The SEC Is Not the King
In late 2020, the U.S. Securities and Exchange Commission (SEC) sued Ripple Labs, Inc. (Ripple), and two of its top executives, Brad Garlinghouse and Chris Larsen, alleging that the cryptocurrency XRP which is used by the company in its financial services products is a “security” under the Securities and Exchange Act of 1934.
Dubbed “the cryptocurrency case of the century” by Forbes, the SEC sought billions of dollars from Ripple and its founders for seven years of XRP sales without registering the token with their agency. The civil filing, based on a sweeping legal theory that a digital asset itself is a security, immediately destroyed more than $15 billion dollars in wealth of innocent holders of XRP who had acquired the token on the secondary markets.
On July 13, 2023, Judge Analisa Torres rejected the SEC’s argument that sales of XRP on exchanges is the sale of a security. Torres ruled that sales by Garlinghouse, Larsen and the hundreds of thousands of secondary market traders of XRP on crypto exchanges were blind-bid transactions, where the parties do not know each other nor the provenance of the assets being traded. Therefore, they couldn’t have been securities.
Only a narrow band of XRP sales by Ripple which involved written agreements with institutional investors in the company fit the long-established definition of securities and were subject to fines. The judge made the simple analysis that the SEC had refused to make as the regulator. Instead, it opted for a multi-billion-dollar lawsuit that threatened to bankrupt the individual defendants, a flashy press release, an aggressive legal theory, and a battery of subpoenas seeking personal financial records from the executives as if they were criminals.
In short, the SEC’s central argument for its 31 month-long case that reportedly cost the defendants $100 million to fight, had failed almost completely under judicial scrutiny. It did not just hurt defendants. The SEC harmed a lot of innocent people in the process.
The SEC’s strongarm tactics did not end there. Ripple’s defense team uncovered a trove of internal SEC documents that proved the agency deliberately deceived the markets for years about its position on crypto. In 2018, a senior SEC official misled the public in a speech suggesting the SEC’s position was that an asset like XRP was not a security. Secretly, though, the SEC’s general counsel held the exact opposite position. Did the SEC ever inform Ripple or the public about that secret position? Not until the multi-billion-dollar lawsuit against Ripple.
Not surprisingly, the SEC tried to keep the evidence of its deceit secret even during the XRP litigation by fighting against disclosing it in discovery. Their fight was so legally obtuse that Magistrate Judge Sarah Netburn admonished the agency for its “hypocrisy” and “adopting its litigation positions to further its desired goal, and not out of a faithful allegiance to the law.” It was a keen insight into the SEC’s abusive excess of its legal authority in general.
Indeed, with the legally discredited argument that digital assets themselves are securities, the SEC has also sued the huge crypto exchanges Binance and Coinbase, even seeking to freeze all of Binance’s assets. In sum, these actions suggest that the SEC’s goal may be to destroy cryptocurrencies entirely, wiping out hundreds of billions of dollars in wealth. When asked to explain his position, SEC Chairman, Gary Gensler, glibly stated: “We don’t need more digital currency … we already have digital currency — it’s called the U.S. dollar.”
Au contraire. The SEC’s mission, is “to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets.” Destroying wealth and protecting the U.S. dollar from competition is not its mission. Nor is destroying an entire industry because the head of the SEC doesn’t like an asset class he has no legal authority to regulate.
In a piece last year, I suggested that if a private litigant had brought such a thin case, the law of malicious prosecution might well give the defendants a remedy to recover the $100 million legal costs of fighting it. Now that the SEC’s duplicity in hiding its internal documents and secret positions about XRP has been revealed, the case for intentional wrongdoing by the SEC is even stronger.
Regrettably, the Federal Tort Claims Act (FTCA) protects federal agencies and their leaders from almost all claims based on their intentional, malicious wrongdoing. Under the FTCA, the SEC and Mr. Gensler cannot be sued for abuse of process or malicious prosecution - common-law intentional torts designed to discourage malicious and meritless lawsuits. The FCTA is based on the ancient English doctrine of sovereign immunity.
The theory behind sovereign immunity was that “the king is never wrong.” More than two hundred years after America fought a revolution over precisely that issue, this artifact of the divine right of kings in the FCTA still protects malicious acts by federal regulators against American citizens from any consequences.
It’s important to reiterate to Congress, armed with the outcome of the Ripple case, that the time has come to revisit this archaic provision of the FTCA to allow federal regulators to be held accountable for their intentional wrongful acts. The SEC’s abuse of its authority and the harm it keeps causing innocent people only strengthens the case for amending the FTCA as soon as possible.
Frank Francone is a Policy Fellow at the Centennial Institute and a California attorney admitted to practice before the United States Supreme Court. Disclosure, the author owns small investments in various cryptocurrencies but owns no XRP.
