XRP is probably a security, don’t @ me

Litigation may take its own sweet time, but with time comes precedent.   

And while we don't quite have that yet in the long-running consolidated Ripple/XRP class action lawsuit pending in California federal court, we do have something of a first peek in a recent order from the Court.

While things could change, they don't look great for Ripple.

As a reminder, this particular lawsuit consolidates a bunch of individual lawsuits against Ripple Labs – and a bunch of its executives – for violations of the Securities Act in connection with the alleged offer and sale of unregistered securities in the form of the XRP cryptocurrency. 

There's also a claim against CEO Brad Garlinghouse for what's known as "control person" liability for the corporation's "primary violation" of the law and then a bunch of California law claims for securities violations and violations of state advertising and unfair trade practices law.

Plaintiff says that XRP is a security under state and federal law.  Defendants disagree, but when they filed a motion to dismiss (which is what this Order resolves) they didn't raise that argument for now, instead saying that the case should be dismissed because it was barred by a three-year statute of repose for these particular claims. A statute of repose is an outside time limit on when you can bring a claim. 

The Court began by reviewing some of the key facts in the Complaint. For purposes of this sort of motion, the Court assumes that they are true, but the Defendant can argue that later. Many of these alleged facts identified by the Court jump out of the opinion. Here are a couple of important highlights:

• "While defendant Ripple sells certain enterprise software products, the primary source of its income is the sale of XRP."
• "In 2013, defendant Ripple generated 100 billion units of XRP. Following their creation, defendant Ripple gave 20 billion XRP to its founders and retained the remaining 80 billion XRP."
• "Since the XRP's creation, defendant Ripple has placed a substantial percentage of XRP that it owns in escrow and developed a plan for when and in what quantities XRP should be sold."
• "In an article, defendant Garlinghouse publicly stated that '[o]ur goal in distributing XRP is to incentivize actions that build trust, utility, and liquidity.' In that same publication, Garlinghouse subsequently characterized the XRP distribution as 'ongoing.'"
• "Ripple's website provides advice on 'How to Buy XRP' and includes hyperlinks to exchanges trading XRP."

Furthermore, the Court notes that a 2015 settlement with the government, defendants Ripple XRP II and Ripple resolved Bank Secrecy Act violations includes a state of facts and violations identifying numerous XRP transfers and exchanges, all of which seem to show centralized control by Ripple over that process.

There's plenty more where this came from. 

If you believe the Complaint, it's hard to see how the purchase of XRP can be seen as anything other than an investment of money in a common enterprise with the expectation of profits from the managerial or entrepreneurial efforts of others. 

Yes, yes, I hasten to add that the Court hasn't decided this yet and I suppose it's theoretically possible that factual discovery could change the analysis.  I gotta say that I doubt it, though.  This sure smells like an investment contract.

Anyway. Ripple and the other defendants argued that a three-year statute of repose barred this lawsuit, so that it wasn't even necessary to get to the question of whether XRP is a security. Defendants argued that you calculated the time for this purpose by looking at the date that a security is first offered on a bona fide basis to the general public. Plaintiff (not surprisingly) said, no, you look at when the security was last offered. 

I'm going to tl;dr the Court's lengthy analysis. The Court said that while the first offered rule applied, "that defendants did not make their first bona fide public offering of XRP before August 5, 2016 (three years prior to plaintiff's filing of his federal securities claims in this action on August 5, 2019)." The Court further noted that "[a]s of December 21, 2017, XRP was available for purchase or sale at over 50 exchanges."

In short, the time-based argument failed. And this was their best shot to get rid of the lawsuit, or the securities claims, anyway.

Another potentially important ruling that was bad for Ripple was on its argument that a securities claim could only be made if plaintiff had purchased XRP in an initial distribution as opposed to on the secondary market. 

The Court rejected this argument and pointed to language in the relevant statute that prohibits sale of an unregistered security "through the use or medium of any prospectus or otherwise." So, if the Court's reasoning is accepted, purchasers of crypto on secondary markets can state securities claims against the issuer where they did not directly purchase the crypto. 

Defendants also argued that they didn’t qualify as "sellers" under the relevant statute. Plaintiff alleges that the defendant systemically marketed XRP and benefitted from its sale in an amount greater than $1.1 billion. The Court said that the Complaint contained more than enough allegations that, if proven true, would satisfy the definition of "seller."

The Court goes on to analyze a number of other legal issues, including potential liability of CEO Brad Garlinghouse as a "control person" under securities laws. As to Mr. Garlinghouse, the Court says that the pleading contains enough allegations to keep him in the case and make him potentially liable for the corporation’s wrongdoing. There are a bunch of state law claims too – some remain, some are thrown out.

Here's what's important, at least in my mind. The alleged facts, which seem like they will be pretty darn hard to controvert, depict a centralized enterprise with a wealth-making asset – XRP – that it has created, controlled, and distributed for profit over a multi-year period. I imagine that when they get to the merits of this case, Ripple will argue that XRP is not a centrally controlled thing that the company minted and has been primarily responsible for increasing its speculative value.  

The thing about federal court, though, and federal judges for that matter, is that the fabulist mythopoesis of crypto is unlikely to persuade a skeptical jurist.  

In short, if I am a betting man, this Court is eventually – someday, and I don’t know when –  going to conclude that XRP is a security and there isn’t a thing that the best lawyers in the world can do to change this fundamental truth.

Or, as my friend/securities lawyer/whiz Gabe Shapiro eloquently put it: