At the heart of the SEC’s case against Ripple, a dispute over legal advice

In 2012, an international law firm wrote two memos for the blockchain company Ripple Labs as Ripple and its top executives contemplated the launch of XRP, a new cryptocurrency designed to compete with Bitcoin. Ripple wanted to know, among other things, whether and under what circumstances XRP could be considered an “investment contract” subject to federal securities laws. The law firm, whose identity is not publicly known, analyzed that regulatory risk in memos provided to Ripple in February and October.

Those memos are now a matter of hot dispute between Ripple and the Securities and Exchange Commission, which sued the blockchain company in December for allegedly conducting an unregistered offering of $1.3 billion in XRP between 2013 and 2020. Among the SEC’s allegations: Ripple’s lawyers told the company in those 2012 memos to ask the SEC how to distribute XRP without triggering securities laws but the company ignored its lawyers’ advice.

Ripple, of course, has quite a different take on the 2012 memos, arguing last month in its answer to the SEC complaint that the government had mischaracterized the legal advice in the documents. According to Ripple, any reasonable reader of the memos would conclude that the company’s lawyers did not believe its digital tokens were securities under federal law.

The company isn’t just fighting with the SEC over the contents of the memos. Ripple is also at odds with the government about whether the advice of its counsel back in 2012 is protected by attorney-client privilege.

In a joint Feb. 15 report to U.S. District Judge Analisa Torres of Manhattan, the SEC said it wants more discovery on the memos, including communications between Ripple executives and the lawyers who advised the company in advance of the first distributions of XRP in 2013. Ripple countered that the documents are shielded by privilege. Yes, the memos were disclosed to third parties in 2013 “business discussions,” Ripple said. But that was years before the SEC began investigating Ripple’s role in the market for XRP, the company said. Ripple told Judge Torres that it never waived privilege and will oppose any SEC attempt to disclose protected material.

This is going to be interesting.

The dispute over the legal advice Ripple received back in 2012 highlights what the blockchain industry calls a regulatory vacuum, in which U.S. regulators, especially at the SEC, have not provided enough guidance to cryptocurrency developers and their lawyers about how to launch digital currency without triggering securities laws. Ripple’s answer to the SEC complaint noted that in 2012, when it asked for advice from the unnamed law firm, it was trying to figure out the rules in a nascent industry. In the eight years since, Ripple has suggested, the SEC still hasn’t provided that much-needed clarity.

Granted, the 2012 legal memos are just one of the controversies in the SEC’s case against Ripple, which was filed in the final days of Jay Clayton’s term as SEC Chair, after an investigation that stretched over more than two years. Ripple, which is represented in the SEC litigation by former SEC Chair Mary Jo White and former SEC enforcement chief Andrew Ceresney of Debevoise & Plimpton, insists that XRP is not a security but a digital currency, – and that the U.S. government has acknowledged as much, in a 2015 settlement between Ripple, the Financial Crimes Enforcement Network and the Justice Department. (The $700,000 settlement involved allegations that Ripple failed to maintain an adequate anti money-laundering program.)

Ripple, which never conducted an initial coin offering for XRP, argues that the SEC’s case has upended a maturing, decentralized market, causing billions of dollars in losses to XRP holders with no connection to Ripple.

The SEC, which declined to comment beyond its public filings, argued that the 2012 legal memos show Ripple knew, even back then, that its distribution of XRP was risky. According to the SEC, Ripple’s lawyers said in the memos that the government was unlikely to treat XRP as a currency because it was not backed by a central government and was not legal tender. The memos also cautioned Ripple, according to the SEC, that XRP was different than Bitcoin because Ripple had identified itself as responsible for the distribution, promotion and marketing of the network XRP traded on. Yet Ripple and its executives, the SEC said in its complaint, “failed to heed some of the legal advice and warnings in the legal memos.”

Ripple declined to provide a statement on the 2012 memos beyond its filings, which accuse the SEC of selectively and misleadingly quoting from the documents.

It’s not clear from the public record how the SEC obtained the memos. The Feb. 15 joint letter said Ripple did not turn them over to the SEC and that disclosure to undisclosed business contacts, outside the context of the SEC litigation, was not a waiver under 1987 precedent from the 2nd U.S. Circuit Court of Appeals in In re von Bulow. The SEC said in the Feb. 15 joint letter the documents and related communications will be fair game if Ripple executives who are also named as defendants in the suit claim they believed in good faith that XRP were not securities. But Ripple said the SEC’s assumption is premature – and that the individual defendants can’t waive Ripple’s privilege in any event.

Judge Torres is holding a pre-trial conference in the case next week. Both sides have agreed to fast track the litigation, with a fact discovery deadline in July. I’m expecting litigation over the 2012 memos to take place later this spring.

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