SEC vs. Ripple:  Why It Affects Us All

SEC vs. Ripple: Why It Affects Us All

July 20, 2021

If you are looking for an interesting courtroom drama to watch this summer, don’t bother with your streaming platform. The SEC vs. Ripple lawsuit has all the drama, intrigue, shady behavior, and suspense you can handle. 

And if you are invested in crypto, then you have the added benefit of having a real stake in the outcome. 

There is no need to binge watch the latest crime series when a single update on the SEC vs. Ripple case will keep you up at night. 

If you are new to this unfolding situation, we will quickly bring you up to speed, then share the latest developments and discuss the implications of the case at large.

SEC

What’s Happened So Far

To better understand the latest developments, here is a brief timeline of the case to date—summarized and paraphrased.

Starting in 2013, Ripple began to sell their XRP token as part of their global payments platform.

Many different companies and countries use their fully decentralized ledger, and the World Economic Forum even labelled XRP as the most relevant cryptocurrency for central banks. 

A number of countries have declared XRP a currency, and hundreds or organizations use it as a means of exchange. It can be found not only in banks, but in wallets, money transfers, and a number of commerce platforms.  It is used by some to pay employees. 

It can—and is—used to purchase goods and services. 

Though the SEC had brought over 70 cases against other crypto firms during the next seven years, they did not include or mention Ripple.  On the other hand, Ripple had actively sought clarification to ensure XRP was not a security. 

The team reached a settlement labelling XRP a “convertible digital currency”, accepted by the Department of Justice. 

Ripple even registered with the Treasury Department’s FinCEN (Financial Crimes Enforcement Network), following all currency-related regulations. 

However, in December 2020 the SEC brought  Case 20-cv-10832 against Ripple, alleging that Ripple and its two co-owners, Christian Larsen and Bradley Garlinghouse, profited by $600 million without registering XRP as a security. 

Ripple’s core defense is two-fold. 

First, they claim that the SEC offered no fair notice that there was a legal concern. Essentially, Ripple claims that their actions have been very proactive in ensuring with the regulatory bodies that they are classified as a currency and not a security. 

The company has even asked the SEC for clarification on this topic, but claim that no response was given either way from the SEC, making it difficult to identify any issues while not receiving any negative advice or warnings.

Second, in 2018, the now former director of the SEC’s Division of Corporation Financing, William Hinman, gave a speech in which he stated that “offers and sales of ether are not securities transactions.” 

This speech moved markets, gave many investors the confidence they were looking for, and acted for many as a clarification of the SEC’s position on this type of token.  It’s also important to note that:

  • This speech is still available for viewing on the official SEC website
  • In a later speech at the Georgetown University School of Law, Hinman said of the ETH speech that it “got a lot of attention because it was the first time we had expressed to the world that we didn’t view ether as a security.”  This statement was never corrected to show it was Hinman’s personal viewpoint, and seemed to have the effect while using the term “we” that the speech was confirmed as the SEC’s official position on ether and similar crypto.

The SEC responded to this defense as follows:

Fair Notice:

  • The SEC claims that they DID provide fair notice in the form of 75 other actions and suits against other crypto firms, indicating that XRP was a security the entire time and Ripple should have realized this. 
  • Ripple countered this by pointing out that all cases were targeted at ICO’s, but the XRP ledger was already in place when Ripple was first established, and it did not have an ICO. 
  • The SEC responded that “the abundance of caselaw interpreting and applying at all levels of judiciary, as well as related guidance issued by the SEC as to the scope of its regulatory authority and enforcement power, provide all the notice that is constitutionally required.”    Very loosely interpreted: We went after others for things that relate to the industry in which you operate, so you should have known we have always considered you the same.  We won’t be bothered to give further distinction to you or anyone else, but you are responsible for knowing.

Hinman’s speech

  • The SEC considers Hinman’s views shared in his 2018 speech—along with the follow up speech where he used the term “we” in referencing the view of the ether not being a security—to be his own.   Even though the markets immediately moved following the speech and the SEC did not respond in order to separate Hinman’s views from official policy, and even though the speech is still on the official SEC website, these are considered by the SEC to be taken as a personal opinion only.

The infamous 2018 speech from Hinman is just the beginning of his involvement in this case.  In fact, the other actions taken by Hinman cast a shadow onto the potential motives of the SEC at that time. 

As a result, Ripple requested to depose the former director in order to explore the potential for conflict of interests, and to better understand the confusing timing of the SEC’s suit against Ripple.

The SEC argued that since Winman is considered a high-level official, allowing him to be deposed “would subject high-level government officials to depositions regarding every law, regulation, or policy they consulted on or spoke about and that later underlay an enforcement action.” 

The response even indicated that if the risk of litigation was present by allowing this deposition, government agencies would suffer because “qualified people” wouldn’t want to pursue a government career out of fear of constant lawsuits.

The judge for the case, U.S. Magistrate Judge Sarah Netburn, disagreed with the SEC’s position. She stated that this is not a normal case, and this deposition was not going to unleash the endless litigation suggested by the SEC. 

Rather, Judge Netburn stated that the case “involves significant policy decisions in our markets, the amount in controversy is substantial and the public’s interest in this case is significant.”

This is a landmark decision by itself, regardless how the lawsuit unfolds.

Vitaliy Kedyk, Head of Strategy at the European crypto platform Currency.com, responded to the decision:

“The SEC vs Ripple Labs Inc. case and the decision to depose ex-SEC director, William Hinman, shows us just how influential the retail voice has become. Ruling in favour of the ‘public interest’ , the result is that Hinman can now be questioned in court. The ruling will enable Ripple Labs to question Hinman and determine his ‘personal views’ around Ethereum (ETH) and why he believes ETH is not a ‘security’. It’s going to be a very interesting deposition , which possibly unveils new facts about the case. While the deposition has not immediately impacted the price of ETH, we expect this outcome to affect Ethereum in the mid-to-longer term.”

Other voices of authority have weighed in on the matter. 

John Deaton, an attorney who filed a Motion to Intervene on behalf of XRP holders, has been quite vocal about the case. 

He has argued that Ripple acted in good faith by ensuring that XRP complied with US currency laws, believing—based on all legal evidence—that it was in fact a currency rather than a security. 

He states that Ripple interacted with the SEC on multiple occasions, in situations where if there was a concern about XRP being considered a security, Ripple should have been informed at that time.  However, no indication of concern was given. 

Moreover, Deaton has shed light on deeply troubling potential conflicts of interest as they relate to the deposed Hinman. 

Hinman was a partner at the law firm of Simpson Thacher, which is a member of the Enterprise Ethereum Alliance, before and after his time as SEC director. 

His speech in 2018 benefitted ETH considerably, which benefitted Simpson Thacher considerably, which benefited Hinman considerably—as he was paid millions in his role at Simpson Thacher.

Judge Netburn stated that Hinman’s 2018 speech was “the central question”, and weighed heavily in the decision to allow deposition.

Though not directly involved with the deposition, Deaton has publicly released a list of questions he believes should be asked of former director Hinman. 

These center around his 2018 speech, who was involved in writing it, who was consulted, what research was conducted in preparing the speech, and who was informed of the speech. 

Getting answers to these questions under oath could reveal any conflict of interest and would possibly uncover any improper motivation for filing a suit against Ripple.

The deposition was scheduled for 19 July 2021, but this was rescheduled for 27 July.

Road, SEC

The Road Ahead

In terms of the case, once the deposition is complete there are several milestones in the upcoming months. The Fact Discovery deadline is 31 August, and the Expert Discovery deadline is 15 October. 

This means that the resolution of the case will likely occur in early 2022, unless further delays push the timeline even more. 

In the meantime, each day the lawsuit goes unresolved is harmful to Ripple. The value of XRP has dropped considerably, and over 50 exchanges have either suspended trading or delisted XRP completely. 

The currency has lost 75% of its value, and is unlikely to recover until the lawsuit has been concluded—or might not recover if the suit rules against Ripple.

Given that 96% of all SEC cases agree on a settlement before a trial, this seems to be a likely outcome, especially due to the negative effects on Ripple and XRP.  Until then, it cannot move forward with its initial public offering. 

The SEC, however, has been stalling on multiple fronts to weaken Ripple’s position, but it is also highly concerned that any judgement for Ripple could create serious problems for the Howie Test, which helps to determine what can be considered a security. 

Others, however, feel that this is a natural step in the right direction for cryptocurrencies, and suggest that a new “Ripple Test” should be adopted that could help test for securities vs. currencies using guidelines that make more sense for crypto projects.

Looking further out on the horizon, this case is important for the crypto community as a whole, and may determine whether the US plays a prominent role in crypto’s future or is left behind. 

If Ripple loses, it would suggest several key possibilities. 

First, that if XRP is a security, then Ethereum may fall under scrutiny next, and in fact any token may incur the judgement of the SEC, even after 5, 10, or more years. This type of uncertainty is notoriously bad for markets, and the effect will be profound. 

Second, that the US as a nation will live with the result of this decision, and if Ripple is ruled against, the US will not be seen as a leader in the crypto industry. 

Instead investments will find homes in more stable markets, leaving the US and its residents out of key lucrative growth.

We will see what the future holds.  This landmark case has a lot riding on it, many twists and turns ahead, and is a drama worth watching closely.

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