In December 2020, the SEC sued Ripple Labs, claiming the company illegally sold XRP as unlicensed securities. This lawsuit has become a pivotal moment for the crypto industry, with billions at stake and significant implications for digital asset regulation. This guide will keep you updated on the key developments and the broader impact of the Ripple vs. SEC battle.
KEY TAKEAWAYS
• The Ripple vs. SEC lawsuit has clarified how digital assets like XRP are treated under U.S. securities law, particularly distinguishing between institutional and retail sales.
• The case will continue to influence how the SEC and other regulators approach cryptocurrency projects.
• While Ripple’s partial victory boosted XRP’s price, the ongoing legal uncertainty continues to affect investor confidence and could shape the future of the broader crypto market.
Ripple vs. SEC: A recap of the lawsuit
Ripple had a hard time utilizing its blockchain and crypto for real-world use. XRP is the cryptocurrency issued by Ripple. Anyone can check the blockchain to see who owns what, but no coin needs to be mined. This made it a target for speculators who started to bid up its value.
Since 2015, Ripple has tried to convince banks to use XRP as a means to transfer funds overseas. In 2016, Ripple hired former Yahoo COO Brad Garlinghouse to help them find a killer use case for XRP. And he did.
Garlinghouse started pitching XRP as a bridge currency for global money transfers to financial institutions and banks. When used for international transfers, banks wouldn’t need to hold reserves of minor currencies that would block the bank’s funds.
Furthermore, the banks would need to hold that particular currency only momentarily, simultaneously increasing XRP’s liquidity and price.
Ripple had partnerships with MoneyGram and Santander, and it was soon one of the big players among the financial institutions. This also raised the price of XRP from less than $0.01 to over $3 in January 2018.
But this is where the SEC (the U.S. Securities and Exchange Commission) comes in. The governmental agency said that Ripple released $1.3 billion worth of unlicensed securities to the public. Moreover, it names Larsen and Garlinghouse as defendants, the top names of the Ripple team.
Stephanie Avakian, Director of the SEC’s Enforcement Division, stated that,
“We allege that Ripple, Larsen, and Garlinghouse failed to register their ongoing offer and sale of billions of XRP to retail investors, which deprived potential purchasers of adequate disclosures about XRP and Ripple’s business and other important long-standing protections that are fundamental to our robust public market system.”
The Ripple vs. SEC lawsuit caused XRP’s price to drop dramatically from 58 cents to 21 cents in December 2020. However, it did rebound later in 2021.
In 2024, Ripple vs. SEC case reached a pivotal conclusion when the Southern District of New York ruled that while Ripple’s institutional sales of XRP were unregistered securities, its sales on digital asset exchanges were not classified as securities transactions. Ripple was fined $125 million, significantly less than the SEC’s initial demand. The ruling is expected to be appealed, possibly escalating to the U.S. Court of Appeals for the Second Circuit.
What is a financial security?
A “security” does not have a utility and is a tradable financial asset representing some form of ownership in a corporation or similar entity. For instance, publicly traded companies often represent shares as “securities “ to raise capital.
There are three types of securities: equity, debt, and hybrid. Together with public sales, securities are regulated by the SEC.
Companies, partnerships, or trusts that issue equity securities give their owners an ownership interest in the entity’s assets.
A debt security is a financial instrument representing money borrowed. The terms specify the loan amount, annual percentage rate, maturity period (when it must be repaid), and other conditions.
What makes a “security” for the SEC?
What is a “security” for the SEC is somehow unclear, given the fact that in 2019, the agency publicly stated that Bitcoin is not a security, arguing that the SEC,
In determining whether a token is legally a security, the SEC uses the Howey Test.
What is the Howey test?
The U.S. SEC vs W.J. Howey was a Supreme Court case in 1946 that has a pivotal role in securities-related cases. It helps determine if a transaction is an investment contract, as stated in the Securities Act of 1933.
What was the Howey case about?
In 1946, two individuals from Florida were sold parts of their citrus grove land. They offered the option to lease the land back to the sellers. They would serve the land, harvest and market the products, and share part of the profit with the landowners.
However, the U.S. Securities and Exchange Commission (SEC) sued them for not filing a securities registration statement.
The Supreme Court ruled that the contract was an investment contract, and it set the following guidelines to be used for future cases:
- There is an investment of money
- The investment needs to be in a company or project (A common enterprise where the investors pool in their money and assets to invest in a project.)
- Profit is expected
The profits come from the promoter’s or third party’s efforts. Although the Howey test uses the term “money,” it is also used for other kinds of investments and assets.
A key point in declaring an investment contract a “security” is the control of the investor over the profit. If the investors have no control over that asset, it is usually a security. For a crypto to be classified as a security, it needs to meet all the criteria mentioned in the Howey test.
How does the Howey Test apply to Ripple?
The Howey Test admittedly has vague guidelines. The SEC concluded that XRP complies with the requirements of the Howey test:
- Ripple Labs, the company, sold $1.38 billion worth of XRP tokens.
- Investors bought XRP because they believed they were investing in a common enterprise.
- Ripple’s marketing promotion and supply manipulation made investors believe that the company’s efforts would raise XRP’s price.
The recent court ruling clarified that while Ripple’s institutional sales of XRP were deemed unregistered securities under the Howey Test, the sales on digital asset exchanges were not considered securities transactions. This distinction is crucial as it limits the scope of the SEC’s application of the Howey Test to XRP sales.
Ripple vs. SEC lawsuit: A detailed timeline of events
Ripple gained attention after their access to the U.S. banking system through partnerships with financial institutions in 2014.
December 21, 2020
The SEC initiated the lawsuit against Ripple Labs, CEO Brad Garlinghouse, and co-founder Chris Larsen.
Allegedly, Ripple Labs is selling unregistered securities instead of a commodity in a centralized environment. The SEC is accusing the two Ripple Labs executives of selling over 14.6 billion XRP tokens to fund the company and get rich.
Ripple Labs CEO Brad Garlinghouse announced that the company would defend itself in court.
December 28, 2020
Coinbase, the largest cryptocurrency exchange, announced the delisting of the XRP token. Full suspension was planned for Jan. 19, 2021, at 10 a.m. Pacific Standard Time.
March 3, 2021
Ripple Labs execs Garlinghouse and Larsen sent letters to the U.S. District Court Southern District of New York Magistrate in pursuit of getting Judge Sarah Netburn to dismiss the lawsuit Ripple vs SEC. They argue the lack of “fair notice and due process.”
March 8, 2021
The SEC responds by sending a letter to the judge requesting that the “fair notice” defense be struck and that a hearing be immediately requested.
March 22, 2021
Judge Netburn told the SEC that her understanding of XRP is that “… not only does it have a currency value but it has a utility, and that utility distinguishes it from Bitcoin and Ether.”
April 13, 2021
SEC Commissioner Hester M. Peirce published the Token Safe Harbor Proposal 2.0. The updated proposal seeks to provide a three-year grace period for developers to find a way to simplify participation in a decentralized network, in which they would be exempted from the securities law.
June 14, 2021
The court granted the SEC’s motion to delay the disclosure of SEC’s internal communications about Bitcoin, Ethereum, and XRP until August 31.
Internal documents on other cryptos may shed some light on the general view of the SEC on crypto. The court has yet to rule on whether they want the SEC to disclose their internal trading policies around crypto.
August 31, 2021
The deadline for disclosing the SEC’s internal documents. The fact discovery must take place by this date.
October 15, 2021
The expert discovery deadline is for the collection of what experts in the crypto space and securities have to say on the matter.
July 13, 2023
The United States District Court for the Southern District of New York (S.D.N.Y.) issued its long-awaited opinion ruling on summary judgment motions in SEC v. Ripple Labs et al. on July 13, 2023. Judge Analisa Torres ruled in partial favor of both the SEC and Ripple Labs, granting certain aspects of each party’s motions.
According to Judge Torres,
XRP, as a digital token, is not in and of itself a ‘contract, transaction, or scheme that embodies the Howey requirements of an investment contract.
Rejecting the notion that all tokens are securities, the court specified that the circumstances of each transaction type must be considered. For Ripple Labs, this amounted to four transaction types, of which three Judge Torres determined did not constitute securities transactions.
The transaction types classified as securities are Ripple’s sales of XRP to institutional investors through written contracts.
The transaction types that do not constitute the unlawful offer and sales of securities are Ripple’s sales of XRP to programmatic buyers (i.e., to the general public through digital asset exchanges or trading algorithms), distribution of XRP as compensation (e.g., to employees), and sales by the defendants (Larsen and Garlinghouse) of XRP to programmatic buyers.
Additionally, the court rejected the widely lauded “Fair Notice” defense. It ruled that the SEC provided sufficient clarity to Ripple and other parties regarding the legal requirements and standards related to the institutional sales of XRP.
Lastly, Judge Torres explicitly chose not to extend her opinion to cover secondary market sales of XRP or other tokens, stating that:
Whether a secondary market sale constitutes an offer or sale of an investment contract would depend on the totality of circumstances and the economic reality of that specific contract, transaction, or scheme.
August 7, 2024
The Southern District of New York issued its final ruling, confirming that Ripple’s institutional sales were unregistered securities but that digital exchange sales did not constitute securities transactions. Ripple was fined $125 million, and the ruling is expected to be appealed.
What does the lawsuit mean for the crypto community?
The entire cryptocurrency industry has watched the Ripple vs. SEC lawsuit play out. The lawsuit’s findings should help clarify the regulatory arena for future ICOs.
While the ruling provides some clarity, it also raises new questions, particularly regarding secondary market sales and the broader application of the Howey test to digital assets. The case’s outcome leaves some ambiguity about how other cryptocurrencies might be classified, leading to potential legal uncertainty for projects operating in the U.S. market.
Ripple vs. SEC: Where does the crypto community stand?
The Ripple vs. SEC lawsuit has been a pivotal moment for the entire crypto community, not just Ripple supporters. The case has highlighted the broader potential of blockchain technology to disrupt traditional financial systems. Throughout the case, the crypto community largely remained optimistic, with many believing the odds favored Ripple Labs. When the court announced Ripple’s partial victory, XRP’s price surged by 75%, although it corrected later as investors booked profits. The outcome of this case continues to send a strong message to the entire crypto industry, influencing perceptions and future regulatory actions.
Frequently asked questions
What is the Ripple vs. SEC lawsuit?
Why is the lawsuit against Ripple important?
What is a security?
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