Hello, this is attorney Jeremy Hogan and this week on the Legal Briefs “Crypto -edition” XRP has returned lightsaber in hand ready to fight the Empire. I wanted to use “The XRP Strikes Back” for the thumbnail but the analogy is backwards.
In this Legal Brief we have some very important insights on the SEC vs. Ripple litigation – there is now a Writ of Mandamus filed by a third party against the SEC we’ll discuss that, Coinbase was sued also by a third party and we’ll talk about that briefly, and then wait until the end for the best part (someone suggested I keep the best for last), where we talk about how the SEC Rules process works and what I think is an inherent misunderstanding of it that I see online and FINALLY we analyze a prior settlement between the SEC and a cryptocurrency and see if we can apply the prior settlement to the Ripple and XRP situation. This will go fast – hang onto your hat.
First, on January 1st of this year Attorney John Deaton filed a Writ of Mandamus against the SEC in response to its lawsuit against Ripple. Let me start by saying that I think the Petition is extraordinarily well done and Attorney Deaton must have spent an entire week drafting this and the Memorandum of Law. The fact that he drafted a 90 page Federal Court Petition in a week? Superhuman. You have no idea how hard that is to do.
Anyways, a Petition for a Writ of Mandamus is fancy Latin way of saying you are asking a superior Court to tell a lower Court to do something correctly. I rarely see a Writ of Mandamus in the wild because they are rarely granted: you must a have an emergency situation, and you must have no other effective remedy at law. Here, the emergency situation is that owners of XRP have been decimated as to the value of XRP due to the SEC’s lawsuit and also because Coinbase and other exchanges are halting trading soon.
Now I’m going to tell you a little secret about reading a lawsuit – start at the end where the “Prayer for Relief” is (page 26). That’s where we start and here the Petitioners are FIRST asking for an Order from the Court asking that the XRP owned by Petitioners is NOT a security. It’s a great way to phrase the Prayer for Relief because obviously the argument that the XRP being actively traded between individuals is a Security is really difficult.
That being said, I don’t think the Petition will be granted for two reasons: first, in a minute we are going to talk about a concept called Stare Decisis which means that once a Court has ruled on an issue, lower Courts must rule on that issue the same way. SO, if a superior Court rules that XRP is not a security the lower Court must follow that opinion and so the Court hearing the Petition is being put in a position of having to rule essentially on the Entire case and that is not the purpose of a Writ of Mandamus. Otherwise you could effectively move a case to an entirely new Judge, if you wanted, simply by filing a Petition for a Writ. The 2nd reason I think the Petition gets dismissed is that because the 2nd part of the Prayer for Relief revolves around money and I am worried the Judge is going to find that there is a “regular” remedy in law in the form of a lawsuit for money.
And that money lawsuit is coming – trust me. I haven’t seen it or heard about it but I would bet a ton of money that Attorney Deaton is drafting the damages lawsuit as we speak. The reason why it wasn’t filed right away is because of a rule of law called “Sovereign immunity” which the USA inherited from English common law where it was said “The King Can do no wrong” and it’s the idea that you cannot sue the government. UNLESS the government allows you to and in the USA that is governed by the Federal Tort Claims Act which says that you CAN sue the government, in this case, the SEC, for negligence or even intentional torts but you have to make the claim with them and give them 6 months to respond before you sue them.
I just made a claim against the Post Office – and sent it to them by mail – is that irony?
So I am certain that a claim has been made for damages against the SEC for the drop in XRP prices but it won’t be able to be filed until June of this year. If you wonder why I think the Petition is great even though I think it’s going to lose it’s because it’s letting Deaton get his argument in front of the Judge twice. This will be reviewed now, even if it’s dismissed, then he gets a second bite at the apple in June with the “real” lawsuit. I call that good lawyering. Plus, you never know.
Now, briefly onto topic number two, I saw that Coinbase is getting sued in San Francisco for selling illegal securities and the alleged damages are not the drop in XRP price but for the commissions paid to Coinbase for the sales. I know those commissions add up because that’s who I use … they are not cheap.
In any case, we are starting to see the repercussions of the SEC lawsuit and I imagine there will be many more such lawsuits shortly. I’m certain Coinbase is following the recommendations of its corporate counsel – who are almost always very conservative in their recommendations. If you are corporate counsel and you are tell them to stop sales and you are wrong – Coinbase loses some commissions, if you tell them to keep selling XRP and you are wrong – then Coinbase suffers a legal tragedy. So they always err on the side of caution and that’s why most are not going to trade anymore – because counsel is telling them not to.
Okay, I want to move onto issue number three before we run out of time and I think this is key and you really have to hear this. Over the weekend I had a couple hours to do more research and found some REALLY interesting things.
Let me start by dispelling a narrative that I have seen online that the SEC lawsuit will somehow lead to “greater clarity” for the crypto or XRP community. In fact in order to understand what is likely to happen to Ripple and XRP you have to understand briefly what the SEC does and DOESN’T do.
The SEC does its job primarily two ways – first as an administrative body it makes rules related to securities. This is what I think many people are thinking of when they say we need more “clarity” related the crypto-blockchain business community. They are thinking that the SEC will release a Rule that lays out how a crypto currency can be bought and sold.
I went to the SEC website and it has a page which talks about its rulemaking process and let’s take a look:
As you can see, the process of the SEC making a rule on something, like for example Cryptocurrency regulation, would start with a Concept Release which apparently throws out a couple different ways to approach a problem and then that is followed by Proposed Rule which is then voted on and, if adopted, it becomes a Final Rule. Note that only Final Rules are rules – there are many statement and opinions that come out of the SEC which are not binding. Let’s take a look at one from the former head of the SEC – Mr. Clayton from back in 2017.
He says many interesting things in this statement but let me highlight a couple things : First he says in regard to cryptocurrencies in general:
“It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction. Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset.”
What is he saying? He’s saying that whether a coin is a security or currency hinges on the particular facts of how each is used. He says exactly that when talking about Initial Coin Offerings: “ A key question for all ICO market participants: “Is the coin or token a security?” As securities law practitioners know well, the answer depends on the facts. “ The Facts.
The reason why there is not even a Proposed Rule from the SEC on crypto is because they know there is no way they can make a bright line rule – it’s not possible. It’s not even legally possible because the second job, the second hat the SEC wears so to speak is to enforce the law on Securities. Those laws were passed by Congress and the SEC has no discretion but to enforce them and the law is that the sales of securities must be regulated. And the SECs 2nd job is to litigate violations of securities laws and that is where Ripple finds itself currently.
What I’m getting at is that I don’t believe the Ripple litigation will end with a dismissal of the case and formation of an Administrative Rule because those are two completely separate things. Rulemaking here and Enforcement here.
So, whether XRP is a security is squarely a legal issue that will depend on the specific facts of each coin and usage, etc. And the only clarity will be brought by the Courts and stare decisis meaning there will have to be extensive litigation before cryptocurrencies get a feeling for which projects will have litigation brought against them and which will not. Meaning, if the Judge or Jury finds that certain aspects of how Ripple dealt with XRP coins back in 2013-2014 meets the Howey test and those transactions were sales of securities then future Courts could find that ICOs that happened in a similar way were also sales of securities as a matter of law. Stare Decisis means that the exact same issues don’t have to be re-litigated.
That sounds bad for XRP right? Wrong. To understand why this is, we need to take a deeper dive into the actual lawsuit against Ripple. Now, what did I tell you earlier about reviewing a lawsuit? Start at the end and look at the Prayer for Relief and see exactly what the Plaintiff is asking for. Let’s take a look.
Roman numeral one, the SEC asks for an Order that Ripple stop selling XRP. That is primarily what is being asked for.
Two, the SEC asks for “Disgorgement” which is a gross sounding term for giving back the money made by the sale of XRP. Who would the money be disgorged to? The buyers of XRP!
The third request is essentially the same as the first and Roman numeral IV is again asking for money this time as a penalty.
When I read the Prayer for Relief a second time this weekend something jumped out at me. Under Federal Law you can request something called a “Declaratory Judgment.” A Declaratory Judgment request asks for an Order clarifying something – like clarifying a contractual provision, clarifying an individual’s legal status, or in this case POSSIBLY a Declaration that XRP is a security and not a currency. So where is the request for Declaratory Judgment in the Ripple lawsuit?? It’s not there.
Understand that in a lawsuit a Judge cannot grant something that is not requested. The omission of a request for Declaratory Judgment tells me that the SEC is not after XRP – they don’t want – for whatever reason- something saying XRP is a security. All they want is to punish or enforce the law as to Ripple and the other 2 Defendants. In other words, the effect of a verdict in this case will be minimal as to XRP – in fact, it would have almost no effect whatsoever except as to how it effects Ripple. SO, our worst case scenario has gotten much much better now I think.
But as you know, my thesis on the situation is that Ripple would be smart and would want to reach a settlement and that a trial and verdict is not likely. So I thought to myself, what would a settlement look like? (Because I always like to dig deeper). So in my practice if I was advising a client I would try to find prior settlements between persons like my client and the Plaintiff and Guess what? We have a settlement we can look at in the public record in the SEC vs. Paragon Coin case – so let’s take a look.
Now the Paragon case looks like it was much more of a “slam dunk” … there wasn’t mush of a fight and the Defendants apparently didn’t have much in the way of resources to put up a fight. IT was also completely different than the Ripple litigation. So, let’s look at the settlement: First, in paragraph 50 (b) the Defendant is required set up claim forms for people who bought the Paragon coins so that the profits can be paid back to them and have those claims monitored by the SEC.
Next, jumping down to paragraph A, the settlement Orders that Paragon Inc cease violating the Securities laws. Part B there requires the payment of penalties in the amount of $250k.
Again, just like in the Ripple lawsuit there is nothing here that would be seen as a Declaration or anything creating any precedent as to whether the XRP out in the wild is a currency …it only reflects on what Paragon did and mainly requires them to stop that activity and give back the money that was made.
Now, the big question is – what effect would a verdict or settlement like this have on Ripple and perhaps more importantly what effect would it have on XRP – its value and its usage. And very sorry nut I am not qualified to answer THAT question – I am sure someone with more knowledge of Ripple and the XRP community can jump in and answer that question for me. Someone lend me a hand with that one. But if it’s not THAT bad a result…why the drama? Why did the coin price just drop by over 50%?
And finally, one more super interesting issue – briefly. Stay with me on this one: My understanding is that Ripple still holds almost 60% of the XRP coins that exist. If there is a settlement or verdict, there is a chance that Ripple will not be allowed to release the coins as they have in the past. It’s actually within the Courts power to Order they not be allowed to release the coins AT ALL. So just a quick question for anyone with a better understanding of XRP and Ripple than myself – what would happen if at the end of this process if Ripple survives in some form, XRP survives, but Ripple is not allowed to do anything with the billions of coins that it holds? What if the supply that’s out there is all there ever will be? What happens to the price of XRP in that scenario? Answer me THAT question for me in a way that I like and … I will probably start buying XRP right away.