A class action lawsuit was filed on May 3rd against Ripple Labs Inc.—a fintech startup that controls the third-largest cryptocurrency in the world—and its CEO Brad Garlinghouse, alleging that Ripple sold unregistered, non-exempt securities in violation of federal and California state securities laws.
In their complaint, Plaintiffs characterized the sale of XRP (Ripple’s native token) as “a scheme by Defendants to raise hundreds of millions of dollars through the unregistered sale of XRP” and “what is essentially a never-ending initial coin offering (ICO).” In addition to attorney fees, costs of the suit, and punitive damages, the plaintiffs also request a declaration from the court that the sale of XRP is an unregistered securities sale and to enjoin defendants from further violating securities laws.
Plaintiffs alleged facts that correspond to the elements of the Howey test for determining whether an instrument qualifies as an “investment contract,” and thus, as security, under the federal securities laws. Specifically, the complaint states that XRP purchasers (1) made an investment of money, (2) in a common enterprise, (3) with a reasonable expectation of profits (4) derived predominantly from the essential managerial or entrepreneurial efforts of others.
This lawsuit comes in the wake of heightened SEC scrutiny of cryptoasset token issuances. As we’ve noted, SEC Chairman Jay Clayton has said in recent months that he has not seen a single token issued through an ICO that is not a security.
Ripple’s prominent position within the blockchain ecosystem, the relationship between XRP tokens and Ripple’s enterprise software, and the manner in which their tokens are distributed could form the basis for tremendously impactful judicial precedent with respect to ICOs.
We will continue to monitor developments in this area.