By John E. Deaton, Founder and Host, CryptoLaw.
The law doesn’t require a CEO to be clairvoyant. It does not require him to “guess” that maybe 7 years later the SEC “might” consider XRP a security.
Today, counsel for Ripple Labs CEO Brad Garlinghouse sent a letter to U.S. District Judge Analisa Torres anticipating a Motion to Dismiss on his behalf in the SEC’s lawsuit against him, Chris Larsen and the company they lead, Ripple. The letter outlines a line of legal attack that exposes how the SEC should be barred from claiming XRP is a security because it violates due process and principles of fair notice.
Previously, I discussed a similar concept called the doctrine of equitable estoppel. I explained the law protects a party from harm by another party’s voluntary conduct. That conduct may be actions, inaction, silence, or acquiescence.
Although the SEC never declared XRP a non-security, for eight years it openly traded in unison with ETH and BTC.
During this time, some from the SEC, including Clayton, commented that BTC and/or ETH were not securities. For 8 years the SEC’s actions, inaction, silence and acquiescence implied that XRP was also NOT a security.
Let’s review a few of the SEC’s actions, inaction, silence and/or acquiescence related to XRP:
1. During the period of time the SEC claims XRP was a security, the SEC granted Ripple permission to take a minority stake in MoneyGram (MGI). Ripple invested $50 million purchasing approximately 9% of MGI. The SEC approved this purchase of MGI with the full knowledge that Ripple would encourage MGI to use XRP as a cross-border utility token related to remittances. The SEC allowed the use of this so-called illegal security to be utilized not just by Ripple, but by MGI. The SEC admitted to this knowledge when it stated in the complaint that Ripple paid “Money Transmitter significant financial compensation – often paid in XRP.” The SEC was fully aware that MGI would not HODL XRP. The SEC knew that MGI would sell XRP in the secondary markets to investors such as XRP holders. Thus, it appears, the SEC, believing XRP to be an unregistered security, provided consent for XRP to be purchased and/or utilized by MGI and then sold in the secondary markets to innocent investors with no connection to Ripple, or even MGI, because purchasers of XRP on exchanges do not know the identity of the seller. If the SEC truly believed XRP to be an illegal security, why would it allow this transaction to take place? The answer is because the SEC knows very well that today’s XRP is not a security. Prior to March 2020, MGI included all compensation from Ripple in the form of XRP as revenue. In MGI’s quarterly earnings report in February 2020, it states that “after a recent consultation with the SEC” XRP received from Ripple “will be accounted for as a contra expense rather than revenue.” It certainly appears that as of February 2020, the SEC started to manipulate the books of MGI as it planned it overreaching action against Ripple.
2. XRP has been trading in the secondary markets since 2013! In 2015, the Department of Jutice and FinCen settled a case with Ripple and determined that XRP was virtual currency and that Ripple is a money transmitter of XRP. The settlement required Ripple’s XRP transactions comply with laws that do not apply to security transactions. This is an agency of the U.S. government classifying XRP as virtual currency. Also in 2015, the U.S. entered into a consent agreement related to the sale of XRP to Roger Ver (early BTC investor/promoter AKA “Bitcoin Jesus”). The U.S. government settled with Ripple and the SEC didn’t allege securities violations, nor did the SEC issue a cease and desist letter or seek an injunction to stop sales of XRP. These government interactions and inactions with Ripple, involving XRP, imply that XRP is not, in fact, a security.
3. In 2017, the SEC brought high-profile initial coin offering (ICO) cases against several companies, alleging that the digital token that was being offered constituted an unregistered security. Two of these cases involved the EOS and KIN Tokens. These companies raised capital by offering ICOs. These tokens were promised by the promoter who received money for that promise. This ICO scenario fits squarely in the 4 factor Howey test of what constitutes a security. Because these ICOs constituted securities, the SEC shut it down. Ripple and XRP, however, were left alone by the SEC during these high-profile prosecutions. In fact, Brad Garlinghouse spoke out against these ICO Token assets at the time. In 2017, XRP had been globally traded for over four years. The SEC, by leaving Ripple and XRP alone during the aggressive prosecution of ICOs, implicitly gave further confidence to investors and Ripple that the third largest crypto was safe from being called a security – just like BTC and ETH.
4. Japan, Singapore, the U.K., Switzerland and the UAE have declared XRP to not be a security, while the U.S. has remained silent.
5. The SEC runs a node on the XRPL, along with thousands of other individuals, and companies. This conduct by the SEC implies that the SEC would not be conveying and/or validating transactions worth billions of dollars in illegal securities. Even if Ripple ceased to operate as a company, the XRPL continues along with XRP as the XRPL is open source and the SEC did not have to seek approval to run a validator node.
6. Since personnel from the SEC have made public statements that BTC and ETH are not securities, and considering, like BTC and ETH, XRP is a digital currency supported by a distributed ledger that uses cryptography to store and transfer assets; and, since the SEC was silent, it was implied that XRP would be treated the same.
7. The Office of the Comptroller of the Currency (OCC) issued a notice that banks could custody crypto. Clayton issued a letter that states the SEC agrees with the OCC in allowing banks to custody crypto. XRP was the third largest crypto. Clayton did not state that he agreed with the OCC with the exception that banks can’t custody XRP because they are unregistered securities! He never provided a statement that XRP or other cryptos could later be determined a security. Instead, it appeared that the SEC was in full agreement. It is reasonable to assume that if the SEC agrees that U.S. banks can custody crypto, it would include the third largest crypto. The SEC, by this letter of agreement with the OCC, provided investors and Ripple confidence that XRP would not be classified a security or the SEC would have excluded certain assets or simply limited the custody to BTC and ETH.
8. The SEC was well aware that financial services companies, such as iTrustCapital allowed U.S. residents and investors with absolutely no connection to Ripple transfer their traditional fiat IRA into crypto assets, XRP.
9. During the time period that the SEC claims XRP was an unregistered security, the SEC was well aware that a third-party entity, Flare Networks, unrelated to Ripple, announced, promoted, and then executed a Digital Asset Token Airdrop for all XRP holders. Flare informed the public that it would be air dropping at least one Spark token for every XRP token held by investors. If XRP is a security and we only have FLR because of XRP, what does that make FLR? If your XRP is a security then your FLR must be a security.
Ultimately, all this SEC conduct, inaction, silence, and acquiescence is why the doctrine of equitable estoppel and the principles of fundamental fairness, fair notice and due process should preclude and bar the SEC from claiming XRP is a security.
Garlinghouse’s letter, and the motion to dismiss it precedes, clearly have merit. The SEC must prove that Garlinghouse believed XRP to be a security, or at least that XRP more likely than not to be a security.
Based on the evidence so far, all the SEC can prove is that Garlinghouse believed it was possible that the SEC could consider XRP a security.
The law requires more than “possible.”