Ripple Investor Sues, Claiming Cryptocurrency Creator Broke Securities Laws Ripple Investor Sues, Claiming Cryptocurrency Creator Broke Securities Laws

Ripple Investor Sues, Claiming Cryptocurrency Creator Broke Securities Laws

A recent lawsuit against the cyrptocurrency startup Ripple sparks additional questions about whether cryptocurrencies can be considered securities and how they should be regulated. Ryan Coffey, an investor in the Ripple cryptocurrency XRP, sued Ripple in a putative class action in California state court in May, claiming the company skated around the securities laws by marketing the XRP tokens without registering them with the Securities and Exchange Commission (“SEC”), in violation of both the Securities Act and the California Corporations Code.

Coffey seeks to represent a class of similarly situated XRP investors, alleging Ripple used unscrupulous tactics to artificially inflate the price of XRP, causing investors like him to lose money. According to Coffey, unlike bitcoin and Ethereum, which are mined by computers validating transactions on their networks, Ripple created XRP “out of thin air” when it was founded and sold the coins in an endless Initial Coin Offering (“ICO”), raking in profits for itself by attempting to bribe cryptocurrency exchanges CoinBase and Gemini Trust Company LLC to list XRP. Although the bribes were declined, rumors swirling around Ripple’s possible addition to Coinbase stirred a sharp price increase. The lawsuit contends that the sale of XRP tokens violates the law, because the cryptocurrency is in fact a security. Ripple has just removed the case to federal court, and it will now be heard in the United States District Court for the Northern District of California.

It remains unclear whether cryptocurrencies can be considered securities, and Ripple’s XRP is no exception. Ripple is one of many cryptocurrency creators who depend upon a distributed ledger or blockchain. When Ripple was founded, it created 100 billion XRP tokens. Eight billion tokens were given to the company, while the three founders of the company received 20 billion. Coffey’s lawsuit isn’t the first time Ripple has been accused of wrongdoing; in May 2015, regulatory authorities fined the startup $700,000 for violating the Bank Secrecy Act by selling XRP without the required authorization.

The Ripple case again brings up the question of whether cryptocurrency can be considered a security and when and if the investments will be regulated by the SEC or by other agencies. This is important, because the current state of cryptocurrency and ICO trading does not offer the same investor protection that the traditional securities markets do. To date, no ICOs have been registered with the SEC.

Last year, the SEC said companies that raised money using ICOs must obey federal securities laws and has warned that exchanges who facilitate trading of digital assets that fit the definition of a “security” must register with the SEC as a national securities exchange.[1] The SEC is stepping up enforcement, too. In September 2017, the SEC charged an individual who was defrauding investors in two nonexistent ICOs. In December 2017, the SEC lodged a complaint against the cryptocurrency PlexCorps for fleecing investors out of over $15 million dollars. And in April 2018, the SEC brought criminal charges against the two founders of the cryptocurrency company Centra for a fraudulent ICO, a venture backed by boxer Floyd Mayweather and producer DJ Khaled.

There are other agencies that are, and will continue to be, concerned about ICOs. These include the Internal Revenue Service (“IRS”), the Commodity Futures Trading Commission (“CFTC”), the Consumer Financial Protection Bureau (“CFPB”), and the Federal Trade Commission. For instance, the IRS has announced it treats cryptocurrencies as property, subject to capital gains taxes.[2] In 2014, the CFTC announced it considers virtual currencies to be a “commodity” subject to agency oversight. The agency has taken several enforcement actions and has issued a number of warnings on cryptocurrency “pump and dump” schemes, as well as cryptocurrencies that falsely portray themselves as “IRS approved.”[3] The CFPB has also put out consumer warnings regarding cryptocurrencies, educating consumers about the lack of protections surrounding virtual currency, potential crypto scams, the risks of digital wallets, and the potentially higher costs of using cryptocurrencies for transactions.[4] Wages paid to employees using virtual currency are taxable to the employee, must be reported on a W-2, and are subject to federal income tax and payroll taxes.[5] And the FTC recently filed a complaint against the promoters of cryptocurrency Ponzi schemes known as Bitcoin Funding Team and My7Network, securing a temporary restraining order. The case is still pending.[6]

While the money lost by Coffey may seem like chump change, his lawsuit may set important precedent in determining whether XRP is a security. If it is, it will be subject to a host of regulatory constraints that it and other cryptocurrencies currently happily ignore. The cryptocurrency securities debate bears close watching, as it could have major ramifications for those who wish to invest in cryptocurrencies of any type and for companies that are exploring the use or production of cryptocurrency.

For more information on data security and cyrptocurrency, contact Stephen Reynolds, Martha Kohlstrand or another member of our Data Security and Privacy Group.  For information on regulatory issues surrounding cryptocurrency, contact Stephanie Courter or another member of the firm’s Government Enforcement and Internal Investigations Practice. For more information on our Blockchain Practice, click here.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
 
[1] “Statement on Potentailly Unlawful Online Platforms for Trading Digital Assets,” The U.S. Securities and Exchange Commission, available at https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading (last visited July 13, 2018).
[2] “IRS Virtual Currency Guidance,” The Internal Revenue Service (Notice IR-2014-36, March 25, 2014),
[3] “CFTC Backgrounder on Oversight of and Approach to Virtual Currency Futures Markets,” The U.S. Commodity Futures Trading Commission (Jan. 4, 2018), available at https://www.cftc.gov/sites/default/files/idc/groups/public/%40customerprotection/documents/file/backgrounder_virtualcurrency01.pdf (last visited July 13, 2018).
[4] “Risks to Consumers Posed by Virtual Currencies,” The Consumer Financial Protection Bureau (August 2014), available at https://files.consumerfinance.gov/f/201408_cfpb_consumer-advisory_virtual-currencies.pdf (last visited July 13, 2018).
[5] Id.
[6] FTC v. DLuca, et al., No. 18-cv-060379-KMM (filed S.D. Fla. Feb. 20, 2018).
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