.