Stephen Palley, partner at Anderson Kill. and Gabriel Shapiro, partner at BSV Law, discuss the SEC’s lawsuit against Ripple and two executives, Chris Larsen and Bard Garlinghouse. In this episode, they explain:
- what was so “egregious” that the SEC went after two executives, Chris Larsen and Brad Garlinghouse, were charged
- why their sales showed an information asymmetry, and why that matters
- why the complaint comes close to being a fraud case, but why the SEC didn’t charge them with fraud
- why the idea that XRP is a currency and therefore cannot be a security will likely not fly
- why it’s unlikely the case will go to the Supreme Court
- the SEC’s case for why XRP is a security, and Ripple’s role in it
- how even on a technical level, the XRP network is centralized
- how strong the SEC’s case is against Larsen and Garlinghouse
- Stephen’s and Gabriel’s predictions on how the lawsuit will play out
- how this will likely impact XRP investors
- whether or not Ripple could become an SEC-reporting company and XRP a security
- what happened with Ripple’s lead investor in its most recent fundraising round
- whether or not the SEC might go after exchanges or other players who made money off XRP or collaborated with Ripple around XRP trading
- what this means for Coinbase, in particular, because it’s going public later this year
- what Ripple’s defense, in its summarized Wells submission, was
- how this case compares to some of the other big SEC/crypto securities cases, Kik/Kin and Telegram
- whether there might ever be a digital token that is determined to be a security for specific transactions but not others
- what the wider implications of the case are for the rest of the crypto industry
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Episode links:
Stephen Palley: https://twitter.com/stephendpalley
Gabriel Shapiro: https://twitter.com/lex_node
SEC lawsuit against Ripple: https://www.sec.gov/litigation/complaints/2020/comp-pr2020-338.pdf
SEC lawsuit against Ripple being close to a fraud case: https://twitter.com/stephendpalley/status/1341523294344896515?s=20
Former SEC commissioner Joe Grundefest on the case: https://www.theblockcrypto.com/linked/89164/former-sec-commissioner-says-ripple-lawsuit-will-cause-multi-billion-dollar-losses-to-innocent-third-parties
Other lawsuit against Ripple: https://www.courtlistener.com/recap/gov.uscourts.cand.334410/gov.uscourts.cand.334410.115.0.pdf
Technical assessment of Ripple network: https://cryptobern.github.io/noconsensusripple/
Tetragon’s case against Ripple: https://twitter.com/stephendpalley/status/1346531087971999749?s=20
What the case means for exchanges: https://www.coindesk.com/coinbase-delist-xrp-exchanges-dilemma
Coinbase suspends trading in XRP: https://blog.coinbase.com/coinbase-will-suspend-trading-in-xrp-on-january-19-2e09652dbf57 https://www.coindesk.com/coinbase-suspends-xrp-trading
Lawsuit against Coinbase: https://www.bloomberg.com/news/articles/2020-12-30/coinbase-sued-over-xrp-commissions-after-sec-pursues-ripple?sref=m9L277rN https://twitter.com/stephendpalley/status/1344352455895691269?s=20
People in the industry thinking for a while that XRP is a security: https://www.theblockcrypto.com/genesis/57366/xrp-is-probably-a-security-dont-at-me
Mary Jo White: https://www.coindesk.com/former-sec-chair-represents-ripple-xrp-lawsuit
Ripple’s Wells submission: https://ripple.com/wp-content/uploads/2020/12/Ripple-Wells-Submission-Summary.pdf
Transcript:
Laura Shin:
Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host, Laura Shin, a journalist with over two decades of experience. I started covering crypto five years ago and as a senior editor at Forbes was the first mainstream media reporter to cover crypto currency full time. Subscribe to Unchained on YouTube where you can watch the videos of me and my guests. Go to YouTube.com/c/unchainedpodcast and subscribe today.
Crypto.com Crypto.com – the crypto super app that lets you buy, earn and spend crypto – all in one place. Earn up to 8.5% per year on your BTC and more than 20 other coins. Download the Crypto.com app now to find out how much you could be earning! 1inch.exchange 1inch.exchange is DEFI’s leading DEX aggregator that discovers the best trade prices across all DEXs. 1inch was launched in May 2019 by two white hat hackers at ETH Global’s ETH New York Hackathon. 1inch has reached almost $7 billion in overall volume in just over a year.Laura Shin:
Today’s topic is the SEC lawsuit against Ripple and two of its executives. Here to discuss are Stephen Palley, partner at Anderson Kill, and Gabriel Shapiro, partner at BSV Law. Welcome, Stephen and Gabriel.
Stephen Palley:
Hey, Laura. Nice to be here.
Gabriel Shapiro:
Thank you.
Laura Shin:
So, let’s set the baseline for listeners. On December 22, SEC announced a lawsuit against Ripple and Chris Larsen who was the former CEO and current Chairman, and Brad Garlinghouse, the current CEO. Stephen, why don’t we start with you. Do you want to give a brief summary of what the SEC is suing them for and why this lawsuit is a big deal?
Stephen Palley:
Sure, and actually the SEC does a very nice job summarizing it itself in the beginning of the lawsuit. It was filed in Federal court in New York, in the southern district of New York, that courthouse is in lower Manhattan, and the SEC alleges that from about 2013 to the present the defendants, which you correctly identified as Ripple Labs, Bradley Garlinghouse, and Christian Larsen sold over 14.6 billion units of a digital asset security, that’s the SEC’s words, called XRP in return for cash or other consideration worth over 1.4 billion dollars to fund Ripple’s operations, and this is I think important, and according to the SEC, to personally enrich Larsen and Garlinghouse who later in the lawsuit the SEC alleges took in about 600 million dollars from their sales.
And this is problematic according to the SEC’s complaint because allegedly and is discussed in detail, XRP is actually a security and under US Securities laws in order to sell a security you either have to register it or it has to be subject to an exemption and the SEC says neither of those things were the case, so they sued Ripple for violating the registration requirements of the US Securities laws, and they also sued Garlinghouse and Larsen personally as…there are two counts to the complaint. The first is violation of the registration requirements under the Securities Act. The second is for aiding and abetting that violation under something called a control person theory which basically says that people in an organization who have sufficient control over the organization can be personally liable for Securities Laws violations. That’s it in a nutshell.
Laura Shin:
And Gabriel, would you like to add to that? What do you think is the significance of the lawsuit and also of the fact that it named two executives?
Gabriel Shapiro:
Yeah. Well, I think you know, this is the first time in one of these series, there have been a number of these token actions. This is the first time when the SEC has gone personally after the founders. It didn’t do that in the Kik case relating to the Kin cryptocurrency, it didn’t do that in the Telegram case, it didn’t name the Durov brothers as defendants, so I think that speaks to what they feel is the level of egregiousness of the violations …
Stephen Palley:
Yeah.
Gabriel Shapiro:
… and I do think it’s noteworthy in that regard.
Stephen Palley:
And it’s not a fraud case either, so there have been token related cases where individuals are named personally but those were securities fraud cases. What’s really interesting about this is to use Gabe’s words, there’s a certain level of egregiousness that’s wound through this but it’s not a fraud case, but in order to make a control person claim against people involved in a Securities Act registration violation you have to show intent and that I mean, I think Gabe hits it exactly, hits the nail on the head, the SEC I think sees the egregiousness that they describe is that these guys, they made 600 million dollars and there was a sort of an information asymmetry, right? They knew things about this asset that you know, regular people who were buying, consumer buyers wouldn’t know and if this had been registered as a security you have reporting requirements which were not followed here.
Laura Shin:
Yeah, and actually Stephen, you did Tweet the Ripple case is the most fraud-like non-fraud filing I think I’ve seen, and you said it’s full of evidence about market manipulation and control, all to the benefit of the issuer and execs, and to the potential detriment of the buying public, and then you said, so where I come down is not will it be delisted and will the thing die, you wrote good chance of both, but are there other more serious charges waiting in the wings? So, like why do you think the SEC didn’t just pursue this as a fraud case and you know, what makes you think that potentially they could still?
Stephen Palley:
So, I’m not suggesting that there was fraud here. I think, what I pointed to earlier if you look at the complaint and you see, it took me a few minutes when I read it to understand why they did this. The reason why there are allegations of trading on inside information or information asymmetry or suggestion of willfulness is because that’s what you need to do in order to satisfy the proof requirements for a control person claim, and I think the reason why they brought that claim is because I mean, if you want to recover money, these guys according to the SEC, they personally made 600 million dollars so if you’re going to try and claw back money to distribute to smaller investors you have to go after them because they have the cash. They have nearly half of the proceeds, and it’s you know, I mean, they’re entitled to a presumption that you know, the SEC, the government has to prove its case but if all of these allegations are true, this was not about freedom, it was not about changing commerce or you know, liberty, it was about personal profit for a couple of people who made a huge amount of money, and there’s nothing wrong with making a lot of money, I’m not suggesting that there is, but that’s I think why the SEC went after these people personally and you know, I think it might have felt personal to them in part, too, because this was basically filed on Christmas Eve, right?
Gabriel Shapiro:
Yeah, Brad Garlinghouse noted that in his Twitter response, right? It was like a particularly egregious factor to show how heartless the SEC is, right?
Laura Shin:
Merry Xmas?
Gabriel Shapiro:
Yeah.
Stephen Palley:
Right.
Laura Shin:
Here’s your gift. But so why do you think that the SEC didn’t just pursue fraud charges? I mean, so you know, as you also Tweeted, you said that there was a very bad fact and that fact is that as early as 2012, Ripple got advice that XRP could very well be a security and even advice to consult with the SEC about it and they didn’t do that and then instead you know, went on to make 1.38 billion dollars in sales.
Gabriel Shapiro:
Well, fraud is very, very hard to prove…
Stephen Palley:
Yeah.
Gabriel Shapiro:
…because it requires what’s called scienter. The scienter standard under securities law fraud is a little weaker than under common law fraud but there is still this element of an intention to deceive and you know, there’s also a class action securities lawsuit against Ripple going on concurrently with this and in that suit there is a fraud, there were a number of fraud causes of action and a couple of them survived the initial motion for dismissal, at least one did. So, there was some possibility of bringing a fraud claim but it’s just much harder and I think you know, the SEC has close to a slam dunk on the registration claims so why would it muddy the waters by bringing a weaker claim when it doesn’t really have to?
Stephen Palley:
Yeah, and it can achieve the same thing by making a control person claim. You still have to prove, I think it’s clear and convincing evidence, so you still have to prove some intent but you know, one of the things…getting back to the most fraud-like non-fraud claim according…these are all allegations, I just want to remind people who are watching and listening that the SEC alleges that Garlinghouse repeatedly said that he was “very long XRP” meaning he had significant positions expected to rise in value without disclosing the fact that he was selling.
And Gabe can speak more to how this works in the public securities context, but typically there are some restrictions on what you can do in terms of selling securities if you are management and you have inside information and I think that’s where…it’s about information asymmetry. Go ahead, Gabe.
Gabriel Shapiro:
That’s right. Yeah, you know, if Ripple Labs was a public company you know, that is if it was complying with the Exchange Act and if XRP was a security, then whenever Brad Garlinghouse sold his own XRP there would have to be something called a Section 16 report filed with the SEC for the entire public to see that reports those transactions and that’s the case whenever you know, Tim Cook of Apple sells his Apple stock, he’s following those and so on, and that’s a very important piece of disclosure because it puts the market on notice you know, that the executives are selling which could impact the market, or could indicate that they have some extra information that the market doesn’t have.
Stephen Palley:
Right.
Gabriel Shapiro:
Now in addition to that, there are some blackout periods where they’re not allowed to sell, right? So, they have a limited window to sell when they ought to have the same information as the public basically because the company has just recently filed one of its periodic reports, and they have to do the disclosure on top of that you know, and there are other limits as well, and so all of those protections that a typical investor in a typical security would have, XRP holders were deprived of and so if XRP is a security you could see how they really lose out relatively speaking by not having this disclosure because if they did have the disclosure they could time their own buys and sells in…
Stephen Palley:
And let’s…yeah.
Gabriel Shapiro:
…a more advantageous way.
Stephen Palley:
Let’s look at a very tangible example of how that might or might not be important, so SEC investigations are confidential. I don’t believe that it was publicly disclosed that there was an ongoing investigation. Towards the close of an investigation, you have the ability in something called a Wells Act response. You have the ability to persuade the SEC in a letter that you know, the SEC will come to you and say we’ve finished our investigation, we’re going to charge you, you can let us know why we shouldn’t. So, that all happened behind the scenes. Ripple and the executives knew that was going on at around the time they were drafting their Wells letter, their response to the SEC, XRP went up to I think 70 cents in price, so there was a huge spike in price, and then when the information came about, the SEC lawsuit, so basically Ripple said the day before the lawsuit was filed they said you know, they were going to be sued, the price tanked. So, they knew for the last two years that they were under investigation. They also knew that they had been told by I think in two different memos by law firms that XRP was probably a security and the general public did not know about that. Now, if I had bought XRP at 60 or 70 cents, it’s trading now at 27 cents which is peculiar to me, I’m not sure why, I think I’d be kind of pissed off.
Gabriel Shapiro:
As opposed to zero.
Stephen Palley:
Yes, exactly. So, you know…
Gabriel Shapiro:
Yes.
Laura Shin:
Yeah. Well, I mean, speaking about a kind of like asymmetry of information, so okay, first of all people really should read the SEC’s lawsuit because yes, I understand it’s 70 pages but you can like skim, you can kind of figure out which parts you can skip and which parts you can read so it’s not actually 70 pages, but the point is so there’s just so much in here. It’s literally like a 70-page list of all the ways in which Ripple itself kind of made itself guilty and yeah, I mean, it’s really a doozy, frankly.
But one of the many, many anecdotes that they have in here is one in which Ripple was having conversations with a big market maker and Ripple was like freely talking about how it wanted to sell XRP timed to some of Ripple’s big announcements and so Ripple’s VP of Finance told the market maker, and so here I’m going to quote from the SEC lawsuit, Ripple would like to go to sales at one percent of trading volume and ask the market maker to quote, be thoughtful/opportunistic around the timing of implementing one percent because Ripple did not want to quote, depress the rally but rather capitalize on the additional volume. So, it’s like literally, they’re literally saying like we want to make money when the news hits so be sure to sell when all the retail people are going to be buying on our news, and so it’s pretty…there’s so many eye-opening moments like that.
Stephen Palley:
Also examples of…
Laura Shin:
But yeah, basic…
Stephen Palley:
…of paying for listings on exchanges. So, yeah, it’s hard to see. I mean, they have very, very fine lawyers who are defending them.
Laura Shin:
Ripple?
Stephen Palley:
Yeah, Ripple does. They’re represented by rally good lawyers who specialize in defending securities lawsuits and enforcement actions and class actions, but I just don’t see how you win. I mean, I guess, what is there, Gabe? There’s a limitations argument perhaps? What are the arguments that can be made? I know that one of the things that they’ve said in the…
Gabriel Shapiro:
I think the arguments will have to focus on are things relating to cryptocurrency and you know, the fact that the Howey precedents don’t squarely address, so I think their arguments will be very policy-based, for sure.
Stephen Palley:
Yeah, that’s right. One of the things, they’ve argued that for example that XRP is currency and therefore it can’t be a security which I don’t think is accurate. That was an argument that was raised in either the Kik, or I think that was the same argument that was made in the Kik case and the judge was not persuaded. So, there’s that. I know they argued that they were going to give it to the Supreme Court and there would be the Ripple case instead of the Howey case. I think that that’s someone’s huffing their own supply. It seems unlikely. I’m sorry, go ahead.
Laura Shin:
All right. Well, let’s actually, just because maybe not all listeners will know how a security is defined, especially if there are new people because as we all know crypto is coming up. So, let’s just talk about how is a security defined in the US and then if you could walk through how you think, or how the SEC makes its case that Ripple’s actions with XRP do fit that definition.
Stephen Palley:
Gabe, why don’t you take this?
Gabriel Shapiro:
Sure. So yeah, the term security is actually defined under a few different laws but aside from very subtle variations they’re mostly the same, so under the Securities Act of 1933 which was the first major Federal securities law you know, it includes a long list of things such as stock, such as evidences of indebtedness, and so on. Among those things is the term investment contract and investment contract is the one among that list that the SEC and others have most focused on as a theory for how tokens or token transactions or token offerings can constitute securities or securities offerings or securities transactions, and the principal test for whether an investment contract exists is called the Howey Test. It’s the name of a Supreme Court case involving orange groves, and the test is quite simple. It basically says that an investment contract is a contract transaction or scheme in which there is an investment of money in a common enterprise with the reasonable expectation of profits from others, so there are essentially four elements. And that test has been further interpreted over time, so for example investment of money doesn’t just mean giving money, it can also mean other forms of value or benefit that someone contributes to the issuer. So, essentially what the SEC is saying is look, Ripple created this in effect, or in any event they had a lot of it, they were selling it, and when people were buying it they were buying it because this company Ripple exists, the company was saying hey, we have all these great products that we’re going to put in place with banks through commercial deals, and those products are going to use XRP, the cryptocurrency and that blockchain, and as a result of that there’s going to be a lot of demand for XRP and therefore the price will go up because this will essentially become the new de facto universal interbank settlement method which is a great thesis, but the problem with that thesis is that without Ripple there to supply these other technologies and do the deals with the banks, that XRP wouldn’t have that value proposition and probably a lot less people would buy it and they would spend a lot less money on it, and so that’s the basic thesis of the SEC’s arguments.
In addition to that, the SEC didn’t really get into this heavily in the complaint although it’s hinted at, shortly before the lawsuit was filed there was a report from several computer scientists at the University of Bern where they basically analyzed that the blockchain itself, the technology is centralized because although you know, Ripple Labs claims that its list of trusted nodes is just sort of optional, it turns out if you don’t follow exactly that list you know, the blockchain just wouldn’t be secure or it wouldn’t be live, and so it’s also centralized in that way and that’s another distinction from you know, cryptocurrency such as bitcoin and ether.
Laura Shin:
Yeah. I mean, the SEC really hammers home that Ripple was the one that was responsible for whether or not XRP was successful and that they themselves kind of made that case for the SEC. I mean, there’s just so many choice quotes here. Yeah, like what are some of the good ones? Oh, and not only that but like Ripple keeps talking about how their, so they have this asset but then after having the asset then they tried to develop a use for it which again, it’s like if it were…
Gabriel Shapiro:
The tail wagging the dog. Yes.
Laura Shin:
Exactly.
Stephen Palley:
Well, the problem with Twitter, and I say this as a litigator, it’s a benefit if you handle disputes is that it’s such easy evidence. Everything is there, so paragraph 47 of the complaint, the SEC says is cryptographer-1, who I believe actually somebody, it’s Schwartz, so I actually think he made his…
Laura Shin:
Yeah, David Schwartz.
Stephen Palley:
David Schwartz actually changed his Twitter handle to cryptographer-1, so as cryptographer-1, a well respected and a Ripple spokesperson, stated in a recent Tweet on Twitter, “The people who created XRP are pretty much the same as the people who created Ripple and they created Ripple originally to among other things, distribute XRP.” I mean, you have to back up from a second to think about how this is going to be resolved. Just imagine a Federal judge who’s got a big docket and handles all kinds of cases, criminal and civil, commercial disputes, whatever. This is not a person who’s like deep in the weeds in crypto, they’re not, like the universe closes, it becomes more narrow when you’re in litigation. I think if you read that, if that proves to be true, it’s very difficult to take statements like that, and that statement is probably…there’s an evidentiary theory basically. That statement is probably attributable to Ripple as what’s known as a party upon statement. In other words, it probably can be said that that statement made by…the SEC will argue that that statement made by somebody very high up in Ripple is attributable to them so if that’s a statement that Ripple made, statement after statement like that being read by a Federal judge, it makes it very hard to see how this wasn’t something other than a centralized moneymaking proposition. Now being a centralized moneymaking proposition doesn’t make you a security necessarily, it doesn’t make you an investment contract necessarily, but it becomes evidence of that. It’s sort of indicia of that because you have to look through this and ask, what was the purpose of this thing other than to be a speculative asset? It just doesn’t really add up.
Laura Shin:
Yeah. There’s a number of these choice quotes, I’m not going to list all, but there was another one. Again, it’s cryptographer-1 who explained in XRP chat in response to the question, if Ripple fails would XRP die? And he said that he didn’t “think it’s likely XRP would succeed without us, though it’s possible.” So, yeah, and there are just so many.
So, one thing then I also wanted to break down is…so we did talk a little bit about the cases against Chris Larsen and Brad Garlinghouse, but in this case you know, what do you think of the SEC’s evidence and how likely is it that they’ll you know, be held responsible in some way as well?
Stephen Palley:
So, this is a prediction and I guess I could be wrong, I have to hedge because I’m a lawyer. Ripple’s going to lose, Garlinghouse and Larsen are going to lose. They’ll monkey around, they’ll file motions to dismiss, they’ll be denied. They probably do some discovery, maybe they take some depositions. Presumably in the enforcement action they took depositions, so depositions for people not familiar with the way litigation works in the United States, those are statements under oath, the examinations of witnesses, and they will probably file cross motions for summary judgement and they’re going to lose. Unless there’s a limitations argument or unless they get a sympathetic judge who reads through this and is convinced that this was not an ongoing securities offering, they lose and they probably settle. Now obviously if I had inside information about the litigation I wouldn’t be talking to you, but it sems like a reasonable way for this to be resolved is I don’t know, they got 600 million so maybe they pay 550 to the government, they keep 50 and something called a fair fund is set up and people can basically get reimbursed for the cost of their XRP. The case, it sounds like they were talking settlement, you can kind of see that. I think they actually talked about that publicly on Twitter. I think the case ultimately has to be settled, I don’t see it going up to the Supreme Court. If they take it up to the 9th circuit they probably lose, I don’t see the Supreme Court taking their side on this because think about it, too, like does anything really care about these guys who made 600 million dollars selling this digital asset? It’s not like…if I were going to take a case to change the law and to change how we look at digital assets, this isn’t the one that I would take because they’re not sympathetic. Now we haven’t seen their answer or their motion to dismiss, but…
Gabriel Shapiro:
What about the remedy.
Stephen Palley:
Yeah, go ahead, Gabe.
Gabriel Shapiro:
What about the remedy, though, Stephen? I mean, what about the interests of the XRP holders? I do wonder about this and sort of worry about it. You know, Grundfest you know, who’s a former SEC…
Laura Shin:
Joe Grundfest.
Gabriel Shapiro:
That’s right, who was a former SEC commissioner himself and now teaches law at Stanford, has talked a lot about token stuff and is no pro token guy you know, you can find his videos on YouTube at one point arguing that bitcoin is a security you know, which is the one thing that everyone now agrees is not a security.
Stephen Palley:
Yeah, I remember.
Gabriel Shapiro:
He wrote a letter to the SEC you know, and now he’s an advisor, an unpaid advisor to Ripple, but he’s a credible guy, he doesn’t just do things, and he expressed a concern like well, this is really, really harming XRP holders you know, who are supposedly the victims in all this, and so part of me does wonder I mean, is a satisfactory remedy here to just destroy all of this and compensate people? How could you ever compensate people, so many people have bought and sold this you know, and many won’t want to KYC themselves. So, personally you know, what I would think is a much more reasonable remedy is that Ripple becomes an Exchange Act reporter you know, and…
Laura Shin:
I’m sorry, an exchange what?
Gabriel Shapiro:
An Exchange Act reporter, basically an SEC reporting company.
Laura Shin:
Oh, an SEC reporting company.
Gabriel Shapiro:
Like Apple or like any other public company, and then XRP holders would get the disclosure that investors should…
Stephen Palley:
So, where would you be able to…right, so if that happened…
Laura Shin:
But then I think that kills XRP, right?
Gabriel Shapiro:
It might. Yeah, I mean, that might still, but they might be able to find ways to generate value for it but yeah, it’s tough.
Stephen Palley:
It kills the utility but also, where would you trade it? I know that Coinbase, they’ve got a broker dealer but I don’t think they’ve been given the green light to use it. None of the exchanges or broker dealers are given the…
Gabriel Shapiro:
You know, these things are going to emerge. Right, these things are going to emerge. I mean, I think it’s inevitable that many of these tokens will be securities, right? So, this issue has to be faced at some point anyway, right? And you’re right you know, there will be challenges to keeping it valuable or maybe finding some new utility for it as a potential security, but is completely destroying it for sure really better than giving it some fighting chance?
I mean, most of the XRP holders, you see them on Twitter, they’re actually not mad. I mean, they have every right to be mad but the only thing they’re mad at is the SEC, right and they see Ripple as the victim. So, they clearly want this to go on, so maybe let it go on and just make Ripple Labs an Exchange Act reporting company. Would that really be so bad? I don’t know.
Laura Shin:
Yeah. I mean, I think then you know, like so the SEC really makes a strong case that Ripple didn’t really have much by way of revenue except from selling XRP and so their big cash cow would be killed, and so I have a feeling Ripple wouldn’t be super excited about making XRP a security because then you know, it’s like then they cut off their big flow of cash that has been coming their way, 1.38 billion dollars’ worth.
But one other thing actually before we go to break that I just want to ask quickly. Stephen, when you said you thought what was most likely is that they would have to disgorge 550 million and they keep 50 million? Why would they even keep 50 million?
Stephen Palley:
Well, I don’t know if that’s…
Laura Shin:
Like that’s a huge…
Stephen Palley:
Well, I’m not…I don’t know if that’s likely or not, what I’m thinking is if I were the defendants you know, in the end if you are pushed to settle, so fine. Maybe once you have that much money 50 million dollars doesn’t seem like very much, but…
Gabriel Shapiro:
Right.
Stephen Palley:
…if there’s a way…I know of other cases where people disgorged a significant amount but were also able to keep a significant amount.
Gabriel Shapiro:
And keep in mind as well you know, Ripple’s fighting a multifront battle here, right?
Stephen Palley:
Yeah, that’s right.
Gabriel Shapiro:
Because it has the class action, it has this case against the SEC and now its equity investors are pursuing it…
Stephen Palley:
Yeah, that’s for sure.
Gabriel Shapiro:
…arguing that you know, that Ripple’s required to redeem their stock now at the investment amount and it probably is creditors, problem has commercial partners. It has employees, right? They earn salaries so yeah, I mean, there could be a lot of people with their hands out here and most likely this will be a total disaster.
Stephen Palley:
Yeah, and so I don’t know, maybe we should explain what that lawsuit is by their investors. Gabe, do you want to talk about that?
Laura Shin:
Okay. Well, let’s do that right after this break. So, first we’re going to take a quick word from the sponsors who make this show possible.
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Back to my conversation with Stephen Palley and Gabriel Shapiro. So, we were just saying we were going to talk about the Tetragon case against Ripple, they were the lead investor in Ripple’s most recent fundraising round, so what is going on there?
Gabriel Shapiro:
Yeah, so there’s not a lot of detail because the complaint has been filed confidentially in the Delaware Court of Chancery which is the biggest corporate law court in the world, the most prestigious, the best, all those things because Ripple Labs is a Delaware corporation, but what one can infer from the press reports is that Ripple has in its Certificate of Incorporation and other investment documents from its last preferred stock financing a provision that says something like if XRP is found to be a security then Ripple is required to redeem the preferred stock at presumably its original investment amount or something very close to that.
Stephen Palley:
So, basically they got to pay the money back that their investors gave them, essentially.
Gabriel Shapiro:
That’s right. Exactly.
Stephen Palley:
And what Ripple said was well, there hasn’t actually been a finding that XRP is a security and we don’t have the investment docs, we don’t know what they say, but that’s what they’re fighting about, and to Gabe’s point there are probably other people out there, too. I mean, it’s interesting. I don’t know, how typical is a covenant like that in financing documents, Gabe? I guess we’d only have that…
Gabriel Shapiro:
Well, redemption provisions are common…
Stephen Palley:
Sure.
Gabriel Shapiro:
…but not tied to some regulatory finding and it shows that everyone knew for a long time that…
Stephen Palley:
Exactly.
Gabriel Shapiro:
…it is a tangible risk. Yeah.
Laura Shin:
I know. Even just knowing that that clause was in there I was like, if I were an investor and I was going to sign a contract with this clause in it, I would be like ding ding ding, maybe you shouldn’t sign this contract. Maybe this is not a good investment to make. That was just my opinion but maybe I would be a very conservative and well, I was going to say bad investor but maybe I’d actually be a good investor.
Stephen Palley:
Look. I mean, people wanted big returns and you know, they were willing to take…
Gabriel Shapiro:
It’s actually the opposite. I mean, if you can get that deal and you know it’s Ripple, Ripple has a lot of money, Ripple had a lot of money back then you know, it’s going to keep selling these things, it’s almost like a risk-free investment you know, so far from being a red flag, I bet the investors were more like going ka-ching. Heads we win, tails they lose, you know what I mean?
Laura Shin:
I see. Yeah, that is true. It is kind of funny, everybody seemed to know. Well, so just while we’re also talking about you know, kind of like other entities that are affected by this, I was just curious because as you’re reading through the lawsuit the SEC just keeps mentioning all these other entities and you know, I mentioned earlier this market maker that you know, they were emailing about the timing of the selling to you know, time it to announcements so they could make the most money from those announcements, but I was just wondering like do you think, would any of these other actors that are named in it be affected in any way, like would the SEC you know, I don’t know, go after them? I’m not sure how this works, but could it affect any of them or any of the exchanges that are now delisting XRP or anything like that?
Gabriel Shapiro:
Well, I mean, one you know, just to your last point, right? One interesting factor here is that Coinbase just filed for its IPO a week or two before this XRP lawsuit and one wonders a little bit about the timing of the lawsuit in light of that, and you know, Coinbase has suspended XRP from trading, but the SEC has a lot of leverage over a company that is looking to IPO because in order for a company to IPO the SEC has to approve its S1, also called its registration statement that registers the shares. The SEC has very broad discretion in the reasons why it can deny that approval, and so the SEC can use that process as leverage against Coinbase, either to get Coinbase to atone for its past sins or to have tighter controls that it won’t repeat them and so on, and you know, obviously if XRP is found to be a security you know, that’ll make it even easier for the SEC to do that.
On the other hand you know, in all these past cases like the Telegram case for example, was really all about underwriting concerns you know, that the investors were acting as underwriters and none of those investors were registered as underwriters, and yet doesn’t seem like the SEC is going after any of these investors under underwriting theory. So, what they do tend to do is they tend to rack up a win and once they’ve won they tend to move onto other things. One might call that unfair in some ways you know, and perhaps it’s not even a smart enforcement strategy because if the money is sort of you know, never suffering the consequences it’ll just keep flowing into the same types of schemes, but in the past they haven’t really gone after these ancillary players.
Laura Shin:
Yeah. I mean, there is that lawsuit against Coinbase, although I did see, Stephen, you Tweeted that you didn’t think it was serious or well done but it is true that there are a lot of companies that made money off of trading XRP, even as like I would say you know, some huge percentage of people in the industry thought XRP was a security, we’ve thought that for years you know, like I remember when I first learned about the Howey Test it just, as I really learned about it I kept thinking, so if all these things are what makes a security, then how is XRP not a security? And you know, there have been like a ton of articles people have written about this forever, so given that most people were of that opinion, like do you think that SEC is just going to be like oh, well, it’s just too much to go after all these people that were making money off of what they knew was probably you know, just going to be a short, fun, free ride?
Stephen Palley:
I can’t speak to who else the SEC might or might not go after but I think you know, that as far as I know there’s only one exchange in the United States where XRP can still be bought and sold. I guess I’d be surprised if they went after exchanges, so the issue is if something is a security and it could either be registered as a broker dealer or you need to be a national exchange or you have to have appropriate registration and none of these exchanges did, and presumably…I mean, I know that some companies looked at the lawsuit and just immediately said no and delisted, but others may have been in touch with the SEC. I’d be surprised if there were follow-on enforcement actions by the SEC against exchanges. I don’t know, Gabe, what do you think?
Gabriel Shapiro:
Other than maybe this Coinbase thing where it may very easy for them to do something because Coinbase is at their mercy for the IPO.
Stephen Palley:
Yeah.
Gabriel Shapiro:
Yeah. I agree, I agree.
Laura Shin:
Yeah, I think what was interesting to me was that, so Coinbase is suspending trading in XRP the day that this episode comes out, Tuesday January 19th, and so I actually thought because their reputation is, or it used to be at least of being kind of the conservative exchange and very regulatorily compliant, and because of the fact that it’s going public, I would have thought that they would have delisted much sooner. So, yeah, I found that a little curious.
Stephen Palley:
It’s complicated because you have to give people time to get their assets off the exchange. I don’t know if they’re still doing buy/sell but if they are maybe you have to give people the opportunity. Did they shut off the money?
Laura Shin:
So, Tuesday is when that…yeah.
Stephen Palley:
Yeah. So, it seems like you have to balance between you know..you’re sort of damned if you do damned if you don’t, but I think it’s fair and reasonable to give retail consumers the ability to cash out or move their stuff and you know, maybe somebody hasn’t logged in for a while, they don’t check their email right away, there are plenty of people that don’t check this on a daily basis. Having a couple of weeks to give people the opportunity to move their assets off of the exchange I think makes sense and I’m not sure, I mean I don’t know that the SEC would be too upset about that.
Laura Shin:
Okay. So, one thing that I want to go back to is, so we talked at a few points about Ripple’s Wells submission, so can one of you describe what Ripple’s arguments were in the Wells submission?
Stephen Palley:
I think one argument was, and to be candid I actually haven’t looked at the Wells submission in a little while, but one was the argument that Kik made which was that it’s currency and therefore can’t be a security. They also argued that you know, they’d been selling it for a long time and the SEC had never complained, and there was almost like a sort of a regulatory estoppel argument, but you know, the parallel argument to that is look, I’ve been robbing the bank every day. I’ve been ripping off this ATM every day for the last you know, five years and the police car drives by and they never say anything. I’m not sure that that’s a terribly, it’s not a really persuasive argument. There is a theory in law called regulatory estoppel by which you can…
Laura Shin:
I don’t even know what that means, estoppel.
Stephen Palley:
Estoppel, it’s an equitable theory. It’s basically the notion that you can prevent someone from taking a position because you relied on them doing something else or saying something else. It’s nearly impossible to make that argument in the United States because a regulator did or didn’t do something and you relied on them that they’re estopped, or basically stopped or prevent it from taking action going forward. There was nothing in their letter that I was terribly persuaded by but it’s been a while since I’ve read it. Go ahead.
Gabriel Shapiro:
And I don’t know that the full letter was actually published. I think they…
Laura Shin:
No. Yeah, it’s like a summary.
Stephen Palley:
Yeah.
Gabriel Shapiro:
…published a summary of that.
Stephen Palley:
Yeah, that’s right, they published an outline summary. That’s correct.
Gabriel Shapiro:
Yeah, and there were a lot of…I’m just refreshing my memory now, a lot of it was about how useful XRP is you know, without Ripple and stuff, which is just not true, right? Because again, Ripple pays almost every node on its trusted list. They are almost all paid by Ripple. There were a bunch of universities, Ripple commercial partners, companies that Ripple had invested in. There’s only one that claims to be independent, right? And so I think if Ripple goes away I just don’t know how this, even in the technology itself would safely function.
Laura Shin:
Yeah. So, going back to the Wells mission, the one part of the summary that I saw some people Tweeting about and that really struck me as just a really bad argument, frankly, was that if the SEC finds XRP to be a security then it “innovation in the cryptocurrency industry will be fully seeded to China…”
Stephen Palley:
I mean, yes, I remember that. That’s a crazy, crazy argument.
Laura Shin:
But let me finish, “…the bitcoin and Ethereum blockchains are highly susceptible to Chinese control because both are subject to simple majority rule.” I was a little bit like okay, if this is your argument I’m not sure this is going to succeed, especially because…
Gabriel Shapiro:
Yeah, that’s kind of a shock, especially considering the caliber of lawyers they have, it’s shocking that you know, that that would be their argument.
Laura Shin:
Yeah, and especially because the SEC has already deemed that bitcoin and ether are not securities so to rely on that, it’s just sort of like okay, if you’re going to try, like make a good attempt here, like why did you go down this path? But anyway, okay.
Stephen Palley:
Because you know, there’s a saying that lawyers have which you’ve probably heard, when the facts aren’t on your side you pound on the law, and when the law is not on your side you pound on the facts, and when neither the law nor the facts are on your side you pound on the table. So, that’s basically why they’re doing it, the law and the facts are bad and the best lawyers in the world…people have a mistaken understanding of what lawyers can do. Gabe and I are both very good, I would say among the best, but you know, like if you’re caught on video robbing a liquor store, I could argue that you had a troubled childhood. I actually had a case, it reminds me. When I was in law school I clerked for the public defender, this was a PD case and we actually had a client who was in fact caught on video robbing a liquor store and he wanted to go to trial and we were like, but the video shows you. That’s you. He’s like, it’s not me, it’s like…it’s you. So, it’s kind of like…so we actually, we tried that case and he lost but he got to be out of jail for a couple days. It’s kind of like you know…sometimes people…
Laura Shin:
There’s an epidemic of this type of behavior in our society right now I feel like.
Stephen Palley:
Well, I think that they may believe this, right? I think they may have like…
Laura Shin:
Oh, wait, Ripple.
Stephen Palley:
Yeah. No, I think that Ripple and Mr. Garlinghouse and Mr. Larsen…
Laura Shin:
They believe that China will control but…
Stephen Palley:
I think they believe that they have created some sort of revolutionary technology. I think they probably believe at this point that it’s not a security and that they’re being unfairly targeted and the law should change, so I think that they actually probably believe this. It’s preposterous but if you tell yourself a story for long enough you know, sometimes you believe it. So, I’m just a simple country lawyer, that’s what I feel.
Laura Shin:
Yeah. Yeah. No, there definitely was a lot of cognitive dissonance in the SEC’s lawsuit. I mean, like I said, it’s literally just quote after quote you know, I mean, it’s a pretty damning document but it’s very interesting because even while Brad was saying things like oh, I’m extremely long XRP, I mean, he was selling it but not disclosing it and making tons of money off of retail investors, so you know, it was pretty…I don’t know him personally, I’ve never met him but for him to keep saying that he’s extremely long XRP, meanwhile he’s doing all these sales behind people’s back, I mean it’s a little bit like okay, either you just sort of lived with that cognitive dissonance and didn’t recognize it as such or you, you know, I’m not going to speculate what was going on in his head but…
Stephen Palley:
I think you would also say, so just to be devil’s advocate here. Somebody else pointed this out, I can’t remember who I was talking to, but one of the allegations is that okay, one of the things that the SEC puts out there as being problematic is that Ripple was paying people to use XRP and it is true that that is not an unusual Silicon Valley play to get an option. PayPal did that, I think Stripe did that, so paying people to use your product or use your service is something that other companies have done, so maybe that’s something that we’ll hear them come back with. So, for example in paragraph 123…
Laura Shin:
Yeah, but I mean, like…well, just but to use PayPal or to you know, use Stripe or whatever, like doing that isn’t engaging in some kind of unregistered securities offering, right?
Stephen Palley:
No, it’s not. Yeah. Right, when you used…I can’t remember what it was but I think when PayPal first came into use I think people were paid, was it five dollars?
Laura Shin:
I think it was 10 dollars if they got a friend to sign up. Yeah.
Stephen Palley:
Ten dollars, to register? Yeah.
Laura Shin:
So, we did also reference a little bit some of the other big SEC enforcement actions in the cryptocurrency industry. I think the ones probably that are most relevant for this case are Kik/Kin as we mentioned, maybe EOS simply because that was one that a lot of people were you know, thought it was pretty egregious because it was a year-long ICO, I think they claimed to block US investors but then they had that big advertisement in Times Square…
Stephen Palley:
Yeah, so…
Laura Shin:
And then of course, Telegram. So, when you look at those, like if you were to read the tea leaves how do you think…I mean, I know Stephen, you want to give your opinion but just in that context?
Stephen Palley:
Oh, this is more like Kik or Telegram.
Laura Shin:
Oh, it is?
Stephen Palley:
Yeah, yeah. So, like with EOS, whatever you think about the technology or the company or the folks involved, they settled and also according to the, I think it’s the consent agreement, the consent order, they really actually did try and block US persons. I know they had that sign in Times Square, it was stupid, but they did do some form of geoblocking, they did actually try and block people in the US. They paid 24 million dollars and you know, they settled and you know, they took the offer.
Laura Shin:
And I think the other difference is that Kik and Telegram were companies that existed before they tried to do this token, and Ripple in a way…so Ripple was actually, wait, how does it go? It was a little bit different where the company was incorporated after, but it’s similar in that the company was just so closely associated with the cryptocurrency and obviously they have you know, what is it, 55 percent of…yeah.
Stephen Palley:
Right. I mean, Kik had a social media app, right? And you know, Telegram is used by 500 million people to communicate. I mean, they are real enterprises that have real users that do real things, and you know, here it’s…I’m sure Ripple would say look, we have enterprise software that’s used by all sorts of banks. I’m not sure how much traction they’re going to get. It does seem like, at least if you read this complaint the principal purpose of the company was to get people to buy and sell XRP and to create market value and create liquidity.
Laura Shin:
Yeah.
Stephen Palley:
And that was not the principal purpose of Telegram or of Kik and they didn’t come into existence to sell a cryptocurrency.
Laura Shin:
Right. So, Stephen, you did talk about how you think this case will go. Gabriel, do you have any thoughts on what you think maybe…
Gabriel Shapiro:
Yeah, I basically agree with Stephen. I mean, I think Ripple will lose. I would say I’m less certain that Garlinghouse you know, that the founders will have independent personal liability, we’ll have to see about that.
Stephen Palley:
Yeah.
Gabriel Shapiro:
But certainly Ripple will lose in my mind, and I’m more just curious about what the remedy will end up being because you know, in the case of Kik and Kin, right, they lost but really, like Kin is still out there and actually like Kin holders were very happy with the outcome, that no one was forced to become an SEC reporting company. They had to pay a fine, but they were left with some money, like Stephen was talking about, and you know, it’s gone up. It’s actually gone up since the lawsuit, it’s gone up in price since the lawsuit ended because it no longer has this cloud hanging over it, worried that Kin itself is a security.
For Telegram on the other hand, it was completely disastrous, right? I mean, Telegram has, as Stephen was saying, it has a real app so it’ll be fine, it has money, but it had to give all the investment back, now it’s raising a debt financing round, and all of the value and time and opportunity cost that went into this was a complete loss. They were just enjoined from doing it flat out and so that’s a huge loss. That’s like a total wipe out, you know, of that part of their business history.
And then with Block.one you know, it’s kind of interesting, right? They’re a little bit of a combination, right? You know, they had much better lawyers I will say, much better dealers you know, because the way they documented their thing which gave them much stronger arguments that they were producing software, that they walked away from it once it was done, and EOS is kind of a self-sustaining thing. You could say it’s a bad blockchain because it has collusion and all that stuff, but it’s not Block.one doing the collusion. If anything you can fault you know, morally fault Block.one because it’s just not doing anything to like increase the value of that ecosystem or not doing that much. So, they’re all very different and I think the real thing that they all have in common is that a lot of ordinary people bought the token hoping to get rich in circumstances where they don’t have all the information and where they’re highly dependent and vulnerable upon other people who also are trying to get rich off of it but in a different asymmetrical way and that’s what all these things have in common despite the apparent differences and that’s why the Howey Test is kind of a genius test because it’s very functionalistic and it’s designed to capture this dynamic where people are vulnerable with their money and investment expectations in a particular way and they all have that in common.
Stephen Palley:
And that again, I mean, going back to what we said at the beginning, that information asymmetry is one of the principal reasons for our securities laws, to make sure that investors are if not on parity or equal terms with insiders, they at least have a guarantee of some quality information so that they’re not taken advantage of. And you can tell that that’s one of the principal purposes or one of the principal themes in this lawsuit by the SEC.
Laura Shin:
Yeah, I mean, and they really make that case that you know, the insiders knew certain things and were making money off of the fact that the people they were selling to didn’t know those things. So, Gabriel, something that interested me about what you just said is that you thought that there was a chance that like XRP survives and then that would be good for XRP holders, and I did see like you know, for instance Japan’s financial authority I think said that XRP is not a security, so I did wonder like, so what happens in that case if the US does…so either one, either that you know, like you said somehow something happens to Ripple but XRP survives or if the US just determines that XRP is a security but other countries make a judgement, like different judgement, how would that affect XRP?
Gabriel Shapiro:
Well, in the second set of facts you mentioned, I mean I’m just speculating here, right? But you know, people are pretty creative, especially if they have a fair amount of money or the ability to get more money, and certainly Ripple has a lot of fans. One thing they could do is just try to…it’s already you know, in my opinion, a centralized chain. They could just add KYC to it, right? You know, and they could just really try hard to exclude US persons, get cozy with some other regulator that says it’s not a security, and keep trying to do their thing with the US just almost totally blacked out. That’s a possibility I suppose if they have enough money left over and so on. Another thing that maybe they could do, although you know, I agree that this might be even more challenging is to embrace that XRP is a security or embrace that certain transactions in XRP are securities, and to kind of keep doing their thing, maybe find some alternative uses for XRP that don’t involve banks because banks sure aren’t going to want to settle all their ordinary transfers in a security, but maybe they could come up with some stuff. I mean, people are good at coming up with ideas of stuff to do with tokens that sound good to people, and maybe they could become an Exchange Act reporter and they could just openly put forth efforts to drive value to this token.
One of the ongoing metaphysical issues, and I’ve had debates with another lawyer named Lewis Cohen about this is what is the security, right? Is it this token, is it always a security or is it only certain transactions in it which are a security, and so on, and you know, the SEC’s complaint fudges that a little bit. It does call XRP a security but on the other hand you know, it’s really talking about these times when Ripple or Garlinghouse sold it, right? And so it’s possible that a judge could craft a remedy that you know, says well, this is a security or transactions in it are securities in certain circumstances and not others and you know, Ripple, you become an Exchange Act reporter so everyone has the information but you know, and when you sell, it it’s a securities transaction but when it’s in the secondary market it’s not. Something like that is possible, so we have to see, you know? I’d be interested to see what the remedy ends up being because the judge ought to care about the XRP holders you know, in my opinion, right? And he ought to try to do the least harm to them possible.
Laura Shin:
Okay.
Stephen Palley:
So the question is, who’s going to make, I guess the people who will make that argument will be Ripple’s lawyers.
Gabriel Shapiro:
Yeah, at the remedy stage.
Stephen Palley:
At the remedy stage but I mean, obviously out of self interest in minimizing harm to their own, so the SEC overall response will be yeah, right. You don’t care about them, you’re arguing out of self-interest. But yeah. No, I think that’s a fair point.
Laura Shin:
Interesting. Yeah, it strikes me as incredibly complicated to say oh, it’s a security in certain transactions but not in others.
Gabriel Shapiro:
It’s incredibly complicated but…
Laura Shin:
Does that exist? Is there another additional…
Gabriel Shapiro:
Okay, so…
Laura Shin:
…any other asset that is a security for certain transactions but…
Gabriel Shapiro:
Yes. Well, there are other tokens. I mean, this flavor of thing is something that’s been embraced by some securities lawyers and to a certain extent by the SEC itself, this more functionalistic interpretation you know, where given thing could be a security and not of a…I talked about Grundfest earlier. I would take him to be sort of a leading proponent of this in the way that he talks about tokens, that certain transactions in bitcoin, for example, are securities.
Stephen Palley:
Well, isn’t the argument is that…so we have to parse security, so we’re talking in an investment contract and so…
Gabriel Shapiro:
Well, that’s Lewis’ thing, but there is an example because one token, the STX token from Blockstack, they did an actual RegA plus offering for their token and that means that they qualified it as a securities offering, and the SEC asked them a lot of questions as part of that. One of the questions they asked for example, is well, does the fact that you’re holding a bunch of STX tokens that you’re later going to sell, does that mean you’re an investment company or something like that, or does the fact that some of the tokens were being burned at the same time as you’re selling them, right? Does that mean you’re buying and selling your own securities at the same time which can be a violation of regulations, and it made a lot of nuanced arguments that are very functionalistic about well, when it’s here, when we hold it in this circumstance it’s not a security. When it’s being burned that’s not a securities transaction for this other reason even though the issuance is being true to the securities transaction. And personally although yes, it’s complexing nuance, I actually think that type of thing makes a heck of a lot of sense so you know, because sometimes the securities laws just aren’t implicated in a particular transaction and you don’t need to be so essentialist and literal about it, but we’ll see.
Stephen Palley:
Well, yeah, no, and I think the argument that I think you were going to say that Lewis makes is that, and this is Lewis Cohen who is a very fine securities lawyer in New York, practices in a firm called DLx Law, the argument is in order for these tokens to fall within the definition of security we have to consider whether or not they are part of an investment contract, and I think he would distinguish between the transaction which involves a contract, and the asset itself, so he would say sure, like when Ripple buys and sells it, it is part of an investment. That transaction is an investment contract that covers this asset but the asset itself is not an investment contract and so therefore it’s not a security. I mean, whether or not a judge buys that argument, there’s maybe something to that from the standpoint of kind of getting a good result for retail investors, you could see that argument having some suasion.
Gabriel Shapiro:
Right. Well, I mean, so where I disagree with Lewis though, right, is that when the retail investors are buying it that’s the time it’s most like a security, right? You know, he thinks that’s when it’s least like a security. For example, if banks were trading it amongst themselves as a form of settlement, I mean, the reason why they’re doing it is actually why the banks would be trading it…
Stephen Palley:
No, there’s no securities purpose.
Gabriel Shapiro:
…would not be to invest in it, and so maybe you could treat the retail ones as a securities transaction, make Ripple Labs a securities reporter, but when the banks are trading it that’s not a securities transaction because they’re just using it as like a monitoring equivalent. I don’t know. It probably won’t go there but I’m just saying that if someone were inclined to be creative and fashion it, there are doctrinally coherent possibilities.
Laura Shin:
Yeah, even just listening to that right now I’m a little bit like implementing that is going to be such a headache I can’t imagine somebody actually is like this is what could happen …
Gabriel Shapiro:
You’re probably right, you’re probably right.
Laura Shin:
…it’s like way too complicated. All right. Well, so we’ve covered a lot of things here, but I guess just to sum up, both of you think what’s most likely to happen is there’s going to be some kind of settlement and Ripple and the executives will disgorge, but maybe not everything because there are other sharks circling the waters and they need to be paid, too. Is that kind of what you think is most likely going to happen?
Stephen Palley:
I think they monkeyed around with this litigation for a year maybe, they have some motion practice. I think Ripple, and I actually agree with Gabe, so the Securities Act violation is strict liability, there’s no scienter requirement. If it’s a security you have to register it, it has to be exempt. There is an intent requirement for Garlinghouse and Larsen for the Control Act claim so those are already approved. I think it’s more likely than not they’d lose on motion practice there, too, just based on this very detailed complaint, and then maybe it goes up to the 9th circuit…
Laura Shin:
Wait, they lose…meaning Chris and Brad lose to the SEC?
Stephen Palley:
Yeah, yeah. I think so.
Laura Shin:
Okay.
Stephen Palley:
It may go up to the 9th circuit but it settles at some point. I doubt that the Supreme Court takes it on __, so it’s just a matter of time and expense, and these things, like the litigation cost to get through a year of litigation and complex discovery and motion practice, 5 to 10 million dollars probably is a good estimate.
Laura Shin:
Okay. So, then, last question before we say goodbye on a super fascinating case is you know, XRP has been around like the third or fourth largest cryptocurrency for quite a long time and you know, it’s quite well known, especially when there’s a bubble. You know, I think a lot of us in the industry hear from like people outside the crypto world, like what about XRP? So, obviously this case is going to have huge implications like you know, as big as EOS or Kik or Telegram were, like they’re just not anywhere near the level of something like XRP because of where XRP has been in the crypto rankings for such a long time. So, once this case is decided, however it’s decided, what do you think the implications are for the wider crypto world? You know, what ripple effects do you think it will have?
Stephen Palley:
All right, Gabe.
Gabriel Shapiro:
Fair enough. No, it’s a tough question that’s why you gave us. I think it’s very hard to say. I mean, the way it has worked so far, this is what I’ll say, is that every time one of these cases gets decided everyone in the ecosystem seems to very quickly become confident that the distinctions between their circumstances and the decided circumstance are just very, very different and the case means nothing to them.
Stephen Palley:
Yeah.
Gabriel Shapiro:
I struggle with this a lot as a transactional lawyer because you know, part of my job in negotiating some of these deals is convincing people to do certain things in order to have a better regulatory treatment of a token and you know, I will do something like point to the Telegram case and you know, what I found is that in many cases some of the people around the table are just very, very convinced that it is completely different and that it has no implications…
Stephen Palley:
Right.
Gabriel Shapiro:
…to the current circumstance and I just think the power of the industry to engage in self-denial and also to engage in proactive things you know, what some call decentralization theatre or these maneuverings to try to make each new circumstance look as different as possible from the last, it’s just part of the culture at this point and so I don’t think it will immediately have some big dramatic effect that changes a lot of people’s behavior. I think there would have to be a lot more blood in the water before something like that happens.
Stephen Palley:
I kind of tend to agree. I mean, I find the same thing. Somebody will propose something and you know, we’ll point out Telegram and Kik and they’ll tell us all the reasons why it’s different, and unfortunately you know, there are lawyers out there who will give people the advice, give people the opinions that they want to hear and you know, that perpetuates this sometimes. One of the really interesting things actually about this complaint, one of the most interesting things to me is that it cites the opinions that the lawyers gave back in the day. I’m really curious how they got that, but yeah, I tend to agree with Gabe. I don’t think it will be…it’s just another case you know, we’ve seen over and over again you know, the law is pretty clear and this is another case where I think the conclusion is somewhat inevitable and I think people will continue to believe what they want to believe at their own peril.
Laura Shin:
Yeah. Actually just answer one last question about what you were saying about how did they get that information about the opinions given by the lawyers back all the way in 2012, you were saying that they’ve been under investigation for two years so I’m assuming, is that where most of the information came from in the lawsuit?
Stephen Palley:
I think so but you know, legal opinions that lawyers provide are confidential and privileged and they would not typically be something that you have to disclose. Now it could be that they relied on an advice of council defense which seems silly given the fact that this advice was contrary to what they ended up doing, but unless there was a waiver of some kind or unless like a third party turned it over, typically no, you would not get a privileged legal memorandum, I don’t think. You could hold them back.
Laura Shin:
Interesting. Well, I have my own theories, but anyway, they’re just theories. Okay. Well, where can people learn more about each of you and your work?
Stephen Palley:
Find me on Twitter, Stephendpalley and I am [email protected], and I’ve got a very fancy and impressive bio up on the law firm website that I don’t know who wrote.
Gabriel Shapiro:
I’m lex_node on Twitter and I have a website, I think it’s called dealninja.law. Anyway, it’s linked on my Twitter bio, I have like all my writings and stuff up there and I have a substack, so yeah, I never stop talking so you can definitely find me.
Stephen Palley:
You have a substack, man. You’re super cool.
Gabriel Shapiro:
I try. I’m a little tardy on it, to be honest with you, but…
Stephen Palley:
I think I’m too late. I think substack is kind of like tech talk for me, I just don’t think I’m cool enough.
Laura Shin:
Stephen, I think we’re in the same club.
Stephen Palley:
Yeah, I hear you.
Laura Shin:
All right. Well, this has been so fun. Thank you both so much for coming on Unchained.
Stephen Palley:
It was a pleasure.
Gabriel Shapiro:
Our pleasure.
Stephen Palley:
Yeah, thanks so much. Take care.
Laura Shin:
Thanks so much for joining us today. To learn more about Stephen, Gabriel, and the SEC lawsuit against Ripple check out the Shownotes for this episode. Don’t forget, you can now watch video recordings of the shows on the Unchained YouTube channel. Go to YouTube.com/c/unchainedpodcast and subscribe today. Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Nuss, Bossi Baker, Shashank, Josh Durham, and the team at CLK Transcription. Thanks for listening.
