Covering the U.S. Securities and Exchange Commission’s (SEC) ill-conceived enforcement action against Ripple Labs is never dull, and last week offered another development in the case. When the agency accused the San Francisco-based software company of seven years of unregistered securities trades by its distribution of the XRP digital currency, it unwittingly opened the door to replacing the SEC’s antiquated Howey Test for defining securities. Moreover, it appears that the judge agrees with the defense’s argument that the SEC failed to provide fair notice to Ripple (or any market participant) that XRP was, in the agency’s view, a security since 2013.
Throughout the pre-trial phase of the case, Ripple’s legal team has demonstrated that the SEC denied fair notice not just on XRP, but cryptocurrencies in general. When Rippled filed a intention to present a fair notice defense, the SEC launched a series of desperate filings to stop Ripple, knowing that if that defense is permitted, the trial case against Ripple will be dead on arrival.
Key to the strategy is the deposition of former SEC Director of Corporation Finance William Hinman, which Magistrate Judge Sarah Netburn has now ordered, overruling the SEC. This is crucial because Hinman gave a now-infamous speech in June 2018, which still appears on the SEC website, declaring that Ethereum’s digital token ether is not a security despite having been launched in an initial coin offering (ICO) in 2014. The SEC disclaimed the speech, saying it reflected only Hinman’s personal views and was not market guidance.
Ripple has assiduously fought for evidence surrounding the preparation of the speech and Hinman’s communications with market participants – especially those with financial interests in Ethereum. Under oath, Hinman could confess he realized his speech was interpreted as market guidance, including by the Ethereum Foundation and other interested parties he met with soon after the speech. This would expose the arbitrary and capricious nature of how the SEC provides fair notice on cryptocurrencies and validate Ripple’s fair notice defense.
When the suit was filed in December, exchanges suspended XRP trading, leading to panic selling that erased $15 billion worth of savings and asset holdings. Believing to be denied fair notice of the SEC’s intentions, retail holders focus their feelings of betrayal with remarkable intensity to the court and on social media. The interest led the Southern District of New York to open thousands of public phone lines to listen to pre-trial hearings. Attorney John E. Deaton filed a Motion to Intervene on behalf of XRP holders and has signed up 19,000 XRP holders by the latest report.
Last Thursday, Judge Netburn ordered Hinman to sit for the deposition and drilled down on Hinman’s 2018 speech. “This is not a run-of-the-mill SEC enforcement case,” she said, but a case that “involves significant policy decisions in our markets, the amount of controversy is substantial and the public’s interest in this case is significant.” The judge’s tone and statement suggests that she and possibly Judge Analisa Torres, who will preside over the trial, are heading towards admitting the fair notice defense, effectively putting the SEC on trial in what could be a precedent setting verdict.
Another portent of doom for the SEC’s legal team is a recent missive on a settlement with crypto exchange Coinschedule from SEC commissioners Peirce and Roisman, two Republicans who voted against the Ripple case driven by former Republication SEC Chair Jay Clayton. The Commissioners were essentially whistleblowers from inside the agency’s top leadership, attesting that the SEC fails to provide clear guidance and fair notice on digital assets.
Peirce and Roisman wrote they were “disappointed” that the settlement “did not explain which digital assets touted by Coinschedule were securities, an omission which is symptomatic of our reluctance to provide additional guidance about how to determine whether a token is being sold as part of a securities offering or which tokens are securities.”
“There is a decided lack of clarity for market participants around the application of the securities laws to digital assets and their trading, as is evidenced by the requests each of us receives for clarity and the consistent outreach to the Commission staff for no-action and other relief,” they wrote. The Howey Test, they said, is “helpful” but “not crystal clear.”
“Market participants have difficulty getting a lawyer to sign off that something is not a securities offering or does not implicate the securities laws; they also cannot get a clear answer, backed by a clear Commission-level statement, that something is a securities offering,” the commissioners complained.
Laying down clear rules for the market “and then bringing enforcement actions against people who ignore them is a better approach than the clue-by-enforcement approach that we have embraced to date,” they argued. “In short, we know folks have questions and confusion persists in the marketplace; it is important that we start providing clear and timely answers.”
The Commissioners’ statement probably does not surprise the SEC’s legal team. They likely know that Hinman’s answers to Ripple’s questions could sink their case and their credibility as an agency. It invites a ruling that could bring the SEC’s farce of fair notice to an end.
This news is originally posted here