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The deadline for fact discovery in the U.S. Securities and Exchange Commission’s lawsuit against Ripple Labs has passed, but the legal slugfest over who gets what information continues — now over how the SEC assessed XRP to be a security.
In its latest legal filing, the SEC is pushing back on the demand by Ripple and its executive chairman Chris Larsen for the agency to respond to several interrogatories — written questions asked as part of the pre-trial discovery process — regarding the SEC’s application of the Howey test to determine the status of XRP.
Ripple and Larsen, had on Aug. 31, filed a motion to compel the SEC to respond to its interrogatories following the SEC’s “vague and ambiguous” responses to questions on the application of the Howey test to XRP transactions that the agency alleged constitute an unregistered securities offering.
In a Sept. 8 letter to U.S. Magistrate Judge Sarah Netburn, the SEC said it had appropriately responded to Ripple’s questions. “Defendants waited until the end of fact discovery, more than seven weeks after receiving the SEC’s first interrogatory responses, to inform the SEC they considered the responses deficient,” the agency complained.
Why the Howey test matters
In December 2020, the SEC filed a lawsuit against Ripple alleging that the sale of its XRP token was an unregistered securities offering worth over US$1.38 billion. In the same lawsuit, the SEC also named Ripple’s CEO Brad Garlinghouse and executive chairman Chris Larsen as co-defendants for allegedly aiding and abetting Ripple’s violations.
At the heart of the SEC’s lawsuit is whether transactions involving XRP constitute “investment contracts” and therefore securities subject to registration under Section 5 of the Securities Act of 1933.
The lawsuit is being closely watched by crypto companies and investors alike for its potentially far-reaching implications on whether other tokens, too, might be deemed securities in violation of the law.
The Howey test, based on SEC v. W. J. Howey Co., 328 U.S. 293 (1946), is used to determine whether the law would deem a financial product a security. Under the Howey test, an investment contract “exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”
What Ripple is trying to find out from the SEC
The SEC, in its letter to Netburn, elaborated on some of its responses to Ripple and argued that Ripple’s interrogatories were a reflection of an incorrect reading of the law.
Referring to Ripple’s interrogatory no. 2 — which asks the SEC to identify all terms of any “investment contract” the SEC contends created an “expectation of profit” by XRP purchasers as “premised on Ripple’s incorrect reading of applicable law,” SEC attorney Mark Sylvester wrote that “investment contracts” could also extend beyond written provisions or agreements to “statements made in commerce and the very nature or character of the instruments.”
The SEC “provided a substantive response of more than a full page, identifying various ways Defendants ‘made implicit and explicit promises to prospective and actual XRP purchasers, or led prospective and actual XRP purchasers to reasonably expect’ an increase in XRP’s price based on Ripple’s efforts,” Sylvester wrote.
On Ripple’s interrogatory no. 6 asking the SEC to declare whether the agency deems Bitcoin and Ether to be “securities” within the meaning of the Securities Act, Sylvester said the question showed Ripple’s “miscomprehension” of how the SEC operated as well as the application of the Howey test and Section 5 of the Securities Act.
“The SEC does not typically make independent determinations that financial instruments, untethered to any offer or sale, are or are not securities,” Sylvester wrote.
Ripple has long questioned the status of Bitcoin and Ether, the two largest cryptocurrencies by market cap, and previously said the lawsuit was “picking virtual currency winners and losers as the SEC has exempted Bitcoin and Ether from similar regulation.” The company has also said it took former SEC Director of Corporation Finance William Hinman’s June 2018 remarks that Bitcoin and Ethereum’s Ether were not considered to be securities to indicate that the SEC “would permit present-day sales of virtual currencies given the current market conditions for XRP.”
With regard to whether XRP purchasers acquired any stake in any enterprise or venture in which XRP holders by virtue of their XRP purchases, the SEC said that the Howey test did not require purchasers to acquire a stake in the venture to have purchased an investment contract. “The ‘enterprise’ at issue is the success of XRP as a digital token in Ripple’s ‘XRP ecosystem,’” Sylvester wrote.
The exhibits filed along with the SEC’s letter include questions and answers that seem mundane and almost random but presumably carry great legal significance, such as: “Request for Admission No. 115. Admit that carpets and flooring can be purchased from My Way Carpet in New Jersey using XRP.”
The SEC has asked the court for permission to not have to respond to any more of Ripple’s interrogatories.
“Defendants’ argument here boils down to a complaint that they do not like the answers they received to the interrogatories at issue, in large part because the SEC’s and Defendants’ interpretation of the applicable law differs,” Sylvester wrote. “The parties’ dispute as to the correct application of the controlling legal standards should be resolved by Judge Torres at summary judgment, not on a motion to compel interrogatory responses.”
In a series of tweets today, Ripple’s CEO and lawsuit co-defendant Garlinghouse said “The SEC’s continued warfare on crypto continues to play out. In Dec 2020, I said that we’d been having discussions with the SEC for nearly 3 years about XRP… ‘and yet never been met with clarity.’”
“Thankfully today many recognize the havoc caused by regulation by enforcement,” Garlinghouse added. “We’re ready to work with responsible actors, pro-innovation members of Congress, and others in paving a path to clarity and certainty with US regulators. If you want to go fast, go alone. If you want to go far, go together.”
XRP, which started the year trading at US$0.22, was trading at US$1.11 as of publishing time, and has lost its spot as the sixth largest cryptocurrency to Solana.
See related article: SEC wins access to Ripple’s Slack message for XRP lawsuit
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