In December 2020, the SEC filed a lawsuit against the executives of Ripple Labs & the company itself. Most entities generally settle with the SEC to ensure they can continue operations. Ripple did not, instead choosing to actively defend themselves in court against the SEC. The case is ongoing but the SEC's stance is clear below:
Ripple Labs raised at least $1.38 billion “over a years-long unregistered offering of securities. Ripple used this money to fund its operations without disclosing how it was doing so, or the full extent of its payments to others to assist in its efforts to develop a ‘use’ for XRP and maintain XRP secondary trading markets.”
It is expected that the SEC will make its case for XRP to be deemed a security based on the common definition and interpretation of the Howey Test, the most common legal test applied to securities. The four-component questions of the test are listed below:
1. Is there an investment of money?
2. Is there an expectation of future profits?
3. Is the investment of money in a common enterprise?
4. Do any profits come from the efforts of a promoter or third party?
When examined through the lens of the Howey Test, XRP passes or narrowly skirts the line on at least two points. The first failure (i.e., being classified as a security) is the investment of money and the expectations of profit. Retail users undoubtedly invested money into XRP and now Ripple is left to defend that they did so for some other reason besides speculation. XRP’s intended use case is as a bridge currency for banks in cross-border payments; therefore, no average person needs to own XRP.
The second issue with XRP deals with numbers three and four of the Howey Test questions concerning a common enterprise and Ripple’s control over XRP. The connection between the activities of Ripple Labs Inc. and the market price of its native token has been put under question. This report has covered the multitude of ways in which Ripple Labs Inc. has an overly-centralized control over XRP; ultimately, it may be Ripple itself that makes the case against them.
Ripple's Response
Since late 2018, Ripple has tried to distance the company from the XRP token, although, in the early years of Ripple’s development, they appeared to state clearly that Ripple Labs created XRP. More recently, the Ripple website has changed that language to directly contradict its original statement and now claims that Ripple did not create XRP.
In response to the Securities and Exchange Commission's (SEC) lawsuit, Ripple Labs Inc. vehemently denied the allegations and filed a motion to dismiss the complaint on January 29, 2021. Ripple's defense was predicated on the argument that XRP, the digital currency in question, is not a security but a medium of exchange and a store of value. They contended that the SEC's lawsuit was arbitrary, capricious, and contrary to the public interest.
Ripple's defense is multifaceted. They argued that the SEC lacked jurisdiction over XRP as it is not a security under U.S. law or any other jurisdiction. They also claimed that the SEC failed to provide fair notice to Ripple and the market that XRP was a security. Ripple further argued that the SEC's lawsuit violated their due process rights and the statute of limitations. They also contended that the lawsuit created uncertainty and confusion, thereby harming XRP holders and the broader crypto industry.
In an attempt to bolster its case, Ripple filed several motions to compel the SEC to produce documents and information. These included the SEC's internal communications and policies regarding XRP and other cryptocurrencies, communications with foreign regulators and exchanges about XRP and other cryptocurrencies, trading data and analysis of XRP and other cryptocurrencies, and documents related to bitcoin and ethereum, which the SEC has publicly stated are not securities.
In Q1 2022, a judge to unseal previously private communications sent to Ripple from its outside counsel in dating back to 2012, prior to the XRP sale. Perkins Coie LLP attorneys “ Ripple not to sell the proposed coins, as various conditions could subject them to being regulated as securities or commodities. A second memo… suggested that XRP may not be considered to be a security under federal law, but cautioned there was a risk the Securities and Exchange Commission would see things differently.”
Over the past several months, Ripple has been slowly putting more and more pressure on the SEC in this case. While Ripple and the SEC have been engaged in a heated legal battle, recent rulings from an overseeing judge have backed the SEC up against a figurative wall. U.S. Magistrate Judge Sarah Netburn called the SEC hypocritical as the organization tried to distance itself from comments made by formal official Bill Hinman that Ethereum (ETH) was not a security. This comment was made based on the advice and guidance from the SEC itself.
The SEC has tried to argue that the speech was irrelevant, but the judge has declined. This places a pivotal victory in Ripple’s column because if Hinman’s comments are legally deemed relevant, Ripple may be given the upper hand and help confirm XRP is not a security either. This would deal a great blow to the SEC’s ability to regulate other similar assets within the cryptocurrency space. This also comes after the SEC attempted to keep its ‘key experts’ in the case confidential - a move Ripple has challenged outright. With pressure mounting against the SEC, there is a growing sentiment within the crypto economy that Ripple may win the case.
