Former SEC Executive Explains Why Lawsuit Against Ripple Over XRP Is a Mistake

Recently, Joseph A. Hall, a former executive at the U.S. Securities and Exchange Commission (SEC), explained why his former employer’s lawsuit against Ripple is “considerably less a slam dunk than its previous crypto enforcement actions.”

Hall has been partner in U.S. law firm Davis Polk since September 2005. Before that, between October 2003 and June 2005, he was working at the SEC, where he ultimately served as Managing Executive for Policy under Chairman William H. Donaldson, where he assisted the Chairman in “directing the Commission’s policy-making and enforcement activities.”

In an article for Law360 published on January 25, Hall attempted to explain why the SEC’s enforcement action against Ripple over XRP showed the need for much more regulatory clarity on cryptoassets.

As you may remember, on 22 December 2020, the SEC announced that it had “filed an action against Ripple Labs Inc. and two of its executives, who are also significant security holders, alleging that they raised over $1.3 billion through an unregistered, ongoing digital asset securities offering.” 

Hall predicts that Gary Gensler, President Joe Biden’s pick for U.S. Treasury Secretary, who was the former head of the U.S. Commodity Futures Trading Commission (CFTC) during the Obama administration, will “chart a different course from recently departed SEC Chairman Jay Clayton.”

With luck, the agency’s heretofore skeptical approach to the regulation of digital assets, or cryptocurrency, will be one of them — particularly with the SEC’s decision, a day before Clayton’s lateDecember departure, to file a suit against Ripple Labs Inc. over its cryptocurrency XRP.

Here is Hall explaining how inadequate the SEC’s Howey test is for deciding whether a particular cryptoasset is a security:

Imagine trying to explain what an iPhone is in language your great-grandfather would have understood
just after World War II. That’s how easy it is to predict which digital assets are securities under the postwar Howey test.

He then argues that this lack of regulatory clarity significantly hurts the development of blockchain technology in the U.S.:

It’s difficult to overstate the impact this uncertainty has on the development of blockchain technology in
the U.S. Outside the venture capital community, corporations, major investors and banks are
understandably skittish about risking serious sums of money on technologies their lawyers can’t assure
them comply with law — even when a technology holds the potential to improve the efficiency of
managing vast amounts of data across countless industries, or the potential for frictionless, inexpensive
transfers of value over smartphones and other widespread consumer tools.

As for the SEC’s lawsuit against Ripple over the sale of XRP tokens, Hall says that after William Hinman’s speech at the Yahoo Finance All Markets Summit in June 2018, where he said that Ethereum (ETH) “might have been born a security but later morphed into a nonsecurity”, it was “a fair bet that XRP would get the same treatment”, i.e. “maybe there were some issues with early sales of XRP, but at this point surely XRP itself was in the clear”.

Hall argues that the SEC’s decision to bring an enforcement action against Ripple Labs for ongoing sales of XRP is therefore “remarkable on several levels”:

  • … the timing — the day before Clayton stepped down — suggests the possibility of a rift among the commissioners as opposed to a case everyone agreed had to be brought immediately in order to avert looming investor harm.
  • … whatever one’s views on the merits, before news of the SEC’s intentions broke, XRP traded with a market cap in the $25 billion to $30 billion range, meaning that any precipitous action by the SEC would surely result in heavy investor losses…
  • Why on earth did the agency bring a case that was considerably less a slam dunk than its previous crypto enforcement actions?

With regard to this last point, Hall says:

Barring a settlement, the Article III courts and not the SEC will ultimately say whether XRP is a security. There are plenty of digital assets with more tenuous use cases than XRP, any one of which might have better helped the SEC etch its views into federal caselaw before taking on a leviathan like Ripple Labs.

And the commission does not have an unblemished record when it comes to defending its prerogatives in federal court — it has lost cases centered on its authority to regulate hedge funds, the reach of its Regulation Fair Disclosure and its ability to prescribe corporate governance standards, among others. A loss on the merits in the XRP litigation could epically damage the SEC’s regulatory project when it comes to digital assets.

Hall also points out that “the SEC has yet to formally confirm that any digital asset… is not a security”:

There have been a few nonbinding statements to the effect that Bitcoin isn’t, and that, today at least, neither is Ethereum, and the SEC staff has said it doesn’t consider three obscure digital assets to be securities. But as the news about XRP shows, the regulatory status of most crypto, including many widely held digital assets, remains cloudy.

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The views and opinions expressed by the author are for informational purposes only and do not constitute financial, investment, or other advice.

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