SEC And U.S. Government Sue Ripple XRP Over Fake Claims Of Customer Interest

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Written by Dana Sanchez
Ripple XRP
SEC And U.S. Government Sue Ripple XRP Over Fake Claims Of Customer Interest. Image: Flickr / Jernej Furman / Creative Commons

The U.S. Securities and Exchange Commission is suing Ripple Labs, its co-founder Christian Larsen and CEO Brad Garlinghouse for allegedly holding an unregistered securities sale that raised more than $1.3 billion.

Ripple created XRP, a digital asset, currency exchange, remittance network and settlement system, in an effort to transform global payments. XRP is built on the XRP Ledger — an open-source, permissionless and decentralized blockchain technology that can settle transactions in three-to-five seconds.

XRP is the third-largest cryptocurrency by market capitalization with a market cap of $21.6 billion, followed by Bitcoin, No. 1 ($435 billion) and Ethereum, No. 2 ($71 billion). It’s one of the most important companies in the cryptocurrency industry.

On Monday, Garlinghouse preempted the SEC’s lawsuit announcement, saying that it was imminent. During an interview with Fortune, Garlinghouse blasted the SEC’s decision to sue right before the holidays and said Ripple will fight the case. “It’s not just Grinch-worthy, it’s shocking,” Garlinghouse said. “It’s an attack on the entire crypto industry and American innovation.”

The lawsuit, filed Tuesday in a Manhattan court, alleges that Larsen and Garlinghouse raised funds, beginning in 2013, through the sale of XRP in an unregistered securities offering to investors in the U.S. and worldwide, according to an SEC press release.

Ripple also allegedly distributed billions of XRP in exchange for non-cash services such as labor and marketing. According to the complaint, in addition to structuring and promoting the XRP sales used to finance the company’s business, Larsen and Garlinghouse also personally made unregistered sales of XRP totaling $600 million. The complaint alleges that they failed to register their offers and sales of XRP or satisfy any exemption from registration, in violation of the registration provisions of federal securities laws.

York Times tech reporter Nathaniel Popper tweeted, “Perhaps the single most damning details from the Ripple complaint” is that “The main financial company using XRP, a money transmitter, told Ripple it was much more expensive than alternatives and only agreed to use it because Ripple was paying it to do so.”

Ripple has insisted for years that XRP is not a security, according to Fortune. The company says it does not have the discretion to tap its reserve funds as it wishes, and that XRP has become increasingly decentralized as banks and other merchants use it as a bridge currency in cross-border transactions. The SEC classifying XRP as a security controlled by Ripple would be like saying oil is a security controlled by Exxon, Garlinghouse said.

If the creators of a cryptocurrency advertise it as an investment to U.S. buyers, then the SEC considers the coin to be a security under U.S. law, Decrypt reported.

The SEC has ruled in recent years that Bitcoin and Ethereum, the two most valuable cryptocurrencies, are not securities, partly because they are decentralized with no person or company in control of them, Fortune reported.

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XRP is different. While Bitcoin and Ethereum are minted in an ongoing process called mining, 100 billion units of XRP were created simultaneously in 2012 for Ripple Labs. Ripple continues to own most of XRP with the bulk of its treasury held in reserve, to be sold in scheduled allotments.

Garlinghouse and Larsen each own a significant amount of XRP, leading some observers to view XRP as more like company stock than a currency, according to Fortune.

In its Framework for ‘Investment Contract’ Analysis of Digital Assets, the SEC urges companies that offer, sell, or distribute digital assets to “consider whether the U.S. federal securities laws apply.  A threshold issue is whether the digital asset is a ‘security’ under those laws,” the SEC states. “The term ‘security’ includes an ‘investment contract’ as well as other instruments such as stocks, bonds, and transferable shares.  A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of ‘security’ under the federal securities laws.”

The SEC has sued other cryptocurrency companies for holding unregistered securities sales, including Block.One, which raised $4 billion to create the EOS blockchain, and chat app Telegram, which had to return $1.7 billion to investors that it raised in an ICO. It has since abandoned its blockchain project, the Telegram Open Network. These companies, like many others, settled with the SEC, Decrypt reported.

“We remain confident after reviewing the SEC’s complaint today that we are on the right side of the law and of history,” Garlinghouse wrote Tuesday in a Ripple blog. “We’ve always said that there is a lack of regulatory clarity for crypto in the US, and the SEC here in the United States has sat back and watched for years. In fact, the discussion around why XRP is a currency (and not a security) is one we have been having with the SEC for nearly three years and yet we’ve never been met with clarity.”

Garlinghouse spelled out in the blog why he thinks XRP is not a security:

  1. “XRP is not an ‘investment contract.’ XRP holders do not share in the profits of Ripple or receive dividends, nor do they have voting rights or other corporate rights. Purchasers receive nothing from their purchase of XRP except the asset. In fact the vast majority of XRP holders have no connection or relationship with Ripple whatsoever.  
  2. “Ripple (our company) has shareholders; if you want to invest in Ripple, you do not buy XRP but rather shares in Ripple.
  3. “Unlike securities, the market value of XRP has not been correlated with Ripple’s activities. Instead, the price of XRP is correlated to the movement of other virtual currencies.”