Home Business How Ripple plans to defend SEC charges over XRP token

How Ripple plans to defend SEC charges over XRP token

How Ripple plans to defend SEC charges over XRP token

Less than one month ago, XRP was the No. 3 cryptocurrency by market cap, behind only bitcoin (BTC) and ether (ETH). This week, XRP sank to No. 5 on some crypto exchanges. Its price is down 52% since Dec. 22, when the SEC charged banking software company Ripple Labs with conducting a $1.3 billion unregistered securities offering in 2013 when it began selling XRP. The charges also name two Ripple executives, cofounder and former CEO Christian Larsen and current CEO Brad Garlinghouse, who allegedly sold $600 million worth of personal XRP holdings.

The central issue in the case: Is XRP a security?

The SEC believes it is, and says Ripple promoted XRP to finance its business.

Ripple sells software products to banks and money-transfer companies, some of which use XRP to speed remittances and provide liquidity. In the wake of the SEC charges, Ripple partners like MoneyGram (MGI) and Tetragon have distanced themselves from the company. Crypto exchanges like Coinbase, Gemini, and OkCoin are all suspending trading support for XRP this month. Coinbase now faces a lawsuit from a customer in St. Louis over trading fees Coinbase collected on XRP transactions.

READ MORE: Ripple CEO: 3 reasons XRP is not a security

The charges against Ripple were announced on outgoing SEC Chairman Jay Clayton’s penultimate day in office, so Ripple finds itself in a limbo period. The SEC interim chair is Elad Roisman; President-Elect Joe Biden’s pick for the new SEC chair is former CFTC chair Gary Gensler, who looks friendly to crypto.

During the transition, the SEC’s cyber unit is continuing the case against Ripple, and the next event is a pretrial conference in New York scheduled for Feb. 22. Given the glacial pace at which the courts move, plus the ongoing COVID-19 pandemic, an actual trial won’t likely happen until spring or later—if it gets that far.

NEW YORK, NY - FEBRUARY 07: Dan Roberts, Brad Garlinghouse, and Andy Serwer attend the Yahoo Finance All Markets Summit: Crypto on February 7, 2018 in New York City. (Photo by Eugene Gologursky/Getty Images for Yahoo Finance/Oath )
Yahoo Finance’s Dan Roberts and Andy Serwer interview Ripple CEO Brad Garlinghouse at the Yahoo Finance All Markets Summit: Crypto on February 7, 2018 in New York City. (Eugene Gologursky/Getty Images for Yahoo Finance/Oath )

SEC vs the ICO boom

In all of its enforcement actions against startups that created tokens, the SEC has relied on the “Howey Test,” which comes from a 1946 case (SEC v. Howey) involving the selling of shares in a citrus grove.

The test determined, as former SEC official Bill Hinman explained at a Yahoo Finance crypto summit in 2018, that an offering represents a security if it “requires an investment of money in a common enterprise with an expectation of profit derived from the efforts of others.” In the SEC’s view, most initial coin offerings during the infamous ICO boom were securities offerings because the coins were marketed with the expectation that the price would rise, and also, as Hinman said, “sold to a wide audience rather than to persons who are likely to use them on the network.”

When it comes to XRP, Ripple begs to differ.

In its response to the SEC, Ripple wrote, “The SEC’s theory, that XRP is an investment contract, is wrong on the facts” and “amounts to an unprecedented and ill-conceived expansion of the Howey test and the SEC’s enforcement authority against digital assets.”

Multiple SEC officials over the past few years have made it clear that the SEC does not view bitcoin or ether as securities. Ripple CEO Garlinghouse made the case multiple times in the past for why XRP is not a security, seeking to prevent this very action from the SEC; it didn’t work. In a memo to Ripple employees, he called the SEC’s action “an attack on crypto in the United States.” (Japan’s securities regulator does not view XRP as a security, and Garlinghouse recently threatened to move the company to Japan or Singapore.)

“XRP is a currency,” Ripple says in its SEC letter, “similar to bitcoin and ether, which the SEC has determined are not securities.”

Ripple calling XRP a currency is interesting, considering that Garlinghouse said at a 2018 Yahoo Finance crypto summit, “I don’t call this cryptocurrency. It’s not currency… These are digital assets. If the asset solves a real problem for a real customer, then there’ll be value in the asset.”

Ripple’s argument

In a trial scenario, one of Ripple’s key arguments will rely on eight years of price data that shows XRP does not move based on news about Ripple, according to sources familiar with the company’s legal strategy.

One specific example: On June 19, 2019, when Moneygram announced it had made Ripple its exclusive partner for cross-border payment settlements, MoneyGram stock popped 170% in a day. Ripple will present data that shows XRP stayed flat. (CoinMarketCap data, on the other hand, shows XRP rose 15% over the two days that followed.)

READ MORE: Former CFTC chair says XRP is not a security—but Ripple is his client

The SEC’s action against Ripple looks a lot like the actions it brought against dozens of companies that conducted ICOs, including Airfox, Paragon, Telegram, and Kik.

Ripple will seek to distance itself from the ICO boom, many of which were conducted by companies that had no product or business model beyond selling a token, by emphasizing that Ripple Labs as a company was around for years before the creation of XRP, and that XRP has a healthy trading market on hundreds of crypto exchanges without any connection to the company.

KATWIJK, NETHERLANDS - JANUARY 3: In this photo illustration, a visual representation of digital cryptocurrency Ripple (XRP) is arranged on a circuit board of a hard drive on January 3, 2021 in Katwijk, Netherlands. (Photo by Yuriko Nakao/Getty Images)
In this photo illustration, a visual representation of digital cryptocurrency Ripple (XRP) is arranged on a circuit board of a hard drive on January 3, 2021 in Katwijk, Netherlands. (Photo by Yuriko Nakao/Getty Images)

As for the company’s own sales of XRP, Ripple will argue that those sales have represented a mere fraction of all XRP trading, and that because its own XRP sales were done through exchanges and market makers on a blind basis, purchasers of XRP didn’t know they were buying it from Ripple, and thus it couldn’t be an investment contract.

But what if the SEC reasons that XRP was so closely associated with Ripple publicly that anyone buying XRP thought of it as a bet on the success of the company?

Ripple Labs registered the trademark for XRP in 2013, and even referred to the token as “ripples” for years (something the SEC cites specifically in its complaint), though it eventually stopped calling it that and began petitioning media not to call it that.

Ripple’s legal team believes the history of what Ripple called the token is a red herring, according to sources. The company also believes it unfair that the SEC filed its enforcement action at the very end of an outgoing administration.

Ultimately, this section of the SEC’s complaint against Ripple might prove pivotal: “The Supreme Court made clear in its Howey decision of 1946 that the definition of whether an instrument is an investment contract and therefore a security is 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 SEC’s complaint mentions that twice: that it can apply the Howey definition of a security flexibly.

The SEC believes XRP fails its “flexible” test. Ripple Labs will need to prove otherwise, for the health of its business and for the XRP market—even if Ripple says that market bears no connection to its business.

Daniel Roberts is an editor-at-large at Yahoo Finance and has covered bitcoin since 2011. Follow him on Twitter at @readDanwrite.

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This article is auto-generated by Algorithm Source: finance.yahoo.com

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