Banks using Ripple’s software for cross-border payments, including PNC Financial Services Group, Bank of America, and Banco Santander, received unwanted news last week when the Securities and Exchange Commission slapped Ripple with a 71-page complaint.
The complaint sheds harsh light on how the company is raising money through the sale of digital tokens called XRP.
According to the SEC, Ripple executives sold 14.6 billion units of XRP for more than $ 1.38 billion to fund the company’s operations and gain personal wealth without registering their offers and sales of XRP with the SEC. Those actions have violated several securities laws, the complaint says. The SEC is seeking to permanently ban Ripple and its leaders from selling unregistered XRP, have defendants “drive out all ill-gotten gains from the transactions,” and impose unspecified civil fines.
What does this mean for the banks that partner with the San Francisco company?
In the early days of Ripple and XRP, some banks were bullish on both.
The capital markets arm of Royal Bank of Canada, a former Ripple partner, enthusiastically endorsed Ripple and XRP in a 2018 report called “Imagine 2025.”
ATB Financial in Edmonton began testing Ripple’s xCurrent software for cross-border payments in 2016. Tim Wan, who was director of innovation at ATB at the time with a net worth of $ 43 billion, saw Ripple as a software company trying to replace the current methods of international money movements (in fact Swift) with a more efficient and cheaper way – “which is respectable. “, he said. “And I believe there is a need.”
But Wan, who is now a member of the digital advisory board of technology company Box, already had reservations about XRP at the time.
“At the time it was still a huge unknown,” said Wan. “I would say it is still a huge unknown.”
The SEC case will affect Ripple’s relationships with banks, he said.
“Banks are built on the idea of trust,” said Wan. “Banks are incredibly sensitive to a perceived lack of confidence in any technology platform used to move money.”
A spokesperson for ATB said the bank has not had contact with Ripple since 2016.
BBVA ran a similar pilot with Ripple in 2017, but didn’t push it forward either. The bank declined to comment on the SEC’s case.
Santander, a major Spanish bank, has been using Ripple’s xCurrent software for cross-border payments since 2018. The bank does not use XRP. PNC went live with xCurrent at the end of 2019. Bank of America has partnered with Ripple since 2016. All three declined requests for comment. Ripple did not respond to a request for comment.
Jay Dubow, a partner at Troutman Pepper who previously worked at the SEC, pointed out that Ripple’s software is separate from the company’s XRP sales.
“As long as the company can arrange the support the software, there should be no problems, ”said Dubow.
US banks have avoided XRP
Ripple has long urged banks to use XRP as a mechanism to move money around the world.
Using Ripple’s xRapid software, banks were able to use their own local currency (e.g. US dollars) to buy XRP. Then, with that XRP, they could buy the foreign currency and use it to make the payment, instead of using a network of correspondent banks.
Euro Exim Bank, based in St. Lucia and London, said last year it planned to use XRP for cross-border payments. The company did not respond to a request for comment.
No US bank uses XRP in this way, at least not publicly.
In an interview last year, Manish Kohli, global head of payments and receivables at Citi, predicted that very few banks will use cryptocurrencies such as XRP in international payments due to the market risk that cryptocurrencies pose.
The SEC’s complaint appears to confirm banks’ cautious stance on XRP.
According to the complaint, Ripple made its money not by selling software, but by selling XRP.
For example, in 2019, Ripple made $ 23 million selling its xCurrent and xVia software, but it raised $ 200 million by selling XRP to investors.
In other words, the vast majority of Ripple’s revenues came from XRP sales, and Ripple relied on those sales to fund its operations.
Additionally, according to the complaint, one of Ripple’s original founders, Chris Larsen, made $ 450 million from the sale of XRP that he donated to himself when he and his co-founders created the first 100 billion. From April 2017 to December 2019, Ripple CEO Brad Garlinghouse sold more than 321 million of the XRP he got when he joined the company and raised $ 150 million.
Ripple’s Potential Defense
The allegations made by the SEC have swirled around Ripple for years, in multiple class actions brought by investors and in off-the-record conversations between people who follow the company.
Ripple and Brad Garlinghouse are likely to argue in court, as they have done in public comments in the past, that XRP is a decentralized digital currency.
In a blog Posted last week, Garlinghouse argued that XRP is not a security because “XRP is not an ‘investment contract’. XRP holders do not share in Ripple’s profits, receive dividends, nor do they have voting or other corporate rights. Buyers will not receive any of their purchase of XRP except the asset. In fact, the vast majority of XRP holders do not have any affiliation or relationship with Ripple. “
Brian Klein, a partner at Baker Marquart who has represented cryptocurrency companies in similar cases in the past but is not involved in this case, said the SEC’s claims have not been tested.
“There is clearly a very different side to this story that has not yet been told and deserves to be heard,” he said. The case could pose an existential threat to Ripple because of the punishments the SEC is pursuing. Unfortunately, just filing this case can permanently damage XRP. That mere allegations of the SEC could be the death knell for a cryptocurrency is very unfortunate. “
The SEC has handled two similar cases, Klein said.
In June, the US District Court for the Southern District of New York approved a settlement with messaging software company Telegram, whose unregistered offering of digital tokens called Grams violated securities laws, the SEC said. Telegram agreed to stop selling Gram in order to repay more than $ 1.2 billion to investors and pay a civil fine of $ 18.5 million. In May, the company stopped its cryptocurrency operation.
In October, a federal district court agreed with the SEC that Kik Interactive’s unregistered offering of digital tokens called Kins in 2017 violated federal securities laws. Kik was not allowed to offer unregistered tokens and will pay a fine of $ 5 million.
“The SEC has been taking many actions against cryptocurrency companies for a number of years,” said Klein. “I think the SEC has unfortunately chosen to use enforcement as a tool to regulate rather than provide clear guidance.”
He would rather see regulators like the SEC work with Congress to make laws to regulate cryptocurrency.
“It can take years for cases to go to court,” said Klein. And even if the SEC wins, as it did with Telegram and Kik, the district court rulings are not binding on other circuits or even other courts in that same circuit. What you have is a tea leaf reading process rather than clear guidance. “