A new amended complaint against Ripple draws on the SEC’s framework for digital assets to outline how XRP might be a security – likely the
first federal case to do so.
- The filing also cites California advertising law, in addition to
federal securities law, to argue that investors were misled by Ripple’s
promotion of XRP. - While the case is a year old and has not yet received class-action
status, the new complaint is the first that Ripple must respond to with a
substantive answer. - Ripple has until mid-September to file its response.
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Investors in the cryptocurrency XRP have filed a new complaint
against Ripple that marshals the Securities and Exchange Commission’s
own words to argue that the startup illegally sold unregistered
securities.
The amended complaint,
filed Aug. 5 in a year-old lawsuit against Ripple, includes several new
arguments and may be the first federal case to cite the SEC’s guidance
for applying existing law and regulation to crypto tokens.
It also marks the first filing to which Ripple must directly respond
by addressing the facts of the case. Four previous complaints were filed
in California state court, but the company successfully moved to have
these cases consolidated and shifted to federal court. Ripple has until
Sept. 19 to file a response.
“That filing will be the first time in the already-long history of
this litigation that Ripple will substantively respond to the
allegations around XRP,” said Jake Chervinsky, general counsel at crypto
lending startup Compound Finance.
The company has been in the legal crosshairs since May 2018, when investor Ryan Coffey filed the first of several lawsuits
seeking class-action status against Ripple Labs, subsidiary XRP II, CEO
Brad Garlinghouse and other individuals. XRP, which Ripple periodically
sells, has “all the traditional hallmarks of a security,” Coffey
claimed.
Investors Vladi Zakinov, Avner Greenwald and David Oconer filed similar suits shortly thereafter. The lawsuits were combined and moved to federal court in November.
While the suit has not yet been certified as a class action, law firms Susman Godfrey and Tayler-Copeland Law were appointed as co-lead counsel at the end of June, with investor Bradley Sostack being appointed as lead plaintiff. (Zakinov, Oconer and Greenwald were denied their own motion to be appointed as lead plaintiff.)
The new amended complaint lays out “a strong case against Ripple,”
said Chervinsky, noting that Susman Godfrey is “one of the best
plaintiff’s law firms in the U.S.” In particular, he highlighted that
the complaint claims XRP is a security under both federal and California
state law.
“This is important because California uses the ‘risk capital test’ in
addition to the [federal] Howey test to determine whether a transaction
qualifies as a security,” he explained. “The risk capital test is
broader than the Howey test, meaning the plaintiffs could lose their
federal securities claims and still win their state securities claims.”
The plaintiffs’ complaint is trying to tie the XRP Ledger, the
distributed network underlying XRP (and therefore the cryptocurrency’s
price), back to Ripple, said Rebecca Rettig, a partner at the law firm
of Fisher Broyles, which is not involved in the case.
Ripple and Susman Godfrey declined to comment.
SEC framework
Perhaps the most important difference between the new complaint and
its predecessors is the citation of the SEC’s framework for analyzing
whether a digital asset qualifies as a security.
“The Complaint reads like a love letter to the SEC,” Chervinsky said.
“Although the SEC’s Framework is technically only non-binding guidance,
the Court will likely give it significant weight in deciding how to
apply the Howey test to the facts of this case.”
Rettig agreed, telling CoinDesk that “this is the first time we have
seen the SEC’s Framework applied in a case in federal court.” She added:
“Although the framework on its own doesn’t have
precedential value – meaning the court is not required to follow it – it
will be very interesting to see how the court handles the utility of
the framework in moving forward in determining whether XRP is a
security.”
The SEC published the guidance in April, providing for the first time a specific roadmap for how it might assess digital assets.
Over the course of 11 pages, the amended complaint details how the
plaintiffs believe XRP is a security based on the framework, stating
that “XRP purchasers made an investment of money in a common
enterprise”; “XRP investors had a reasonable expectation of profits”;
and “the success of XRP requires efforts of Ripple and others”.
“Lead Plaintiff and the Class invested fiat and other digital
currencies, such as Bitcoin and Ethereum, to purchase XRP. As explained
in the SEC Framework, investment of both fiat and digital currency meets
the first prong of Howey,” the filing says.
Ripple and its affiliated parties are the common enterprise, the
complaint alleges, saying that any profit the potential class might see
“are intertwined with the fortunes of Ripple.”
The price of XRP is dependent on Ripple’s efforts, the lawsuit
alleges. Investors would have expected the value of their holdings to
grow based upon the efforts of the company.
The complaint goes on to say:
“Lead Plaintiff and the Class have entirely passive roles
vis-à-vis the success of the XRP Ledger and XRP. Rather, as Defendants’
own marketing makes clear, the success of the XRP Ledger, and the
profits the Class reasonably expected to derive from investing in XRP,
are dependent on the essential technical, entrepreneurial, and
managerial efforts of Defendants and their agents and employees.”
Rettig noted that “each of the [factors in the SEC Framework] are
based on underlying federal case law, so the litigants will likely rely
upon these underlying cases and not simply the framework [itself].”
Tweets as evidence
Like past complaints, last week’s filing points to public statements
made by Ripple executives such as CEO Brad Garlinghouse and CTO David
Schwartz to bolster its argument.
For example, Garlinghouse said in a 2017 CNBC interview
that “people are looking at the success Ripple has been having as a
company, and I think that’s increased the value of XRP,” according to
the complaint.
Elsewhere, the complaint says Garlinghouse “conceded” that Ripple’s
own self-interest is tied up “with building and maintaining a healthy
XRP market.”
“The Complaint emphasizes Ripple’s own statements to prove that XRP
investors had a reasonable expectation of profits flowing from Ripple’s
managerial efforts,” Chervinsky noted. “This is similar to how the SEC
framed its own Complaint against Kik,” the messaging app company that
the SEC alleges violated securities laws when it raised $100 million during a 2017 token sale.
Beyond interviews, the complaint cites tweets that the plaintiffs
believe demonstrate that Ripple indicated XRP’s price would rise due to
work the company was doing.
Roughly 40 tweets are referenced in the filing, including tweets from
the company, executives and other employees discussing exchange
listings, Ripple’s XRP reserves and other marketing efforts. The
complaint also references a Garlinghouse quote-tweet of a Motley Fool
tweet which said companies using Ripple’s tools “could be a big deal for
Ripple’s XRP cryptocurrency” as an example.
“I’ve never seen so many citations to Twitter in a complaint before,” Chervinsky said.
(The suit also notes that Digital Currency Group, which holds a stake
in Ripple, is also the parent company of CoinDesk, and cites a 2017 article
on this website reporting that XRP’s price had risen above $1 for the
first time ever as “one of many instances in which Ripple would promote
XRP price movements.” For the record: CoinDesk operates independently
from the parent company, working in separate offices and maintaining
strict policies on editorial independence and transparency.)
Beyond simply promoting XRP, the complaint hints that Ripple may have
gone as far as to mislead the general public about which of its various
products were being adopted.
“On April 26, 2017, Ripple tweeted
a link to an article on its own site, proclaiming: ‘#Ripple welcomes 10
additional customers to our #blockchain #payments network.’ Neither
this tweet nor the article it linked to informed readers that the
blockchain payments network did not refer to the XRP Ledger, but rather
Ripple’s xCurrent enterprise solution,” the complaint said, adding in
the next paragraph:
“Just days later, on May 3, 2017, with the price of XRP continuing to rise, Ripple tweeted: ‘#Ripple adoption is sparking interest in XRP ‘which has had an impressive rally in the last two months’ via @Nasdaq.'”
California claims
Securities law aside, the lawsuit also adds new claims that have not appeared in previous filings in the case, Chervinsky noted.
“For the first time, the plaintiffs now claim that Ripple violated
California’s false advertising and unfair competition laws by making
fraudulent statements about the genesis, circulating supply, and
adoption of XRP,” he said.
The fact that this complaint is in federal court may have helped the plaintiffs. Chervinsky explained:
“Interestingly, the plaintiffs probably couldn’t have
alleged those claims on behalf of a global ‘class’ — all persons or
entities who purchased XRP — if Ripple had left the case in California
state court instead of removing it to federal court.”
According to the filing, Sostack and his fellow plaintiffs are looking for Ripple to reimburse them for their losses.
For the lead plaintiff, those losses total $118,100, according to the
complaint, but the full size of the losses allegedly incurred by the
class has not yet been calculated.
More significantly, the plaintiffs want the court to declare that XRP
is a security, which could have an impact on Ripple’s ability to
continue selling XRP from its reserves, as well as potentially limit who
can acquire the token.
Other prayers for relief include the plaintiffs wanting Ripple to pay
for all legal fees and have the court award any other damages that
might be warranted.
Ripple now has 45 days from August 5 to answer the complaint, and could file a response (like Kik Interactive did to the SEC) or a motion to dismiss.
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