SEC sues Ripple Labs, claiming XRP is a security

The SEC thinks the cryptocurrency XRP is a security — i.e., it was promoted by Ripple Labs as an investment contract that meets the Howey test of being a security under US law. [WSJ, paywalled]

About four years after it arguably should have, and after two years of discussions with Ripple, the SEC finally sent Ripple a Wells notice — a letter from the Enforcement Division notifying a company of a planned action, and asking for a submission as to why the action should not proceed.

Ripple publicly posted their short response letter this morning, Tuesday 22 December. Ripple’s eight-page reply rested on XRP being actually useful, and what about Bitcoin and Ethereum, and also what about the need for XRP so the US can compete with China, huh? [Ripple, PDF]

XRP crashed on the news.

The SEC wasn’t convinced by the reply, and has charged Ripple Labs and executives Brad Garlinghouse and Christian Larsen with conducting a $1.3 billion offering of unregistered securities. [Press release; complaint, PDF]

Perhaps they could change the ticker from XRP to RIP.



The short history of Ripple and XRP

XRP as we know it was created by Jed McCaleb, Arthur Britto and David Schwartz in January 2013. The name “Ripple” came from Ryan Fugger’s project “Ripplepay,” a “system of debt money without artificially imposed scarcity,” which started in 2005. McCaleb’s innovation was to add a token. McCaleb started OpenCoin in 2012, which changed its name to Ripple Labs in September 2013. [IEEE Spectrum, 2013]

Larsen co-founded OpenCoin in 2012; Garlinghouse joined Ripple Labs in 2015, and became CEO in 2017.

XRP runs on a permissioned blockchain, so it’s much faster than a Bitcoin-style proof-of-work blockchain and doesn’t waste a ton of electricity. There is a system of multiple validators in the network — but functionally, if you want to be on the official XRP system, Ripple Labs needs to let you be there.

This sort of centralised control is against all cryptocurrency ideology — but XRP trades in the same markets as all the other coins. Because the market doesn’t care about your ideology.

Ripple has tried to sell services to banks and financial institutions for years. These efforts have always run at a loss, and been heavily subsidised by Ripple Labs. [Tr0lly]

As of 2018, money transmission use of XRP ran at … $9,000 a day. Around this time the Financial Times asked 16 banks who’d touched Ripple’s other software if they’d used XRP; the number was, of course, zero.

The thing that Ripple makes its money from is periodically selling its massive stash of XRP, pumping it with claims of bank partnerships — all of which Ripple subsidises. [Tr0lly]

Ripple has tried to claim it has nothing to do with XRP, including making this claim to a UK Parliamentary inquiry — which is historically just nonsense. Preston Byrne has dismantled this claim previously. [Preston Byrne]

A private class action was brought against Ripple in 2018, alleging that XRP was an unregistered security. This suit has proceeded slowly.

The SEC complaint: XRP is offered as a security

The SEC maintains that XRP is a security, issued by Ripple, and actively promoted as an investment by Garlinghouse and Larsen. The offering should have been registered, with the full and detailed disclosures required for an offering of securities to the public — and it was not.

The complaint is 71 pages. Paragraph 8 is the XRP scam in a nutshell:

8. Defendants continue to hold substantial amounts of XRP and — with no registration statement in effect — can continue to monetize their XRP while using the information asymmetry they created in the market for their own gain, creating substantial risk to investors.

The SEC demands disgorgement of Ripple, Garlinghouse and Larsen’s ill-gotten gains ($1.3 billion), with interest, and that they pay appropriate civil penalties.

The SEC also wants them stopped from issuing any more digital securities — “including by delivering XRP to any persons or taking any other steps to effect any unregistered offer or sale of XRP.”

2. Ripple created an information vacuum such that Ripple and the two insiders with the most control over it — Larsen and Garlinghouse — could sell XRP into a market that possessed only the information Defendants chose to share about Ripple and XRP.

Ripple received legal advice in February and October 2012 that XRP could constitute an “investment contract,” thus making it a security under the Howey test — particularly if Ripple promoted XRP as an investment. The lawyers advised Ripple to contact the SEC for clarification before proceeding.

Ripple went ahead anyway, without SEC advice — and raised “at least $1.38 billion” selling XRP from 2013 to the present day, promoting it as an investment all the while:

63. For example, in a promotional document Ripple circulated to potential investors around May 2013, Ripple explained that its “business model is based on the success of its native currency,” that it would “keep between 25% to 30%” of XRP, and noted the “record highs” of prices other digital assets had achieved as something Ripple hoped to emulate for XRP.

Garlinghouse and Larsen have made at least $600 million from XRP sales to date.

The SEC has been discussing this issue with Ripple since at least 2019 — some Ripple staff have been claiming this action was sprung on them, but this is simply not the case.

The use case for XRP

Around 2015, Ripple finally hit on its scheme to sell XRP-based money transfer systems to financial institutions. But first they had to create a trading market for XRP.

Ripple did not disclose how much it was paying others to support a “use” for XRP — or to subsidise secondary markets for XRP, to make XRP look like a desirable crypto-asset.

Garlinghouse and Larsen were closely involved in managing the market for XRP. The document cites multiple public statements from both of them, and details of internal promotional decisions, with the aim of making XRP go up:

316. Garlinghouse himself was a particularly persistent spokesperson for Ripple’s efforts to market XRP as an investment from which investors could potentially profit. While he was selling millions of XRP, Garlinghouse frequently told investors that he was invested in XRP, and that he was bullish on the investment. Throughout the Offering and as XRP’s price fluctuated, he also encouraged investors to be patient and look at the price of XRP on a longer time horizon.

Ripple settled with FinCEN in 2015 for having failed to register as a Money Services Business. Ripple is now fully registered and compliant as a MSB. This has led Ripple to claim that XRP is a “currency,” and therefore not a “security.”

The SEC dismantles this theory — XRP is not legally a currency, FinCEN doesn’t consider that being a virtual currency excludes you from securities laws, and XRP has never been marketed as a substitute for currency, nor as a payment system:

358. Instead, Ripple and its executives repeatedly publicly disclaimed that XRP was “currency” and tried to dissuade investors from thinking about XRP as “currency.”

Ripple didn’t even come up with a product using XRP until 2018 — ODL and xRapid — and it has negligible use.

The closest to a real-world user of XRP on ODL was “at least one money transmitter” — that’d be MoneyGram — who “found it to be much more expensive and therefore not a product it wished to use without significant compensation from Ripple.” MoneyGram have received 200 million XRP from Ripple to date, for the service of pretending that XRP is useful for remittances.

Ripple didn’t disclose this massive subsidy — it only came out in MoneyGram’s quarterly SEC filings.

What happens now?

Ripple’s eight-page response to their Wells notice was basically insubstantial. But this action has been coming since 2019. So I expect the next stage will be a lengthy and detailed response, but on the themes in their Wells response.

Ripple may also attempt a settlement — for less money than disgorging $1.3 billion they don’t have.

Exchanges are likely to delist XRP — you are not allowed to sell securities in or to the US unless you’re a registered broker-dealer, and ICO marketers have been busted on this precise point before. Beaxy is the first delisting to be announced. [Medium]



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