Bloomberg Law
March 2, 2022, 9:00 AM

Ripple’s Historic Showdown on SEC Cryptocurrency Overreach Heats Up

J. Carl Cecere
J. Carl Cecere
Cecere P.C.

Cryptocurrencies had a breakout year in 2021, which saw total cryptocurrency market cap rise above $3 trillion for the first time. And while crypto values declined since then, little suggests this is anything more than one of the temporary hiccups that have been happening since 2011 during cryptocurrency’s remarkable decade-long rise.

Now, more than ever, it is clear that the use case for digital assets and decentralized ledger technology have brought blockchain beyond mere speculation toward mainstream corporate adoption.And 2022 is set to be a year for critical legal and regulatory transition that could decide whether this remarkable technology’s growth path will continue accelerating in the U.S. or be diverted overseas.

Speculation and uncertainty originally created by the Trump administration’s failure to provide clear guidance on cryptocurrency regulation could be laid to rest, through one of the Trump’ administration’s worst crypto moves, a misguided enforcement action Trump’s SEC brought against the enterprise blockchain software company Ripple over sales of the cryptocurrency XRP.

This suit, which the SEC brought in the name of investor protection, saw retail investors lose $15 billion in value. And it tests whether the SEC has any authority to regulate cryptocurrencies, and whether its dangerous approach of regulation by enforcement should be allowed to continue.

The investing community had hoped the Biden administration would prove a steadier hand, provide some regulatory guidance on the scope of the SEC’s authority over cryptocurrencies, and end the misguided Ripple enforcement action. But Biden’s pick for the SEC, Gary Gensler, instead has doubled down on the previous administration’s mistakes.

So this year it looks like the SEC’s enforcement authority may have to be settled in court, in the legal battle between the SEC and its hard-fighting target, Ripple, currently raging in the Southern District of New York, which is likely to reach the U.S. Supreme Court.

What Is at Stake: Is XRP a Security?

At stake is whether XRP is a “security” that must be registered with the SEC. Both Trump’s SEC, and Biden’s, alleged that it is, based on a test the Supreme Court adopted SEC v. W.J. Howey Co., (1946), which provides that a “security” is an instrument allowing issuers to “use the money of others on the promise of profit.”

The SEC says XRP meets that definition simply because Ripple makes, and presumably “use[s],” money from “others” with each batch of XRP it offers. And that position would give the SEC omnipotent power over cryptocurrencies—because every issuer benefits from the issuance of their cryptocurrency.

But while Ripple no doubt finds use for the money its XRP generates, Howey’s touchstone for a “security” is not the results of what issuers are selling, but what purchasers are buying―a promise of “profits.” Apple stock is a “security” because it gives shareholders a stake in Apple’s business, one that gains value based on Apple’s performance as a business.

But XRP’s value has nothing to do with Ripple’s performance. That value derives from how XRP performs. That should keep cryptocurrencies beyond the SEC’s grasping reach. Hopefully, the district court will agree, setting up a critical test case allowing the Supreme Court to resolve how its 75-year-old test applies to revolutionary blockchain technology.

A New Battle Erupts

Even as this battle has barely heated up, another is blazing, because Ripple has introduced an affirmative defense of fair notice that is also critical to crypto’s future. Ripple maintains that it could not have anticipated that the SEC would have considered every sale of XRP to be a long string of unregistered securities transactions―not when it started selling XRP in 2013 without noted SEC concern, not when it first reached out specifically to the SEC for guidance, and received no negative response, and not when XRP began to be listed on public commodities exchanges without any suggestion from the SEC that all of those listed trades were unlawful.

Ripple also noted that the SEC had given specific market-moving guidance in 2018 through a speech by then-Director of Corporation Finance William Hinman that cryptocurrencies like Ethereum were not securities. And that makes its sudden about-face a violation of due process. The SEC has asked for that defense to be stricken from the case, arguing that its powers are so obviously sweeping that it owed no guidance to cryptocurrency traders—despite a decade of silence on the issue, punctuated by SEC-induced guidance to the contrary.

The district court’s ruling on that question could not only be critical to protect Ripple, its investors, and XRP buyers from billions in fines and invalidation of transactions, it will also be vital to curb the SEC’s general stance of omnipotence over cryptocurrencies.

Gensler has built upon the SEC’s Ripple stance to say, both in congressional hearings and in speeches, that the SEC’s authority is so sweeping that every crypto issuer, past, present, and future, should “come in and talk to us” about registering digital assets as securities or face potential enforcement action. Leading industry voices say they are dumbfounded: “How can a currency be a security?” But that has not stopped Gensler.

Only a district court ruling allowing Ripple’s fair-notice defense to remain in the case, and for it to eventually succeed, to curb these sweeping assertions of authority. That would require the commission to give up its governance-by-subpoena stance, and provide some guidance before taking future enforcement actions so that crypto developers can have some understanding of the rules of the game

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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J. Carl Cecere is the owner of Cecere P.C., a law firm devoted to Supreme Court and Appellate practice. The author says he has no interest or stake in Ripple.

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