In the past few months, a number of class action lawsuits have been filed against Ripple over the sale of its XRP token in an unregistered securities offering. So far, the US Securities and Exchange Commission has not published an official statement that left everyone puzzled.
To put an end to the uncertainty, Chris Giancarlo, former chairman of the Commodity Futures Trading Commission, released a paper last week in which he argued that Ripple’s XRP was not a security. Giancarlo is known for helping to establish the CFTC’s stance that Bitcoin (BTC) and Ether (ETH) are not securities. So it seems that he is the right person to take on this case.
The only problem is that Giancarlo no longer works for the CFTC – he is now in his own practice. He’s also currently working for a law firm that’s on Ripple’s payroll. Given the clear conflict of interest, I prepared myself to expect some bias before reading the paper. However, I could never have imagined how bad it would be.
I know this kills the tension, but there is no way to break words here: the case made in Giancarlos newspaper that Ripple’s sale of XRP is not viewed as an offering of securities is so nonsensical and absurd that it confuses me that Giancarlo it was ready to publicly put his name on it.
Read on in today’s article as I go through Giancarlo’s analysis of whether or not the sale of XRP is an offering of securities, along with a real analysis of whether or not it is.
Related: Is XRP a Security? We may never know
This is how you can tell whether a token offer is an offer of securities
The Howey Test is the SEC’s primary method of determining whether or not an investment is an offering of security. If so, the issuer must either register the offer with the SEC or ensure that the offer falls under a recognized registration exception.
As a quick refresher, the Howey test includes four prongs set up in a 1946 Supreme Court case. The verdict was that there is an investment contract if:
“A contract, transaction, or plan in which a person invests their money [prong one] in a joint company [prong two] and is led to expect profits [prong three] exclusively from the efforts of the organizer or a third party [prong four]. “
In order for the sale of XRP to be considered an offering of securities, it must meet all of these aspects. If the offer fails even with one of them, it is not considered a securities offer.
Read on to see how XRP compares to Howey’s test.
Investment
The first point of the Howey test is pretty simple: was there any money invested in the transaction?
In his analysis, Giancarlo claims that XRP fails this Howey Test point because “the general understanding of the term ‘investment’ is the transfer of something of value in exchange for a future return, not a present one”.
At first glance, that sounds reasonable. However, the idea of ”investment” as an expectation of future return is handled by the “expectation of profit” of the Howey test. There is no reason to confuse it with the term “investment”.
Giancarlo essentially presents a circular argument in order not to admit the obvious: You cannot say that no money has been invested here. People were clearly paying money in exchange for XRP tokens. There is no other way to see this. I think almost all courts analyzing this would agree that money has been invested.
Remember, just because the XRP offering passes this step of the Howey test, it does not mean that Ripple held an unregistered offering of securities. The victim must pass all of the other prongs on the Howey test. So Giancarlo didn’t have to get so creative to argue against these tines. Of all the prongs that could be hit, none is stronger than this.
Yes – there was no doubt a cash investment when people bought XRP. Ripple owned XRP and sold it for US dollars. End of the story.
Joint enterprise
The next point of the Howey Test relates primarily to whether the returns are shared by those who have invested as a result of the efforts of a joint venture. This aspect is likely to be fulfilled as well, as all XRP holders share in the profits and losses as the value of their tokens rises and falls due to Ripple’s management efforts.
In Giancarlos paper he claims that there is no joint venture in this case because “an owner of XRP is not entitled to participate in the profits and losses of Ripple”.
That’s a terrible argument. There are innumerable investments classified as securities that do not allow any participation in the profits or losses of the company. Take a bond, for example. They do not participate in the profits or losses of the company or government that issued them, but a bond is undoubtedly a security.
Next, Giancarlo compares Ripple to Bitcoin to back up his argument. He claims that holders of XRP are no different from holders of BTC, and if BTC is not a security, then neither is XRP.
Unfortunately, there’s one big gaping flaw in this line of reasoning: Bitcoin’s development is really decentralized, while XRP is dominated by Ripple. So the owners of XRP are obviously in a joint venture, as their fate is bundled in equal parts and almost entirely depends on Ripple’s development efforts. The XRP network requires constant work, and much of the use of the token will depend on its future evolution. So to argue that there is no joint venture clearly denies the reality.
Giancarlo argues against this reality by claiming that the XRP ledger would work without Ripple’s involvement. And while it’s true that if Ripple closed today, XRP would continue to exist, it’s also true that the price of XRP would go down and use of the platform would crumble.
Yes – XRP owners have invested in a joint venture. All funds are pooled by Ripple to build the system and all users benefit or lose from the corresponding fluctuations in the token price.
Profit expectation
In his paper, Giancarlo argues that there were no profit expectations as Ripple never officially promised investors any kind of profit or return and instead emphasized that the main purpose of XRP is liquidity.
This was a smart move for Ripple, as any marketing of potential profits or price increases on XRP would automatically have resulted in the sales of XRP being flagged by the SEC. But just because Ripple doesn’t promise future profits in its marketing doesn’t mean people don’t buy XRP with the expectation of profits. Anyone who has followed crypto at all in the past few years knows that people are buying XRP in the hopes that the price will go up.
XRP was one of the most successful tokens at one point. To argue that there are no profit expectations is absurd, let alone pointless. Both Kik and Telegram tried to make this line of argument with the SEC and were shot down.
Then Giancarlo goes on to make a ridiculous comparison between XRP and Bitcoin, arguing that XRP does not meet this aspect because Bitcoin is not a security.
But this comparison is also grossly flawed. Bitcoin is not a security as it does not meet all of the Howey test requirements. Even if people buy BTC with the expectation of profit, it is not a security because it does not meet the other points of the Howey test.
Although Giancarlo does his best, his arguments in this prong are circular and nonsensical.
Yes – users bought XRP in hopes that the price would go up.
From the efforts of others
The last point relates to whether the profit comes from the individual efforts of one person or entirely from the efforts of the third party in whom they invested. Although Giancarlo doesn’t take the time to thoroughly explain his case at this point, he claims he benefits from holding XRP is not entirely due to the efforts of the Ripple team.
His argument is that “the XRP architecture is completely autonomous and exists completely independently of Ripple”. To back this up, he points out that the bulk of Ripple’s XRP is held in trust and that the amount released is controlled by the Ripple program. Control over the delivery of the token is only a minor way of influencing the price of the token.
Just take a look at the Ripple website and you will see the comprehensive team behind Ripple who are driving the development of the token and its introduction to institutional investors.
As mentioned above, it is possible that the XRP ledger could continue to function without the Ripple team. But that would undoubtedly lower the price of the token dramatically. Thus, it is clear that the growth of XRP and the corresponding profits for token holders depend heavily on the efforts of the Ripple team.
Yes – buyers of XRP are simply passive investors who count on the work of the Ripple core team to develop new products, drive adoption, and increase the overall value of the token.
Selling XRP is clearly an offering of securities
In my opinion, XRP clearly meets all of the Howey’s test points and would be considered a safety. Through his paper, Giancarlo relies heavily on the assumption that bitcoin and ether failed all the prongs of the Howey test, which is simply not true.
All of his reasoning was amateurish and deliberately misleading. Very different prongs were lumped together and supported with nonsensical legal language in order to confuse and distract.
The views, thoughts, and opinions expressed herein are those of the author alone and do not necessarily reflect the views and opinions of Cointelegraph.
Dean Steinbeck is a US business lawyer specializing in data protection and technology. He is General Counsel of Horizen, a blockchain platform that enables data protection through a fully decentralized sidechain ecosystem.
Comments are closed.