Recently, Bloomberg Crypto put up a tweet that showed the details of a lawsuit pending against Ripple at this very moment for the ‘unregistered sale of securities’. Here is the link below:
The tweet reads, “Ripple has been hit by a lawsuit alleging that it led a scheme to raise hundreds of millions of dollars through unregistered sales of its XRP tokens.”
Let’s take a look at the article, shall we?
It does appear that there is now a court filing, per the preview that was presented in the tweet by Bloomberg Crypto.
According to the article, “Coffey purchased 650 XRP tokens for about $2.60 each, or $1,690, at the start of January and sold them a few weeks later at a loss of approximately $551, or about 32 percent of his initial investment, according to the filing.”
What’s stunning about that fact is that this investor invested a relatively small amount of money (in relation to the total amount of money invested in Ripple). So, his victory in such a suit could open the door for thousands, if not tens of thousands of investors to join in on the class action lawsuit.
So, What is a Security?
In order to even attempt to assess the merit of this lawsuit or any claim that Ripple is a security, we need to clearly define what a security is.
Remember, this is in the United States. So, we need to go by the definition that is used in the United States itself.
Time For A History Lesson
So, you may be reading this thinking, what do this mean?
Essentially, the excerpt that I gave to you above refers to any and all of the instruments that could be issued in the form of a security.
This might prompt a response of, ‘Okay, well, they didn’t list anything about tokens though!’
In this assertion, you would be correct. However, the courts were astute enough to consider the possibility that there would be new creations or financial instruments created in the future that they did not have knowledge of at that time.
So, the Supreme Court has ruled that:
Thus, any and every object/instrument/concept that refers to the issuance of a security falls under this category. So, if a token is being used in a manner that the courts/SEC conventionally define as a security, then they will be defined as such. The argument of, ‘This is a crypto!’ or ‘This is a token’ will not suffice.
I’m sure many people reading this or that have background knowledge in this area (securities) will be more than familiar with the ‘Howey Test’.
For those that aren’t, allow me to explain.
In the United States, we have a list of amendments (first amendment, second amendment, etc.) as well as other laws that are somewhat ambiguous in nature.
For example, the 1st Amendment = Free Speech.
However, there are limits on what is considered lawful free speech. Calling up a local school and issuing a bomb threat, would NOT be considered protected free speech. You would be jailed (more than likely placed in prison) after the FBI kicks your door in.
Yet, if you logged online and said ‘Johnny is a fucking dumbass!’ — While the speech is insulting and Johnny would more than likely not continue to be friends with you, this would not be considered ‘illegal’.
How Do We Know?
Because of Supreme Court cases. Basically, the situations that I mentioned above were in contention at one point in time. When these cases eventually got up to the Supreme Court, the judges made a ruling that established how one should define whether one has breached the law or not.
This is called ‘precedent’.
This is how we get a set of rules or ‘limits’ on certain amendments. This happens often in American society because, the way our laws/amendments are written, they don’t really cover all possible cases and if we don’t clearly define some limits on it, then we’d run the risk of allowing too much or restricting too much.
Okay, end of that history lesson.
So, Let’s Move Forward — What is the Howey Test?
“The ‘Howey Test’ is a test created by the Supreme Court for determining whether certain transactions qualify as ‘investment contracts’. If so, then under the Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered securities and therefore subject to certain disclosure and registration requirements.”
So, this is the test below. In order to be deemed a security:
- There must be an investment of money.
- There must be an expectation of profits from the investment.
- The investment of money in a common enterprise.
- Any profit comes from the efforts of a promoter or third party (i.e., there are other forces at work that are responsible for the monetary gain.)
Once again, it is important to note that the form of the investment being given is neither here nor there. So, the fact that it’s a token, piece of paper, friendship token, whatever — makes no difference whatsoever.
Based On This Definition, Ripple is a Security
I’m going to go down each one of the requirements outlined in the Howey Test and provide evidence for why Ripple is a security.
Before I do so, it’s important to note that being a security is not a bad thing. However, issuing a security without registering with the SEC is a bad thing.
It’s important to note though, with the Howey Test, ALL of the conditions must be met. So, that means the 1st, 2nd, 3rd, and 4th elements must all be satiated.
So, let’s start:
#1 — There Must Be an Investment of Money
This one is pretty intuitive. No one can deny that an investment of fiat is necessary in order to acquire the Ripple token.
I’m sure some people will argue that they’ve been given XRP (which I don’t doubt) or that they’ve acquired it through some other means. However, the main way of purchasing XRP is through fiat.
This, however, is what counts. Ripple has directed people to exchanges where fiat or a fiat-equivalent or some other cryptocurrency that must be obtained via fiat has to be used in order to acquire Ripple.
So, #1 can be safely checked off here.
#2 — There Must Be An Expectation of Profits
Okay, let’s review this one a bit closer because this will more than likely be one of the items that receives the most push back from both the community and Ripple itself.
The most common argument that will be made here is that the purpose of the Ripple token is to settle international payments in a more efficient manner via the xRapid network.
That’s something that I’m not going to argue against.
However, there is a very instance in where the United States ruled that a company was issuing a security, despite the fact that the company made the argument that their security served a purpose outside of pure investment.
The parallel case involving the SEC is the Munchee ICO
You can read the actual opinion by the SEC here: https://www.sec.gov/litigation/admin/2017/33-10445.pdf
Here are the pure facts regarding the issue, as contained within the case itself in the link that I posted directly above:
I Know This Was A Lot To Read, But Here Is Some Critical Information From The Review
So, as you can see — Ripple doesn’t need to come out and explicitly state, “Hey guys! If you buy our token, you’ll make a load of money!”
So, what evidence do we have that Ripple investors are expecting to obtain profits?
You Get the Picture By Now.
There’s overwhelming evidence that investors have an expectation of profit from their investment in Ripple. There are thousands, if not tens of thousands of tweets and posts around the internet concerning the price of Ripple and whether or not it’s a good ‘investment’ or not. This doesn’t include the YouTube videos or the televised appearances on investment-based TV shows, conferences or other platforms that are geared toward helping investors make smarter investments.
So, #2 can safely be checked off right now.
#3 — The Investment of Money in a Common Enterprise
This common enterprise here is Ripple Labs. Undeniably. Brad Garlinghouse, the CEO of Ripple, has made it clear that his company, Ripple Labs, is responsible for the curation of the Ripple token.
This statement, which I extracted directly from the Ripple website, makes #3 a slam dunk.
Note that the above messages states that, “Ripple XRP holdings incentivize the company to make Ripple as useful as possible.”
It does not say, XRP holdings incentivize the company to make XRP as useful as possible.
To add to this, Ripple has already liquidated several million of these tokens for the sake of advancing the company itself. So, this includes aspects of Ripple that are entirely unrelated to XRP, like the xCurrent system that they have in place.
Please note that the news of xCurrent partnerships with other banks, which are usually titled as, “Ripple just forged a new relationship with a bank!” or something similar, has led to price increases in the past as well, despite the fact that there is a clear difference between Ripple as a company forging partnerships and them doing so with XRP. However, the obfuscation of this fact has been facilitated greatly by the fact that the token $XRP is referred to as Ripple, which is the same name of the company.
There’s no doubt that the company as well as other interested parties have taken full advantage of this fact.
#4 — Any profit comes from the efforts of a promoter or third party (i.e., there are other forces at work that are responsible for the monetary gain.)
This one is a slam dunk almost.
As noted above, Ripple’s partnerships with other companies have led to an increased in price multiple times.
Rumors of it being added to Coinbase have done so as well.
Perhaps the most incriminating example of this is the alleged bribery attempts by Brad Garlinghouse to have the $XRP token added to Coinbase/Gemini.
Why else would they attempt to do so if not to boost the price or at least make investment easier for lay customers?
The Ripple company has made it clear that they deal with institutional investors directly OTC. So, they could not have been doing this to allow greater access by the alleged banks that they believe will be using the token for international transfer settlements.
Also, it is a known fact that the onus of the Ripple token’s price increase is contingent upon the idea that the company (a third party) must ink agreements with either exchanges, banks, or other entities that would lead to a demonstrable increase in price.
There’s a pretty strong argument in place that the Ripple token is essentially a security.
No, it does not matter whether there was an ICO or not or if the ICO is over. ICOs are not the only phase of a cryptocurrency’s life cycle that it’s eligible for this designation either.
It would be hard to imagine that any federal/district judge would rule otherwise as well.
I’m not a legal expert, nor have I ever litigated on such cases or practiced law directly. But, from what is available on all relevant sources and content, it seems that Ripple is in a bit of trouble at this point.