The legal battle between the United States Securities and Exchange Commission (SEC) and Ripple Labs has been making headlines for its implications on the cryptocurrency industry. Ripple Labs, founded in 2012, introduced the RippleNet network and its digital currency, XRP, with the promise of revolutionizing cross-border money transfers. However, in 2020, the SEC filed a lawsuit against Ripple Labs, along with its current and former CEOs, Chris Larsen and Brad Garlinghouse, alleging violations of securities laws. This article aims to provide a comprehensive overview of the SEC’s claims in this ongoing legal dispute.
Ripple Labs entered the fintech landscape in 2012, offering a solution for financial institutions to conduct low-cost and rapid cross-border money transfers. Central to their platform was the cryptocurrency XRP, which facilitated real-time settlement and clearance of transactions on the RippleNet network. However, over time, XRP expanded beyond its intended use.
Ripple and SEC unveiling securities classification
The crux of the SEC’s lawsuit against Ripple Labs centers on the allegation that Ripple conducted an initial public offering (IPO) of XRP, which the SEC considered an unregistered security when the capital was raised. According to the SEC’s complaint, Ripple engaged in the sale of XRP tokens through unregistered security offerings to investors both within the United States and internationally. Additionally, the SEC claimed that Ripple exchanged billions of XRP for non-cash services like market-making and labor.
The lawsuit further alleges that Chris Larsen and Brad Garlinghouse, co-founder and current CEO of Ripple Labs, respectively, engaged in personal unregistered XRP transactions valued at approximately $600 million. Moreover, they are accused of actively promoting XRP sales to support the company’s operations, thereby violating federal securities laws’ registration restrictions.
A pivotal question in this legal dispute is whether XRP qualifies as a security. Generally, securities are financial instruments representing ownership in a corporation or similar entity without any inherent utility. The SEC argued that since XRP tokens were used to fund Ripple’s platform and enriched its management, they should be considered securities. Notably, the SEC distinguishes XRP from Bitcoin, which it does not classify as a security.
The SEC’s determination of XRP as a security draws from the “Howey test,” a landmark Supreme Court case from 1946. The Howey test aids in determining whether a transaction falls within the Securities Act of 1933’s definition of an investment contract. According to this test, the critical factor in determining if an investment contract is a security is the investor’s lack of control over the profit. If investors have no influence over the asset, it is typically considered a security.
The SEC argued that XRP satisfied the requirements of the Howey test, which mandates that securities must be registered with the agency, and certain financial information must be publicly disclosed. These requirements aim to protect the interests of investors and combat fraudulent practices. The SEC’s assertion that XRP met the Howey test’s criteria is a central point of contention in the lawsuit.