Introduction to Ripple
Ripple is a U.S.-based blockchain technology and digital asset company. Ripple developed the RippleNet payment network and issued the XRP cryptocurrency.
RippleNet is an open, decentralized payment network that enables banks and financial institutions to conduct low-cost, efficient cross-border payments. The XRP token is the digital asset used for payments on RippleNet.
SEC's lawsuit against Ripple
In December 2020, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against Ripple and its co-founders Brad Garlinghouse and Chris Larsen, accusing them of failing to register XRP as a security before offering token sales or other consideration valued at $1.38 billion. The failure to register XRP as a security violated laws prohibiting the sale of unregistered securities.
because it represents an investment contract, granting investors ownership or profit-sharing rights in Ripple. The founders of Ripple held large amounts of XRP prior to its public offering, which the SEC believes violates the obligations of securities issuers. . Ripple emphasizes that XRP is a digital asset with specific uses, intended for payments on RippleNet, which helps enhance the liquidity of cross-border payments. It does not offer ownership or rights to profits in Ripple company.
Howey Test
Before continuing with the timeline analysis, let's first look at the Howey Test. The Howey Test is a standard used under U.S. securities law to determine whether a particular transaction constitutes an investment contract, and thus must comply with securities regulations. This test originates from a 1946 Supreme Court case, SEC v. W.J. Howey Co.
The Howey Test includes the following four elements:
Investment of money: This means that the transaction involves the commitment of funds. It does not have to be cash; it can also be goods, services, or at the cost of certain rights. In a common enterprise: The investor invests in an enterprise that involves multiple participants. Expectation of profit: The purpose of the investor is to hope to make a profit from the transaction. Profit derived from the efforts of others: The expected profits of investors mainly come from the efforts of others outside the investor. This means that investors rely on others rather than their own efforts to obtain profits.
If a transaction meets all four of these conditions, then in the United States, it will be considered an investment contract and subject to U.S. securities laws. This is what's known as the Howey Test.
Timeline
Since 2021, the SEC and Ripple have engaged in multiple rounds of litigation over this case. The focus of the dispute has primarily centered on the legal status of XRP and whether Ripple violated securities laws by selling XRP as a security.
U.S. District Judge Analisa Torres of the Southern District of New York supported the SEC's position, ruling that Ripple must provide internal communications and reports from 2012 to 2020 related to XRP sales strategies and marketing to the SEC. The court deemed these documents relevant to the facts of the case and found no reasonable justification for Ripple to withhold them.
The judge rejected the SEC's motion and did not rule XRP as a security because the SEC failed to provide sufficient evidence to support its allegations. In June 2022, the court also dismissed Ripple's request to completely dismiss the litigation. At this point, the litigation between the SEC and Ripple was still ongoing.
The SEC filed a motion requesting the judge to postpone the trial so that it could have more time for trial preparation. Ripple opposed the motion and stated that it was ready for the trial.
The judge granted the SEC's motion to delay the trial, which is now set to begin in February 2023.
Ripple Labs secured a partial victory in the SEC's lawsuit against it. U.S. District Judge Analisa Torres ruled that Ripple Labs did not violate federal securities laws by selling its XRP tokens through public exchanges. However, she also sided with the SEC on part of its case, agreeing that Ripple violated federal securities laws by directly selling XRP to informed investors.
Interpretation of the ruling
The court determined that XRP, as a digital token, does not meet the criteria of the Howey test and therefore cannot be considered a security. The securities nature of XRP has no direct connection with whether its transactions constitute an investment contract. After all, some commodity transactions may also be regarded as investment contracts, which entirely depends on the specific sales situation. The validity of such transactions constituting an investment contract should be reviewed separately for each type of transaction. In the SEC's statement, various forms of Ripple's transactions constituted unregistered issuance and sale of XRP, one of which—the institutional sales by Ripple—met all four criteria of the Howey test. Investors who purchased XRP tokens sold through Ripple's programmatic issuance made blind trades, as they had no way of knowing whether Ripple had received their funds. The court ruled that such transactions did not constitute an investment contract. The allocation of XRP tokens used to pay employee compensation and compensate third-party developers for developing XRP and its ledger was not considered an investment contract, because in this case, there were no investors injecting funds into Ripple. XRP sales in the secondary market were not included in the scope of review in this case, so it is currently uncertain whether such issuance or sales constitute an investment contract.
Impact of the Event
Although this decision does not fully support Ripple, as the judge also ruled that Ripple's direct sales of XRP to sophisticated investors violated federal securities laws, it still represents a significant victory for Ripple. Even though there may be appeals, this could provide strong arguments for other cryptocurrency companies that are disputing with the SEC over whether their products fall within regulatory boundaries. The ruling had a major impact on the price of XRP, which surged by up to 80% after the decision. Additionally, this ruling positively affected other cryptocurrency exchanges in legal disputes with the SEC, such as Coinbase, whose shares rose nearly 25% on the day.
Ripple Labs CEO Brad Garlinghouse stated that he believes the legal battle with the SEC is nearing an end. Overall, despite achieving a major victory in this legal struggle, due to potential appeals and the unclear definition of "securities" under securities law, the regulatory battles for the crypto industry are far from over.