On December 22, 2020, the Securities and Exchange Commission lodged a complaint in the Southern District of New York (SDNY) against Ripple Labs, Inc., and Ripple officers Bradley Garlinghouse and Christian A. Larsen in their respective capacities.1
The objection alleges that (i) the defendants are engaged in the unregistered sale of securities in contravention of Sections 5 (a) and 5 (c) of the Securities Act 1933 through the sale of again the XRP token dates back as far as 2013, and (ii) Larsen and Garlinghouse assisted with the unregistered sale of Ripple securities, dating back as far as 2013 and 2015 respectively, by performing tasks such as deciding when and what Ripple ‘s XRP would sell, setting up an escrow account holding most of Ripple’ s XRP. investor concerns about sales,2 making progress reports on XRP and taking other actions aimed at increasing demand from XRP. The SEC did not allege that any fraud occurred to investors, but did detail how the defendants placed their sales of XRP reducing unfair information.3 The SEC called on the SDNY (the only federal district that recently heard the cases against the two Telegrams4 and Kik5) to permanently injure the defendants in contravention of Sections 5 (a) and 5 (c), to disregard unearned benefits and to apply civil money penalties, as well as prevent the defendants from participating in any future offer of digital asset securities.
On January 29, 2021, Ripple – represented by the former chairman of the SEC – submitted its response to the SDNY.6 Ripple denied the SEC’s allegations that it had “never offered or sold XRP as an investment.” Ripple noted that “XRP holders do not receive any application to Ripple funds, hold any property interest in Ripple, or are entitled to share in Ripple’s profits in the future. coming. ” Furthermore, Ripple argued that “Ripple ‘s limited contracts with symbolic parties were not investment contracts, but standard purchase and sale contracts with no guarantee from Ripple’ s efforts or future profits. . ” According to the answer, so Ripple has no relationship with most XRP holders today, and almost all XRPs were purchased from third parties on the open market. “
Ripple concluded that “the SEC theory in the Complaint would read the word‘ contract ’out of an‘ investment contract, ’and extend beyond all the sensible recognition of the Supreme Court test for being confirming investment contracts in SEC v. WJ Howey Co., 328 US 293 (1946). Ripple has never held an ICO, never offered tokens in the future to raise funds, and has no contracts with most XRP holders. “
Background on Ripple’s unregistered offers
Ripple was founded in San Francisco in 2012 and defines itself as a “private payments technology company that uses blockchain innovations (including XRP) to allow money to be sent across the world. the world instantly, reliably, and cheaper than traditional ways of distributing money. . “7 In December 2012, the total supply of 100 billion XRP on the Ripple protocol was created, and 80 billion XRP was transferred to Ripple, with the remaining 20 billion XRP transferred to three early employees.8
The complaint covers as far back as February 8, 2012, and October 19, 2012, Ripple received two legal memoranda from an international law firm that warned “there was a risk that XRP would be considered as” investment contract. “9 Ripple argues this argument arguing to some extent that “any reasonable reader of the true and correct content of the memorandum dated 19 October 2012 would understand that the final conclusion of the adviser was that Ripple Credits ( as defined) make up ‘securities’ under the federal securities. laghan. “10
According to the complaint, the unregistered offers of securities began in August 2013 with the sale of XRP in exchange for fiat currencies or digital assets. The SEC also said those unregistered sales continued until 2017 when they accelerated as Ripple faced rising operating costs and limited revenue sources.
According to the SEC complaint, from 2014 through the end of 2019, Ripple sold at a collection of 3.9 billion XRP to buyers in the open market for about $ 763 million in total. Ripple made market sales by first moving the XRP to investors and then using traders to offer and sell XRP to investors. The complaint alleges that Garlinghouse and Larsen personally participated in these market sales and made a profit of approximately $ 600 million.
According to the SEC complaint, from 2013 through the end of the third quarter of 2020, Ripple sold at least 4.9 billion XRP to investment funds, wealthy people or other solemn investors for about $ 624 million. The complaint notes that XRP II, LLC, NY’s limited liability company and Ripple’s wholly owned subsidiary are the entity through which Ripple sold the majority of the XRP in institutional sales at discounts between 4% to 30% off market price. XRP II is registered as an MSB by FinCEN and has BitLicense from NYDFS.
Further, the complaint alleges that Ripple exchanged XRP for non-monetary considerations, such as labor services or market manufacturing, aimed at achieving widespread distribution of XRP. Beginning in 2013, Ripple began distributing XRP through “bounty programs” paid by a programmer for reporting problems with Ripple protocol code.11
Observations
Looking back, one of the highlights of the complaint is its timing. According to the SEC, Ripple violated the Securities Act through unregistered offers of securities dating back to 2013, but the SEC’s complaint was filed more than seven years later. In its response, Ripple noted “The SEC filed this Complaint 8 years after the creation of XRP, 5 years after the DOJ and FinCEN designated XRP as a frontier currency, and after more than 2½ years of scrutiny in which the SEC allowed Defenders to continue to distribute XRP, allowed the XRP open market to grow, and allowed millions of market participants to rely on the activity of the XRP. free and efficient market. “
Despite any possible final outcome for the law, the impact of the SEC complaint has been immediate. As Ripple said in its response, “the direct filming of the Complaint has severely damaged XRP holders, severely cutting the value of their holdings and causing a number of exchanges, market makers, and partners. Another market stopped activity in XRP. ” As this warning has been published, XRP is still listed by many crypto exchanges, leaving the people the SEC is securely defending with no way to liquidate their positions.
Looking ahead, the SEC’s case against Ripple, Garlinghouse and Larsen has the potential to set an additional meaningful precedent for enforcing securities laws for the sale of digital assets. One important aspect of the controversy is the need for the SEC under a new direction that Gary Gensler and the SDNY may have to deal with with the possible remedy for the defendants’ allegations. The SEC has noted settlements that would require unlicensed securities issuers to offer re-licensing to buyers of digital assets as frameworks to follow for treatment.12 However, asking Ripple to offer a recourse for all sales of XRP could have a detrimental effect on the company ‘s Ripple and XRP, as well as exposing administrative nightmares. Asking Ripple to register XRP as a security could offer a way forward, but it would bring immediate and potentially unavoidable breaches. In its response, Ripple acknowledges the far-reaching impact that would flow from XRP being referred to as “security,” arguing that “convenience relies on near-immediate XRP configuration and in low-cost transactions . Treating XRP as security, by contrast. , bringing thousands of exchanges, market makers, and other players in the virtual currency market to long, complex, and costly regulatory requirements. “13
Footnotes
1 The objection is available here.
2 In its response, Ripple “admits that on May 16, 2017 Ripple announced that it would put 55 billion XRP in escrow on the XRP Ledger, after which the escrow implemented that XRP.”
3 In response, Ripple argued that “The Complaint alleges an imbalance of information between Ripple and XRP holders in unclear, unspecified terms, but does not identify any relevant information and avoid Ripple ‘s detailed quarterly reports on Ripple’ s activity in the XRP market. And such non-existent information could not, even in its presence, turn the sale of digital assets into a secure donation. “
4 SEC v. Telegram Group Inc., No. 1: 19-cv-09439-PKC (SDNY March 24, 2020) (pre-order comment and order).
5 SEC v. Kik Interactive Inc., 19-cv-05244-AKH (SDNY June 4, 2019) (opinion and order granting motion for summary in favor of the SEC).
6 Answer
7 Answer
8 In its response, Ripple “acknowledges that, to the best of its knowledge and belief, a total of 20 billion XRP has been secured by Mr. Larsen, Co-Founder, and Ripple Agent-1 and has never been transferred to Ripple. “
9 Complaint
10 Answer
11 In its response, Ripple “acknowledges that Ripple made special payments in XRP as virtual currency instead of fiat money through a bounty bug program in 2013 and 2014.”
12 In respect of CarrierEQ, Inc., d / b / a AirFox, Order to Establish Cease-and-Desist Proceedings pursuant to Section 8A of the Securities Act of 1933 (November 16, 2018); In the case of Paragon Coin, Inc., Order to Establish Cease-and-Desist Proceedings pursuant to Section 8A of the Securities Act of 1933 (November 16, 2018).
13 Answer9>
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