XRP Class Action turns new SEC directives on Ripple and Brad Garlinghouse

John Moore
  • Updated Class Action lawsuit cites new SEC Framework for 'Investment Contract' Analysis of Digital Assets in case against Ripple
  • Suit seeks to define XRP as a security, says Ripple misrepresents its role in their enterprise solutions and seeks compensation for investors 
  • Consolidation and escalation of the action means that Ripple must now reply to the allegations by Sept. 19

Since June last year, Ripple has been under the shadow of a California-based Class Action lawsuit alleging that its cryptocurrency, XRP, was sold as an unregistered security. Now, an update to the case invokes new directives from the SEC to further the case against it. 

Led by Bradley Sostak of Saint Petersburg, Florida, on behalf of a potentially huge number total number of XRP investors, the amended complaint’s summary now outlines 13 distinct points around which the case is built. It begins with the statement that it arises “out of a scheme by Defendants to raise hundreds of millions of dollars through sales of XRP—an unregistered security—to retail investors in violation of the registration provisions of federal and state securities laws.”

The suit demands that the court recognize XRP as a security under law, and compensate the group for damages. According to CryptoCompare, XRP’s USD value is currently around $0.30, having peaked briefly at $2.70+ just prior to the lead plaintiff’s investment.

Sostack himself claims to have lost around $118,000 through trading XRP between January 1 - 17, 2018, having been inspired by the promotional statements of Ripple, and the “Defendants’ repeated representations that adoption of XRP by financial institutions and banks would drive demand for XRP”. 

Brad Garlinghouse, CEO of Ripple Labs, has previously described the Class Action moves as "outrageous". 

XRP Is a "Red Herring"

Specific allegations include that, rather than making money through its products and software, Ripple’s main source of income is the sale of XRP - a business that has generated it around $1.1 billion since the start of 2017, the filing states - a cryptocurrency that it created “out of thin air” in 2013 “prior to its distribution to investors and without any functionality.”

Due to the way the tranche of 100 billion pre-mined XRP was divided, with 20 billion going to the company’s founders and 60% of the supply still sitting in Ripple’s wallets, the suit alleges that Ripple’s  claim that XRP has utility as a bridging currency in international payments - the role it plays in the Company’s RippleNet system - is a “red herring attempt to avoid the application of securities laws”. Specifically, it says that “none of that XRP is used for anything at all, other than to be sold in the future to investors.”  

It also outlines the belief that Ripple controls XRP’s supply in order to drive price appreciation. This has long cut through to a larger debate about centralized control of the cryptocurrency, with Ripple arguing that its system is more decentralized than even Bitcoin's, while others point to the tightly controlled, pre-mined supply as proof of who is really in control of matter. 

Further to this, it claims that when it comes to the XRP already in circulation, “the vast majority of it is not used for bridging international transactions, but for investment purpose”, not least by the company and its employees.

To this end, the third allegation is that Ripple market’s XRP “aggressively” to drive demand and increase profits - including giving extensive guides on how to buy it, promoting its availability on exchanges (including well-reported offers by Ripple to reward exchanges for listing XRP), as well as via conferences, the media and through political lobbying. 

Blurred Lines Between XRP and Enterprise Solutions

Perhaps the most interesting claim, though, is that Ripple knowingly conflates XRP with its xCurrent and xVia enterprise systems, giving the impression that increased usage of those drives up the price of XRP “even though they have little or no correlation” and that neither system utilizes XRP. It cites various media sources and statements to back up this claim. 

Perhaps confusingly, another part of what is now so-called 'RippleNet' ecosystem - the company's cross-border payments platform xRapid - does rely on the transfer of XRP between liquidity providers in order to operate. 

Is XRP a Security?

The case will ultimately revolve around whether those bringing it can establish XRP’s status as a security, the area of definition covered by the SEC’s recent statement on digital assets entitled Framework for “Investment Contract” Analysis of Digital Assets.

It, as has been seen time and again over the last 18 months or so, invokes the famous ‘Howey Test’, the generally applied US legal principle which establishes this - which the new directive makes clear should apply to any asset, digital or not. 

It says: 

The so-called “Howey test” applies to any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities. The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales). Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply.

Opinions have been divided over XRP’s status among the crypto community for some time, while many have expressed disdain at the centralized control of its supply, some luminaries such as Changpeng Zhao of Binance have offered support for its claim not to be a security. Equally notable, has been the fact that two high-profile US exchanges, Gemini and Coinbase, long avoided listing XRP - though the latter brought it on-board earlier in the year. 

Around a year ago, in a paper published for Bloomberg, researchers for Satis Group went as far as to allege that they saw “little or no value in XRP”, or similar cryptoassets that were “misleadingly marketed, not needed within their own network, and have centralized ownership/validation.” 

In the UK, however, Ripple was given some degree of insight into how regulators perceive XRP just last month, as part of the Financial Conduct Authority's Consultation Paper on Prohibiting the sale to retail clients of investment products that reference cryptoassets.

In that document, the Authority drew comparisons between XRP and the multiple use cases of Ethereum, saying that it can be used in multiple applications as either a method of payment or given utility. "Ether can be used as a means of ‘payment’ (exchange token) on the Ethereum platform, and can also be used to run applications (utility token). XRP has similar features."

The FCA has settled on a definition of a Security Token as one that explicitly offers contractual rights and obligations the owner has as part of its "intrinsic characteristics", rather than the implicit way the US Class Action alleges XRP was sold as having these features. 

This means that such a comment likely helps Ripple, and hints they will not be pursued on the matter in the UK. The comparison with Ethereum is also telling, as it has not historically been embroiled in the same ethical debates regarding status as XRP. Thus, it was a stance applauded by Brad Garlinghouse. 

Now that debate over exactly what XRP is under US rules will continue over the Atlantic, and seems increasingly likely to be heading towards a Federal Court, and before a jury - a situation inspired by Ripple’s own wish to have the cases against it consolidated into a single ‘Complex Case’, rather than multiple actions in various US States.

This move by the legal team supporting the company has been seen as an expression of confidence in its status, and indicative of its wish to establish a Federal precedent for XRP’s legitimacy as a cryptocurrency that would over-arch individual state laws.