As the cryptocurrency trial of the century draws to a close in a Manhattan federal court, there are growing signs that the US Securities and Exchange Commission (SEC) is facing a tough defeat against San Francisco-based blockchain business chain innovator Ripple Labs . The verdict could drastically limit the SEC’s power to regulate cryptocurrencies in the United States. If it ends like this, it would be a self-inflicted disaster from the start.
The SEC filed the bombshell lawsuit against Ripple and its two senior executives in December 2020, on the last day of former chairman Jay Clayton’s term. The Republican voted with the two Democratic commissioners to claim that the XRP cryptocurrency is an unregistered security because its only use since 2013 has been as an investment contract in a company that uses it for its payments software.
The scope of the complaints was sweeping as the legal theory of the suit was overcome. Nearly two years later, the SEC faces a painful reckoning because Ripple decided to fight back, as do tens of thousands of retail users of XRP who have nothing to do with Ripple other than being co-victims of the government’s behavior.
The SEC realized early in the trial that they were lost in a maze of their own making. The star defense team for Ripple went for the jugular, saying the SEC’s strange case that XRP was an unregistered investment contract in Ripple since 2013 and that even sales of billions of XRP tokens on the secondary market over seven years were also headlines. Ripple didn’t have to look far to document how the SEC had repeatedly puzzled market participants for years about whether XRP was a security. However, he now claimed that Ripple and everyone else in the market should have known about it anyway.
Ripple was also the focus of a market-moving speech in 2018 by Clayton’s Director of Corporation Finance, William Hinman, who presented a vision of how XRP’s main market competitor in the cryptocurrency markets – Ethereum’s native cryptocurrency ether – it was not security because his book had “decentralized” over time. The SEC’s internal emails and drafts behind that speech became central to Ripple’s rebuttal, and the SEC spent 18 months fighting six separate bench orders to overturn them, making it increasingly clear that their real behind-the-scenes confusion around tokens would be humiliating if it ever went public.
Ripple finally got the Hinman speech documents last month, CEO (and co-defendant) Brad Garlinghouse reported that the SEC “wants you to believe that it cares about disclosure, transparency and clarity. Don’t believe them. When the truth finally comes out, the shame of their behavior here will shock you.”
Now that the parties have reached the end of a grueling discovery phase with summary judgment battles, Ripple has fired off a strong set of arguments while the SEC’s proposal was merely a red-hot version of its original complaint. Some legal observers noted that the agency failed to prove its case. The expert told her that XRP’s market value is not tied to Ripple’s performance and that after two years he had found no way to prove how tens of thousands of retail XRP users and traders knew the token was an investment in a company that most of them they had never heard.
This is where the case went south for the government. Retail XRP holders entered the case by the tens of thousands. Led by Rhode Island attorney John Deaton, they first tried to intervene against the SEC by asking the judge to make them defendants along with Ripple. The SEC responded with a ferocious attempt to personally malign Deaton and portray his clients as unworthy duds.
Rather than thumbing her nose at XRP holders without comment, Judge Analisa Torres declined their motion to intervene saying she had spent time searching the legal precedent to see if it was still possible for a party to become a defendant in a case, and came out empty. But it offered them a chance to file an amicus brief, sending a blunt message to the SEC that real investors were going to have its ear when the presumption of their motives was being considered. In retrospect, with everything that has happened since then, anyone with political instincts close to Gensler should have convinced him to fold from then on.
Deaton’s alleged class of XRP holders has grown to more than 75,000, including more than 3,000 who gave affidavits to Ripple’s defense team stating that they had never heard of the company they allegedly invested in before the SEC filed the suit . Those affidavits were entered into evidence in Ripple’s motion for summary judgment, which was a brutal takedown of a federal agency at odds with its own mission to protect private investors by invoking authority granted in 1946 Howie Supreme Court decision to hold that anonymous lines of computer code are investment contracts in a company.
Behind Deaton were other XRP users with no connection to Ripple who have filed amicus briefs, as well as the two most prominent crypto industry associations, the Digital Chamber of Commerce and the Blockchain Association. The SEC had no allies, not even its own experts who ended up giving the defense ammunition. Attorney Jeremy Hogan, who followed the case on his popular YouTube channel, says the SEC can prevail with its summary judgment only if Judge Torres “forgets her first year of law school.”
Prominent legal experts such as Curt Levey of the Federalist Society and Professor JW Verret of George Mason University’s Scalia School of Law agree that Ripple is well on its way to winning this case. Worse for the SEC, Verret predicts that if the SEC goes to the Supreme Court, it is likely not only to lose but to set a sweeping precedent that would limit or eliminate enforcement entirely Howie in cryptocurrencies, which defy 1946 definitions.
So why is Gensler still letting his enforcement department drive this bus off a cliff? They are judges, but Gensler is ultimately a political figure. Politicians, Deaton said recently in an interview, want to somehow turn a defeat into a victory and move on. Ripple’s general counsel, Stuart Alderoty, has made it clear that they will settle “within minutes” and pay a fine if the SEC makes it clear that today’s XRP is not a security. Having spent his political capital, Gensler will have to take the deal.