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Ripple: SEC did not give fair notice that XRP violated law

  • Michelle Lim
    • XRP in Purple Light

    The U.S. Securities and Exchange Commission (SEC) failed to provide “fair notice” that XRP transactions violated the law or that the SEC would later claim XRP itself to be an investment contract, says Ripple Labs in its latest court filing.  

    In a 100-page legal document filed on Mar. 4 in response to the SEC’s first amended complaint, San Francisco-based payments technology company Ripple provided additional details on its fair notice defense. “Prior to the SEC’s Complaint, countless market participants for years transacted in XRP believing it was not an investment contract,” the document stated.

    Ripple’s latest filing is a response to the SEC’s amended complaint and follows the pre-trial conference last month. The case is being closely watched by the industry given the potential impact on XRP investors and the legal precedent it could set for other cryptocurrencies.

    A central issue in the lawsuit is whether transactions involving XRP — the native cryptocurrency for the Ripple platform — constitute “investment contracts” and thus securities subject to registration under Section 5 of the Securities Act of 1933.

    Referring to former SEC Director of Corporation Finance William Hinman’s remarks in June 2018 that bitcoin and Ethereum’s ether were not considered to be securities, Ripple said it had understood those remarks to indicate that the SEC “would permit present-day sales of virtual currencies given the current market conditions for XRP.”

    Ripple argued that the lack of fair notice was made further apparent when “Platform A” met with the SEC in 2019 regarding its intention to list XRP, and the SEC, even when asked, did not state that XRP was considered to be a security.

    “The SEC had meetings with multiple other companies that traded or facilitated activity in XRP or that planned to do so and in such meetings — including as recently as 2019 — the SEC did not tell those companies that XRP was a security or that transactions in XRP would be subject to the federal securities laws,” Ripple stated in its response. “Consequently, those companies proceeded to play significant roles in the development of use cases for XRP, and further contributed to expanded uses of XRP as a virtual currency, with full knowledge of the SEC.”

    See related article: No Ripple-SEC lawsuit settlement in sight as XRP prices tumble

    Ripple’s general counsel Stuart Alderoty took to Twitter today to say, “We’re looking forward to learning more about the SEC’s meetings with major XRP market participants who asked for guidance but were never told that XRP txns would be subject to the federal securities laws.”

    It remains to be seen how this legal defense strategy will unfold. Jake Chervinsky, general counsel at Compound, a decentralized lending protocol, also took to Twitter today to say, “‘We got away with it for a really long time’ actually isn’t a viable defense to an SEC enforcement action, btw.”

    Last December, the SEC filed a lawsuit against Ripple for the alleged illegal sale of XRP in an unregistered securities offering worth over US$1.38 billion. Ripple’s executive chairman Chris Larsen and CEO Brad Garlinghouse have been named as co-defendants for allegedly aiding and abetting Ripple’s violations and making US$600 million in personal profits from their unregistered sales of XRP. Larsen was Ripple’s CEO from October 2013 through December 2016.

    Following the SEC lawsuit, many exchanges delisted XRP, and MoneyGram, the world’s second largest money transfer service, also suspended its partnership with Ripple. But Ripple continues to enjoy strong support in parts of Asia, including Japan.

    XRP, currently ranked seven by market cap, is trading at US$0.46 as of publication time.

    See related article: XRP prices see ‘pump and dump’ as Ripple outlines legal defense strategy

    Are Ripple executives to blame?

    The SEC has also alleged the involvement of Garlinghouse and Larsen in Ripple’s violations: “At all relevant times, Garlinghouse and Larsen knew or recklessly disregarded that XRP investors had a reasonable expectation of profiting from Ripple’s efforts with respect to XRP.” Ripple denied the allegations.

    Separately this week, Garlinghouse’s defense counsel filed a letter outlining the arguments that Garlinghouse anticipated raising on a motion to dismiss the SEC’s complaint.

    “This case represents regulatory overreach, plain and simple,” asserted the letter, which underscored that the SEC’s amended complaint failed to adequately allege scienter — intent of wrongdoing — a necessary element of the aiding and abetting claim. “The SEC fails even to adequately allege negligence, let alone the far more onerous knowledge or recklessness standard.”

    “Not satisfied simply to try to fit the square peg of XRP into the round hole of the securities laws, the SEC has also chosen to target Mr. Garlinghouse with personally violating the securities laws — both by selling his own XRP and by allegedly aiding and abetting Ripple’s sales,” the letter stated. “Straining to impose personal liability on an executive like Mr. Garlinghouse for simply doing his job where he reasonably understood that his actions complied with the law represents an abuse of prosecutorial discretion that has sent a dangerous signal to entrepreneurs and will chill innovation.”

    Garlinghouse’s defense also noted that the amended complaint failed to allege that his sales and offers of XRP were conducted in the U.S. and therefore within the territorial scope of the Securities Act.

    “The truth is that the vast majority of Mr. Garlinghouse’s XRP sales were made on foreign exchanges, and those transactions do not and cannot violate the federal securities laws,” the letter stated. “The SEC cannot save its pleadings by arguing that Mr. Garlinghouse’s offers or sales are domestic simply because either he or XRP purchasers (the location and identity of which Mr. Garlinghouse was unaware) may have been physically present in the United States at the time of the transactions.”

    Larsen’s defense counsel too filed, on the same day, a letter regarding his motion to dismiss, stating in its letter that the SEC had failed to plausibly allege that Larson knew or was reckless as to XRP transactions being “investment contracts” and that Ripple’s activities were “improper.” Like Garlinghouse, Larsen is arguing that the case falls outside the court’s jurisdiction.

    Larsen’s defense also argued that the SEC’s claims for monetary relief are time-barred, “Because the SEC has alleged that the sales of XRP over a multi-year period constituted only one offer, which began in 2013, the statute of limitations began to run in 2013 and expired in 2018.”

    What would Gary Gensler do?

    The prospect of settlement is unlikely at this time, according to a joint letter submitted by Ripple and the SEC to the judge last month. But the impending change in SEC leadership — Gary Gensler, President Biden’s SEC chair nominee is currently awaiting confirmation by the Senate — could reshape the SEC’s stance towards cryptocurrencies.

    At his confirmation hearing before the Senate Banking Committee earlier this week, Gensler said, “Bitcoin and other cryptocurrencies have brought new thinking to payments and financial inclusion. But they’ve also raised new issues of investor protection that we still need to attend to.”

    “It’s important for the SEC to provide guidance and clarity,” added Gensler, who has taught and researched blockchain and cryptocurrency policy as a professor at the Massachusetts Institute of Technology. “Sometimes that’s a clarity that will be a thumbs up, but even if it’s thumbs down, it’s important to provide that.”

    Ripple piloting a private ledger for CBDCs

    Although the outcome of Ripple’s legal battles against the SEC remains uncertain, Ripple is now pushing its “XRP Ledger” (XRPL) in a new direction for global digital payments.

    Earlier this week, Ripple announced that it was piloting a private ledger for central banks to issue and manage digital currencies.

    According to Ripple’s blog post, central banks require more transaction privacy and control over their currencies, and are more likely to create a central bank digital currency (CBDC) on a private ledger than on a public ledger. Interoperability — the ability to connect with existing global financial infrastructure as well as other CBDCs and digital currencies is also critical.

    Ripple says its CBDC Private Ledger — based on the same blockchain technology powering the XRPL — is built for payments and could be used to facilitate transactions involving CBDCs and other currencies at scale, lower cost and require less energy compared to public blockchains that leverage proof-of-work.

    “Tokenization has always been a key feature of the XRPL with over 5400+ issued tokens since inception,” tweeted Monica Long, general manager at RippleX, Ripple’s developer platform for money. “CBDCs will live on new private ledgers that run parallel to XRPL, using XRP as a bridge to interoperate w/ other currencies. No more walled gardens!”

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