As the cryptocurrency lawsuit of the century draws to a close in Manhattan federal court, there are growing signs that the United States Securities and Exchange Commission (SEC) is facing a murderous defeat against San Francisco-based enterprise blockchain innovator, Ripple Labs. The verdict could significantly limit the power of the SEC to regulate crypto in the United States. If this is how it ends, it will have been a self-inflicted disaster from the start.
The SEC filed its bombshell lawsuit against Ripple and its two senior executives in December 2020, former Chairman Jay Clayton’s last day in office. The Republican voted with the two Democratic commissioners to allege that the cryptocurrency XRP is an unregistered security because its only use since 2013 is as an investment contract in a company that uses it for its payment software.
The scale of the allegations was considerable while the legal theory of the lawsuit went too far. Nearly two years later, the SEC faces a painful toll because Ripple decided to retaliate, as do tens of thousands of retail XRP users who have no connection to Ripple other than being co -victims of government behavior.
The SEC realized early in the litigation that it had gotten lost in a maze of its own making. Ripple’s Stellar Defense Team went for the jugular, calling the SEC’s bizarre premise that XRP was an unregistered investment contract in Ripple since 2013 and that even sales of billions of XRP tokens in the secondary market for seven years were also titles. Ripple didn’t have to look too far to document how the SEC repeatedly dithered in front of market participants for years over whether XRP was a security. Yet he has now alleged that Ripple and everyone else in the market should have known about it anyway.
Ripple also focused on an emotional market keynote in 2018 by Clayton’s Chief Financial Officer, William Hinman, who presented a view of how XRP’s main rival in the crypto markets – ether native cryptocurrency of Ethereum – was not a security because its ledger had “decentralized” over time. The internal SEC emails and drafts behind this speech have become central to Ripple’s rebuttal, and the SEC has spent 18 months fighting six separate bench orders to deliver them, which increasingly shows that their real confusion behind the scenes around the tokens would be humiliating if it ever went public.
Ripple finally got the documents from Hinman’s speech Last month, CEO (and co-defendant) Brad Garlinghouse tweeted that the SEC “wants you to think they care 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 an exhaustive discovery phase with dueling motions for summary judgment, Ripple has launched a robust set of arguments while the SEC motion was just a rehash of his original complaint. Some legal observers noted that the agency failed to prove its case. His own expert said that the market value of XRP was unrelated to the performance of Ripple, and he found no way after two years to demonstrate how tens of thousands of retail users and traders of XRP knew that the token was an investment in a company that most of them had never heard of.
This is where things really went south for the government. Retail XRP holders have jumped into the business by the tens of thousands. Led by Rhode Island attorney John Deaton, they first tried to intervene against the SEC asking the judge to name them as defendants with Ripple. The SEC responded with a ferocious attempt to slander Deaton personally and paint his clients as unworthy eccentrics.
Instead of turning her nose up at XRP holders without comment, Judge Analisa Torres denied their request to intervene saying she had spent time digging into legal precedent to see if it was even possible for a party to be a defendant in a case. , and came up empty. But she offered them the chance to file amicus briefs instead, sending a stark signal to the SEC that real investors were going to have her ear when her presumptions about their motives were considered. In retrospect, with everything that’s happened since, anyone with political instincts close to Gensler should have convinced him to fold on the spot.
Deaton’s putative class of XRP holders grew to over 75,000, of which over 3,000 provided affidavits to Ripple’s defense team stating they had never heard of the company in which they would have invested before the SEC filed the lawsuit. These affidavits were entered into evidence with Ripple’s motion for summary judgment, which was a brutal dismantling of a federal agency at odds with its own mission to protect retail investors, appealing to authority granted in 1946. Howey Supreme Court decision to argue that anonymous lines of computer code are contracts of investment in a business.
Behind Deaton were other XRP users unrelated to Ripple who filed amicus briefs, as well as the two most prominent associations in the crypto industry, the Chamber of Digital Commerce and the Blockchain Association. The SEC had no allies, not even its own expert witnesses who ended up giving the defense ammunition. Attorney Jeremy Hogan, who followed the case on his popular YouTube channel, said the SEC can only prevail with its summary judgment motion if Judge Torres “forgets his freshman year of law school.”
Prominent legal experts like Curt Levey of the Federalist Society and Professor JW Verret of George Mason University’s Scalia School of Law agree that Ripple is on track to win this case. Worse still for the SEC, Verret predicts that if the SEC appeals to the Supreme Court, it risks not only losing but setting a sweeping precedent that would limit or entirely eliminate the application of Howey on cryptocurrencies, which defy 1946 definitions.
So why is Gensler still letting his Law Enforcement Division drive that bus off a cliff? They are litigators, but Gensler is ultimately a political figure. Politicians, Deaton said in an interview recently, want to turn a defeat into a victory and move on. Ripple’s General Counsel, Stuart Alderoty, has made it clear that he will settle “within minutes” and pay a fine if the SEC clarifies that today’s XRP is not a security. Having spent his political capital, Gensler should take the deal.