Regulatory riddle: An investigation into the SEC v. Ripple case and its consequences for crypto

It seemed like a no-brainer inside the Securities and Exchange Commission last December when the agency filed a lawsuit charging that one of the biggest players in crypto technology, Ripple Labs, violated securities laws.

Then-Chairman Jay Clayton signed off on the case just hours before resigning from the SEC following the defeat of Donald Trump in the 2020 presidential election. That made the timing a bit odd, since big decisions in government are usually left to the incoming administration to sort out.

But the SEC’s enforcement division has a reputation for being independent, with staff attorneys remaining in their roles no matter who is in power. And the enforcement staff was united in their decision to file, while the five-member commission voted 3-2, FOX Business has learned.

Ripple executives had, according to the SEC's lawsuit, brazenly ignored warnings from the commission that when they sold $1.3 billion worth of XRP, the digital coin used on the Ripple platform, they were violating securities laws because the sales weren’t registered with the commission and disclosures to investors weren’t provided — contrary to mandatory prerequisites for whenever a company sells a security.

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XRP was definitely a security, in the SEC’s view, just like a stock or a bond, because it was being used to finance the buildout of Ripple’s platform and enrich its top executives. The company could settle with the commission, as most do even if the price is steep: It would have to repurchase $1.3 billion in XRP that the SEC believes was illegal. Or Ripple could fight it out in federal court, a battle SEC staff attorneys were confident they would win. It didn’t seem to matter that SEC action would hammer not just Ripple, but average people who purchased the now suspect XRP digital coin.

Well, not so fast. Yes, most SEC targets choose to, in fact, settle rather than spend money fighting in the courts, but not Ripple. Its CEO Brad Garlinghouse and general counsel Stuart Alderoty chose to fight both in the courtroom and in the court of public opinion. They hired a dream team of legal talent and top lobbyists, and crafted a compelling public relations campaign that the SEC's lawsuit is nothing more than prosecutorial overreach, wrong on the law, and so riddled with conflicts of interest that, if successful, it will benefit its competitors and stifle crypto innovation.

Things are now getting nasty as both sides head to court. The SEC is taking issue with Ripple’s voluminous document requests from the commission, comparing them to harassment. Ripple says the SEC has abandoned its role as an independent regulator and has overstepped its authority. Legal experts question whether the SEC’s time could have been better spent on other issues.

With neither side looking to back down, the case is likely headed for trial possibly early next year.

The U.S. financial industry is one of the most regulated businesses in existence so it only makes sense that the rapidly expanding crypto business is attracting regulatory scrutiny from other layers of government and the SEC, also known as Wall Street’s top cop. The bedrock of the SEC’s enforcement agenda is disclosure — mandating that sales of investment contracts that are legally deemed "securities" be registered with the commission, and the company make public necessary financial information.

Crypto is, of course, an industry that was created as an alternative to heavily regulated centralized finance such as banks, but its growth couldn’t be ignored by regulators, current and former SEC officials tell FOX Business. In 2018, for instance, the industry barely cracked a valuation of $400 billion; today it exceeds $3 trillion. For context on its size: There are currently more cryptos in circulation than U.S. dollars.

Treasury Secretary Janet Yellen says crypto is being used for illegal purposes since digital coins are used to price transactions secretly through decentralized blockchain technology that skips over costly middlemen — but also many government checks. SEC officials believe investors in crypto need more disclosure, not less, about the industry’s various blockchain technologies and the digital coins themselves.

But, and there’s always a "but," regulations have been known to slow innovation in emerging technologies. Industry proponents say for all the talk about bad stuff, the crypto business holds out the potential to be the next internet. Illegal activity occurred on the web but the government allowed its development to flourish. If cryptos and blockchain can survive meddling from regulators it will create a whole new ecosystem for transacting everything from buying a pizza to buying a house through the decentralized blockchain technology.

In what shape crypto and blockchain survives could well come down to the SEC’s case against Ripple, legal experts and industry insiders tell FOX Business. The case launched by Clayton, former President Trump’s SEC chair, is now one of the top priorities of the current SEC Chairman Gary Gensler, a Biden appointee.

If the SEC can prevail in federal court before Judge Analisa Torres in the Southern District of New York, it will go a long way in establishing the agency as crypto’s primary regulator, imposing what industry executives believe is the SEC’s traditionally heavy-handed oversight approach, possibly demanding massive amounts of disclosure in a business that prides itself on being an alternative to government control.

It could, for example, go back in time and determine whether other crypto companies that conducted their operations and sales of digital coins in much the same way Ripple did, similarly violated the law, and now must pay up as well. Regulators, not the markets, will be choosing winners and losers, based on arbitrary interpretations of law, and based on relationships with powerful players in the crypto business (more on this later), critics of the SEC say.

Even worse, crypto innovation could be stifled here in the U.S., and move offshore to places where the government isn’t demanding financial disclosures. China, fighting for dominance of the world economy, could gain a key advantage in developing a game-changing technology.

If Ripple wins, the stakes are just as high but in different ways. Yes, innovation could flourish as the SEC cedes control to the Commodity Futures Trading Commission, the regulatory body that regulates commodities with a much lighter regulatory touch. Blockchain might just become the new internet, a technology so transformative that it can replace traditional banking, and other ways people buy and sell stuff.

Yet, so too will be the myriad ways that criminals use crypto given the largely anonymous nature of blockchain technology. And does the U.S. government want to allow a new form of money to be created that directly competes with the U.S. dollar?

FOX Business investigation

With so much riding on the case, FOX Business has conducted a wide-ranging investigation into the regulatory approach taken against Ripple. One particular area of focus in our reporting was charges made by Ripple executives and others that Ripple and the XRP cryptocurrency are in the regulatory crosshairs because other digital outfits have successfully cultivated ties to individuals and firms active in the regulatory community.

They were given a "hall pass" by the SEC, allowed to operate as virtual currencies without the rigors of government oversight.

The question is an important one for any business given the over-arching role that regulation plays in shaping who survives, particularly in a nascent industry such as crypto. If the SEC is indeed picking winners and losers based on connections rather than merit, as Ripple executives believe, it would certainly tarnish the case and SEC regulation going forward.

We do not offer an answer to this question, but instead a roadmap of sorts so the reader can come to his or her own conclusions. We do this by identifying the roles played by the key actors in the Ripple drama – and their connection to various crypto outfits, such as Clayton, the former SEC chair who brought the case, and Gensler, the current chairman who is pushing this case forward and looking to expand SEC regulation over crypto.

Other important players include Bill Hinman, who made his career as a quietly successful lawyer on some of the biggest M&A deals to hit the market in recent years. Yet because of the SEC’s efforts to regulate crypto, he suddenly found himself in the crypto spotlight when he took a top post at the SEC and made a speech heard around the digital-currency world.

We delve into the business of Ethereum, which has not been accused of any illegal conduct, and has overcome Ripple in size, through savvy deal-making and, some competitors say, cozying up to the regulatory community. Ripple and its CEO contend that because of an uneven regulatory playing field, their business is being crushed while Ethereum is flourishing.

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FOX Business spoke extensively to Ripple officials in preparation for this story. They say they've done nothing wrong and the facts will eventually show that as the case moves forward. But former SEC officials and industry executives tell FOX Business Ripple has no one to blame but itself; they describe Garlinghouse & Co. as opportunists who got rich off of the sale of XRP by not playing by the rules.

Lastly, we discuss the role of John Deaton, an asbestos-litigation attorney who has become a crypto folk hero while pointing out the inequities of the SEC’s case and giving a voice to the tens of thousands of XRP holders who bought the digital coin as passive investors and are on the losing end of the SEC’s actions.

Much is riding on the outcome of the Ripple case. The ongoing fight has caused some members of Congress to rethink crypto regulation and caused friction inside the SEC. Increasingly, GOP commissioners, like Hester Peirce, the so-called "crypto mom," want her nominal boss, Gensler, to back off crypto regulation. Peirce earned that moniker for her advocacy of crypto over the years and she is floating an idea of a "safe harbor" that stalls all future SEC enforcement actions until a more holistic regulatory framework is enacted. She wants Congress to take into account crypto’s unique status as an important technology that needs to be nourished as opposed to attacked by the government. Peirce was one of the two commissioners who voted against the full commission bringing the charges against Ripple.

A new uber regulator over crypto appears years away, however. Divisions in Congress will slow any move, and if the Republicans regain control of the House and Senate in the 2022 midterms, there will be even more inaction since Joe Biden, a Democrat, will control the White House until at least 2025. Meanwhile, the Ripple case will drag on, and the industry will debate its messy state of affairs.

Again, FOX Business takes no sides in this account, but will let the reader decide.

Jay Clayton: The case against Ripple commences, and Ripple’s case against regulators begins

For much of his tenure as chairman of the SEC, Jay Clayton grappled with how best to regulate the rapidly expanding crypto business. And for the most part, the former securities lawyer for the white-shoe firm Sullivan & Cromwell took a measured approach, cracking down on obvious frauds but allowing the crypto business to bloom without significant government intrusions.

At the top of his enforcement agenda were his lawsuits against Initial Coin Offerings (ICO) that were trading like securities without SEC approval and with false promises of massive profits to come. He brought enforcement cases against instant messaging platforms Telegram and Kik for selling alleged unregistered securities, which resulted in Telegram abandoning its separate crypto operation and returning $1.2 billion to investors. Kik was ordered to pay a $5 million fine and was later bought out by MediaLab. Both companies neither confirmed nor denied any wrongdoing and press officials did not return requests for comment.  
 

All told, the Clayton SEC brought 87 crypto-related actions, a significant tally, mostly involving ICOs that traded like stocks but their sales were not registered with the commission, making them essentially illegal. But one clearly stood out from the pack: Ripple. It was Clayton’s final act as chairman of the SEC, and it would emerge as the most important – and controversial – regulatory marker for the nascent industry. 

Delivered just hours before Clayton would leave the post, on Dec. 22, 2020, the SEC filed an enforcement action against Ripple and its two senior executives, Brad Garlinghouse and Chris Larsen, for failing to seek SEC approval and register sales of the XRP cryptocurrency while using the profits to build out the Ripple platform. The move made sales of XRP illegal in the eyes of the commission, and put Ripple possibly on the hook for $1.3 billion — the amount of XRP the SEC believes was illegally sold.  

The move also immediately raised eyebrows in the crypto world, which was on its way to becoming a $3 trillion business. For starters, the SEC didn’t appear to have broad regulatory powers in the crypto space; that role belongs to the Commodity Futures Trading Commission, known as the CFTC. 

While regulators were concerned about fraud and abuse in the crypto business, Ripple wasn’t a sham; its underlying technology facilitates cross-border payment using XRP, which was then rivaling the largest digital coins bitcoin and ethereum for dominance. 

Speaking of Ethereum, its founders financed their buildout in 2014 through an ICO of the Ether token. Ripple’s lawyers had long concluded the XRP sale was even less a security than Ethereum’s Ether digital coin. Ether issued through an unregistered ICO; Ripple raised money to fund their business initially through venture capital.   

Ripple vowed to fight the case, but its business in the U.S. came to a near-standstill and it was forced to expand overseas to make up for the losses stateside. As a result of the lawsuit, holders of XRP were caught in a regulatory purgatory; exchanges like Coinbase and Crypto.com suspended trading so they couldn’t cash out. Losses to small investors and project developers using the XRP Ledger were said to total $15 billion.   

The case is ongoing; a FOX Business investigation shows its origins can be traced as far back as 2018, and in a way that has drawn criticism from many in the crypto community.

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In order to establish some regulatory clarity for digital currencies, Clayton maintained what people in the crypto business describe as an open-door policy with academics and some industry experts. He had already begun to delve into the ICO business, where new coins that resembled securities were trading without being registered — a violation of securities laws. In January 2018, he asked the venture capital firm Andreessen Horowitz to weigh in on the regulatory debate. The result was a summit involving top industry players and law firms sponsored by the big venture capital firm that, when concluded, would issue recommendations for how the SEC could regulate crypto. 

FOX Business has learned that the crypto industry was represented in part by XRP’s industry counterpart, Ethereum, and players with ties to the Ethereum family, including the law firm Perkins Coie. Ripple was not invited to the summit that took place in March 2018 at the SEC headquarters in Washington, D.C., according to people with direct knowledge of the matter and documents reviewed by FOX Business.  

Lowell Ness, a partner at the firm Perkins Coie, provided some details about the summit later that year at the "BlockCon" blockchain convention. Ness described himself as having "represented Andreessen on all their crypto investments." Clayton, Ness said, asked Andreessen to "round up the industry players to essentially lay out a very detailed written, foot-noted memo on what existing law says about utility tokens" and "give a proposal about where to go from here ... I got the chance to be the one to write all that stuff."  

Executives at Ripple point out that players associated with Ethereum had a major role in influencing the SEC’s eventual thinking on crypto. Though, people inside the meeting counter this, stating the purpose was to come up with a balanced view of how crypto could be regulated in the future. 

That said, Perkins Coie is also a member of an Ethereum advocacy group known as the Enterprise Ethereum Alliance, according to the alliance’s website. Andreessen invests in startups that use Ethereum and Bitcoin as their main blockchain, according to the firm’s website. 

A person close to Clayton said he has no recollection of meeting with Ness and had no comment on the memo. Ness didn’t return repeated telephone calls and emails for comment. Press representatives for Ethereum and Perkins Coie didn’t return calls for comment.  

FOX Business has learned that in March 2018 Clayton received some regulatory advice from a prominent and powerful Ripple critic. The critic, Gary Gensler, was a former Goldman Sachs partner, and head of the CFTC during the Obama administration, when he took the government’s initial steps in regulating crypto.  

Gensler was a finance professor at MIT specializing in crypto and a special adviser to MIT’s Digital Currency Initiative, a crypto think tank that was a significant supporter of Bitcoin and its blockchain platform.  

It’s unclear exactly what was said between the two, but people with knowledge of the matter said Gensler broadly advocated that the SEC take a more aggressive role in regulating the industry because, he believed, many cryptos were securities that fell under the commission’s oversight. The view that the SEC was a lead regulator was somewhat controversial since the CFTC appeared to have the most power under current law to assume the role as top crypto cop.  

But Gensler believed that the SEC could expand into crypto regulation by applying the so-called Howey test, based on a 1946 Supreme Court ruling, SEC v. W.J. Howey Co. The Howey ruling held that any investment contract could be declared a security, and then would need to be registered with the SEC, if, for instance, the contract was used to finance "a common enterprise with a reasonable expectation of profits to be derived from the efforts of others."  

In applying Howey, Gensler believed Bitcoin, the world’s first crypto, was clearly outside the SEC’s purview and not a security. He publicly stated in June 2018 that there’s a "strong legal case" for Ethereum being a security since it had issued an ICO in 2014 without SEC registration.   

But Ripple definitely met the Howey criteria, or as he put it to The New York Times in 2018: "There is a strong case for both of them — but particularly Ripple — that they are noncompliant securities." 

A few days later, Clayton himself reiterated what he believed was a security under the Howey test. Speaking at a town hall meeting with staff at the SEC’s Atlanta Regional Office, Clayton stated: "Most of what I’ve seen in the ICO space is a securities offering. It is raising money for a project where I give you my money, you give me some type of write-back that reflects a return on your project. That’s a securities offering. And I don’t know how much more clear I can be about it."  

The SEC’s views on crypto, once somewhat of a black box to the industry, were now taking shape. A day after the Atlanta Town Hall, the SEC would provide even more clarity. Veteran corporate lawyer Bill Hinman had been appointed by Clayton as director of the SEC’s Division of Corporation Finance — an important post inside the commission that sets policy over what corporate entities must disclose to the investing public. 

In a prepared speech at a conference sponsored by Yahoo Finance, Hinman said that applying the disclosure requirement to current transactions in bitcoin and ethereum "would seem to add little value." In other words, bitcoin and ethereum were not going to be considered securities in the eyes of the SEC.   

He made no mention of XRP, which set off alarm bells inside Ripple’s San Francisco headquarters. Over the next two years, Ripple officials and its legal team met several times with key officials at the SEC. 

These former Clayton SEC officials tell FOX Business that they specifically warned the Ripple team that the unregistered sales of XRP meant they were operating outside SEC laws. Management’s direct involvement in Ripple’s operations also meant it failed the decentralization test, which means the sales were no different than the sale of stock. They needed to register sales of XRP with the commission or they would face enforcement action, and that Ripple was playing rolling the dice on the platform’s future. 

Ripple continued to argue the opposite was true: Ripple was largely financed by venture capital. XRP is a free-standing cryptocurrency that’s held by Ripple officials and many other investors. Ethereum, with its ICO, was clearly closer to breaking the law by remaining unregistered.   

In late 2020, with Trump’s defeat in the presidential election, Clayton was ready to rejoin the private sector, and Gensler was about to go back into government. Gensler was part of President-elect Biden’s transition team and was being considered for a top administration post, including SEC chief. 

Clayton would meet Gensler twice more during his final weeks at the SEC. Clayton’s public schedule described the sit-downs this way: "Meeting with Gary Gensler, president elect Joe Biden’s transition team." There was no further detail provided, but the last meeting between the two had an interesting coincidence: It occurred on Dec. 21, just a day before Clayton and the commission filed its case against Ripple.

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Since leaving the SEC, Clayton, a long-time securities lawyer with expertise in M&A, has become a senior adviser at his old law firm Sullivan & Cromwell and an independent director to the board of directors of private equity powerhouse, Apollo Asset Management.    

He serves on the advisory board of Fireblocks, an infrastructure provider for digital assets, and is on the advisory council for a money-management company called One River Digital Asset Management.   

A few days before the SEC brought the Ripple suit, One River announced that it would invest $600 million in Bitcoin and Ethereum with a commitment to holding around $1 billion in digital assets by 2021. There is no evidence to suggest that Clayton influenced the company's decision while in government. 

Clayton is also a contributor for the financial news network CNBC. In a Sept. 23, 2021 interview, as the controversy of the Ripple case began to unfold, Clayton addressed charges of conflicts of interest made by Ripple and XRP holders given his new role in the private sector working with companies that have a business relationship with Ethereum. 

"In terms of my after-government service ... what I can say is the companies I advise … I did not know these companies while I was in the government. I was introduced to them after I exited," he said during a segment with the network. 

He declined to provide a comment for this report.

Bill Hinman and the speech heard ‘round the crypto world

Before joining the SEC as director of corporation finance in 2017, Bill Hinman spent much of his legal career representing tech giants and other big companies engaged in mergers and acquisitions without attracting much notice.

All that would change with one speech in 2018.

It had been nearly a year since Hinman was appointed by Jay Clayton to run the division, among the most important units inside the commission. One of the SEC’s main jobs is investor protection, and part of protecting investors is making sure that companies that fall within the SEC’s oversight disclose information to the public.  

Deciding how much information needs to be disclosed and what entities must do that disclosure is the top job of the corporation finance division. The now booming crypto industry – and whether top players were evading the SEC’s disclosure mandates – had begun to consume the SEC.

With the explosion of ICOs, many cryptos were trading in the cash market like currencies, but SEC officials believed they were currencies in name only. Under the Howey Test, they had all the characteristics of being a security that mandated SEC registration and proper disclosures. Others were clearly not securities under the Howey test, while still others straddled being a currency and a security.

It was Hinman’s job to help sort out the disclosure mess. Hinman spent much of 2017 and 2018 meeting industry executives as he began to develop a more coherent disclosure framework for crypto, FOX Business has learned.

In December 2017, he met officials from a blockchain technology business named ConsenSys that operated on the Ethereum blockchain. He also held a handful of other meetings with this firm over the next year. ConsenSys is the brainchild of Joe Lubin, one of the founders of Ethereum, the second-largest blockchain.

In March 2018, the SEC received a white paper from leading venture capital firm Andreessen Horowitz – a big investor in Ethereum and sponsor of the aforementioned crypto summit – that proposed a so-called safe harbor for token sales. The paper states that ether, despite its earlier ICO, is a good example of a type of token that has become so decentralized it should not be deemed a security, thus keeping it outside SEC oversight.

Hinman would spell out much of his thinking – and that of the SEC’s – in a June 2018 speech at a conference sponsored by Yahoo Finance, the financial news and data website. Whether he knew it or not, Hinman was about to make crypto history, laying out publicly and for the first time why certain cryptos were operating legally and why, in the opinion of the SEC, many weren’t.

The event took place in San Francisco, but the entire crypto world would soon take notice. Before he began, Hinman provided what SEC officials describe as a standard disclaimer, telling the audience that the remarks represented his views and "not necessarily" those of the SEC.

What he didn’t say was that his boss, Clayton, was clearly in the information flow. A source with direct knowledge of the matter says Clayton provided "some reactions" after reviewing the text before the event.

Hinman, himself, would later concede in a post-speech interview, that the rationale for the speech was that "the chairman and the SEC" wanted to "be clearer" and "transparent" about crypto regulation.

To that end, Hinman stated the Howey test applied "overwhelmingly" in the ICO market; they were de facto securities, and some were issued to build out platforms much like a stock or a bond. Translation: Many cryptos were trading illegally without meeting SEC disclosure mandates. Some of the platforms were outright frauds.

Others weren’t, he said. Bitcoin, the oldest crypto, did not meet the Howey test because there was no longer a central actor involved in operations that investors were relying on to make them a profit. There was no Bitcoin ICO and its blockchain was completely decentralized and now run by bitcoin users. Its legendary founder, known as Satoshi Nakamoto, was no longer guiding the blockchain’s operations. In fact, there is still a debate over who founded Bitcoin; it could have been many people, thus adding to its decentralized nature.

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Ditto for Ethereum and its ether digital coin, but for different reasons. While its founders issued an ICO years earlier, they were no longer using Ether to build out the Ethereum platform, thus falling outside the Howey parameters of what makes something a security. Its founders are not playing a central role in the blockchain, thus Ethereum, like Bitcoin, is completely decentralized.

"Putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions," Hinman said.

He made no mention of Ripple and XRP, a glaring omission that quickly made its way back to Ripple’s nearby offices, leading to a series of frenzied meetings between key Ripple executives including Garlinghouse, SEC officials and Hinman himself.

Ripple and its lawyers, who included famed federal prosecutor and former SEC chief Mary Jo White, argued their operations were not materially different from those of Ethereum. In a 2019 video of an Ethereum conference reviewed by FOX Business, Lubin said that Ethereum "wasn’t going to be scalable" at its inception and needed to be improved. Ripple has argued that Lubin was suggesting that Ethereum wasn't decentralized until well after it began, contradicting one of Hinman's and the SEC's rationales for not declaring ether a security.

They also argued that XRP should not be conflated with Ripple; both were separate legal entities. Ripple executives held XRP, as do thousands of investors. Taken together, Garlinghouse and Larsen had no legal responsibility to register their XRP sales even if the money was used to finance the Ripple platform.

Hinman disagreed; Ethereum was no longer selling Ether to finance its blockchain, and Ripple was still selling XRP "without any type of restrictions," according to a person with knowledge of the conversations. Ethereum was now decentralized, and Ripple was not. Hinman was emphatic: Ripple needed to stop selling its unregistered XRP or come to the SEC and begin the registration process, this person said.

Ripple executives continued to sell XRP through the third quarter of 2020, and in December of that year, the SEC filed its last major enforcement action under Clayton, charging Ripple, Garlinghouse and Larsen with failing to register with the SEC $1.3 billion in XRP sales over a seven-year period.

The current SEC chairman, Gary Gensler, is now moving forward with the case. Ripple executives, as they fight the SEC action, are arguing that the SEC is picking winners and losers, also pointing out that other digital platforms in the space enjoyed cozier relations with key SEC officials both past and present.

For instance, Gensler’s ties to Bitcoin date back to his days working at the MIT Digital Currency Initiative, the think tank that also finances blockchain development involving the digital currency. Clayton now serves as an adviser to an investment fund with significant holdings in bitcoin and ether.

Again, there is no direct evidence that either Gensler's or Clayton's ties to Bitcoin and ether influenced any of their decisions, but these conflicts are at the center of Ripple’s defense. 

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After leaving the SEC in December 2020, Hinman went back to Simpson, Thacher & Bartlett, as an adviser. The firm is one of more than 100 members of the pro-ether advocacy group, the Enterprise Ethereum Alliance.

FOX Business has also learned that Hinman is an advisory partner to VC firm Andreessen Horowitz’s new $2 billion crypto fund that invests in ether and bitcoin. A person close to Hinman said he had no knowledge of the firm’s crypto investments when he was at the SEC. A spokesman for Andreessen Horowitz didn’t respond to emails for comment.

Hinman’s Yahoo Finance speech, meanwhile, is still drawing controversy. FOX Business has reviewed a 2019 YouTube video of a panel chat where a lawyer involved in the 2018 Andreesen Horowitz crypto summit takes at least partial credit for the content of Hinman’s Yahoo speech.

The lawyer, Nancy Wojtas of Cooley LLP, said "director Hinman’s speech … most of what he says in there came out of the safe harbor as well as the meetings we had with him." Wojtas would not provide a comment for this report.

Ripple executives say the summit, which featured firms with ties to Ethereum, is proof of the uneven regulatory playing field, while the Hinman-Ethereum connection is also something Ripple’s lawyers have tried to seize upon as they fight the SEC action.

Earlier this year, they won a key legal victory by convincing a federal judge to allow them to take Hinman’s deposition. The deposition, reviewed by FOX Business, is heavily redacted but shows Ripple lawyers grilling Hinman on his ties to Ethereum.

In his deposition, Hinman said he doesn’t have any personal investment or interest in Ethereum both while at the SEC and today in private practice.

He also stated that he was not aware that Simpson, Thacher & Bartlett was part of the Enterprise Ethereum Alliance when he was in government.

Hinman declined to provide a comment for this report.

Gary Gensler enters the fray

Gary Gensler and Jay Clayton would appear to have very different world views on most issues. A former Goldman Sachs partner, Gensler is also a progressive Democrat and regulator who earned a reputation as an aggressive enforcer of the securities laws.  

Clayton also hails from Wall Street but from the legal end as an M&A attorney for a white-shoe law firm. He’s a long-time Republican and a believer in free markets. He had a productive tenure at the SEC, presiding over a record 65 new rules, but many of them came in the form of deregulation.

Yet while Clayton and Gensler were hardly besties, they bonded, it appears, over crypto regulation.

The timeline of the alleged Clayton-Gensler crypto mind-melt has become a touchstone for holders of XRP and supporters of Ripple; they believe it underscores the uneven playing field regulators have created by picking industry winners and losers with Ripple and XRP being among the biggest losers.

Clayton and Gensler did not meet formally until March 2018; Clayton was then the SEC chair, nearly a year into his job and weighing how best to regulate crypto. Gensler just left the Obama administration as head of its CFTC, the agency that was nominally in charge of crypto regulation.

He had now taken a job in academia as a finance professor at MIT and wanted a say in how regulation would develop in the industry, according to a person with direct knowledge of the matter.

As part of Gensler’s role at MIT, he was a senior adviser at its crypto think tank, the Digital Currency Initiative, which funded projects in crypto that largely involved Bitcoin. Gensler’s views on the regulation of Bitcoin were well known at this point. He believed the digital coin was operating legally outside of SEC regulations and disclosure mandates, and thus could be regulated with a light touch by his old agency, the CFTC.

He was less keen on Bitcoin’s industry counterparts, Ethereum and Ripple. As previously stated, Gensler told the New York Times in January 2018 that there’s a strong case for Ripple and Ethereum being non-compliant securities.

The problem with CFTC regulation of cryptos is that its authority was limited in terms of forcing entities under its jurisdiction to make broad disclosures to investors. The SEC’s mandate was more sweeping if, and this is a big if, the cryptos meet the Howey test and can be deemed securities, which Gensler believed to be the case in many instances, his public statements suggest.

It’s unclear if Gensler made a similar case to Clayton during their March discussion. A month later at an MIT event titled "The Business of Blockchain" he said that Ripple and Ethereum "needed clarity" from the SEC about whether or not they classify as securities. What is clear, according to a person with knowledge of the meeting, is that it focused on what the SEC could do to crack down on cryptos that meet the Howey test for SEC regulation while they are trading as unregistered securities.

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Its also unknown how much Gensler’s views resulted in SEC crypto policy, but the commission’s enforcement division began to ramp up its cases against so-called non-compliant tokens issued as ICOs. Clayton began making the rounds inside the SEC stressing that if a token met the Howey test, its sales either needed to be registered with the requisite disclosures or face enforcement action.

And, of course, Bill Hinman, the SEC’s director of corporation finance, would go on to make his now-famous speech and case for crypto regulation by the SEC that would put Ripple in the commission’s crosshairs.

Clayton met twice more with Gensler during his tenure as Trump’s SEC chair in late 2020 when the MIT professor was transitioning to government, according to Clayton’s public schedule. Gensler had joined the transition team for Biden. He also emerged as a leading candidate to replace Clayton at the SEC.

One of those meetings occurred a day before the Clayton SEC filed its Ripple lawsuit, according to Clayton’s public schedule. It could not be determined what was discussed at the meeting but since being confirmed by the Senate as SEC chair, Gensler vowed to press on with Clayton’s Ripple case and go even further in terms of regulating the digital industry.

Indeed, Gensler’s aggressive approach has surprised many in the crypto business since some people looked at him as an industry advocate while teaching at MIT, though a closer look at Gensler’s public statements show that he was a supporter of the industry in a fairly narrow sense.

For instance, he was most supportive of Bitcoin and its blockchain as not being under the SEC’s regulatory umbrella — a huge victory for Bitcoin investors since the value of digital coins is often derived from their ability to remain outside of government control.

Since being confirmed as SEC chief, Gensler has referred to the space as the "Wild West" and is said to be relishing the SEC’s legal battle with Ripple, believing the case handed to him by Clayton is airtight and that a court victory would establish legal precedent for the SEC playing a major role in crypto regulation.

It should be noted that Gensler is seeking additional powers from Congress to better regulate the crypto space. In an August speech at the Aspen Security Forum, Gensler stated that additional congressional authority is necessary in order to "prevent transactions, products and platforms from falling between regulatory cracks."

Some industry insiders tell FOX Business that if the SEC is successful in court in proving XRP is a security, Gensler might go back and apply that standard to Ethereum, further complicating the crypto business. Would Ethereum have to repurchase the tokens it sold to finance its platform as the SEC may force Ripple to do with XRP? Gensler has avoided questions of whether Ethereum should be held to the same standard as XRP and face regulatory enforcement for its unregistered 2014 ICO. 

On Nov. 10, when FOX Business asked the SEC to confirm details surrounding Gensler’s involvement in the Ripple matter, a spokeswoman said they would "double check on a couple of items" and get back to us. As of today, the spokeswoman has provided no comment despite multiple attempts to reach out.

A spokesperson for the Ethereum Foundation and Vitalik Buterin declined to provide comment for this report. 

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The Ethereum Empire

The world’s second-largest blockchain by market cap ($500 billion behind Bitcoin’s $1 trillion as of this publishing) and second most popular crypto (priced at over $4,000 compared to Bitcoin’s $57,000) has made a group of digital coin insiders that created the platform extremely rich since the technology was unveiled in 2013.

Ethereum’s rise in the crypto world has also been controversial. Critics say its top executives and legal team clearly worked the regulatory system in a way that gave the platform and its crypto a clear advantage over others such as Ripple and the XRP digital coin. Stoking the controversy has been the public statements from people associated with Ethereum, who aren’t bashful about their connections inside the SEC.

For instance, at a conference in 2019, cofounder Joe Lubin cited the Ethereum family’s close ties to the SEC, saying they are "big friends and fans" of the agency. In a recent interview, Lubin said Ethereum has a "regulatory advantage" in the crypto space stating, "Bitcoin and Ethereum arrived before regulators were paying attention" and that "we were fortunate enough to frame our token as a utility token" while "others will be seen as securities."

People familiar with Ethereum’s operations say the company and its founders shouldn’t be faulted for playing by the rules as they were understood during the development of its platform, and eventually winning the backing of key regulators.

"How can you fault the company for trying to convince the SEC to back off," said one former SEC official now in private practice and advising crypto businesses on how to deal with regulators.

One thing is certain: Ethereum is a case study of how, under the right circumstances, crypto has been one of the world’s greatest creators of wealth in recent years. Financed with a 2014 initial coin offering worth $18 million, Ethereum now has an estimated market value of $500 billion. One of its founders, Vitalik Buterin, has an estimated net worth of $1.4 billion. Lubin is said to be worth as much as $5 billion.

People familiar with Lubin’s business ventures say he’s been able to compound his wealth because he has created several entrepreneurial efforts using the Ethereum blockchain including a blockchain software technology company called ConsenSys. The company has sponsored a crypto advocacy group, the Enterprise Ethereum Alliance that has become an important forum for bringing Ethereum into the mainstream, through seminars and research.

Some of the biggest players in corporate America, such as mega-bank JPMorgan Chase & Co., have joined the organization, and today, the Ethereum platform is rivaling Bitcoin’s blockchain for dominance; it has developed the largest ecosystem of cryptocurrency projects and counts major companies like Amazon and Microsoft as clients.

In August 2020, in one of the most high-profile deals in the digital industry, ConsenSys acquired the blockchain platform of JPMorgan to further advance its technology. Ethereum’s digital coin, ether, has risen more than three times as much as bitcoin over the past year.

But Ethereum could not have achieved all of this without a significant regulatory advantage, critics like those at Ripple tell FOX Business.

As FOX Business has learned, Bill Hinman, the SEC former director of corporation finance, held a handful of meetings in 2017 and 2018 with people associated with ConsenSys, according to logs provided by the SEC to Ripple’s lawyers.

The purpose of those meetings, Ripple has argued, was to try and convince the SEC that Ethereum should not be considered a security during a time when the agency was trying to discern how cryptocurrencies should be regulated.

The question among people inside the crypto business is whether Hinman was influenced during these meetings in shaping policy, and, if so, how much? One corporate attorney who was involved in the SEC’s crypto summit in March 2018 tells FOX Business that participants believe much of Hinman’s eventual thinking involving crypto regulation derived from these ConsenSys meetings.

People close to Hinman disagree; they say he developed his guidance on crypto from speaking with many players in the business, including Ripple executives. His position that Ethereum was not an unregistered security (and Ripple was) boiled down to a simple reading of the facts—and the Howey precedent.

Either way, the SEC under Clayton formally accepted Ethereum and its related businesses as not being under its purview — a huge win for the Ethereum empire, which caused the price of ether to surge more than 9%.

FOX Business provided a spokesman for ConsenSys and Lubin a complete summary of the company’s role in shaping SEC policy and other matters. He declined to comment other than to say: "We decided we don’t want to comment on Ripple and the SEC’s on-going matters."

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The Ripple Rebellion

In January 2018, Ripple achieved a major milestone: The XRP digital coin used on its platform, held by its top executives, had become the second most valuable crypto in the world, worth more than $100 billion, surpassing the digital currency of the mighty Ethereum blockchain.

Ripple had certainly come a long way. It was founded in 2012 by Chris Larsen and Jed McCaleb with the idea of making cross-border payments smoother and cheaper than what was offered by the banking system, and using crypto as the currency of choice. That coin was known as XRP, developed by McCaleb a year earlier as a competitor to the industry’s first crypto, bitcoin.

Although many people refer to XRP as the Ripple coin, both are legally distinct entities, one of the key points company officials use as they argue XRP is not a security under the Supreme Court’s Howey test.

The argument also was one the crypto community embraced as the value of XRP grew and Ripple’s platform gained acceptance. Much of that would change over the next year, of course. Ripple and its top executives found themselves on a collision course not with users of its technology, or holders of XRP, but with Wall Street’s top cop, the Securities and Exchange Commission.

In June of that year, the SEC would first signal that it believed the company was violating securities law by not registering its sales of XRP in the Yahoo Finance Hinman speech. Ripple officials then began their counter-offensive arguing with top SEC officials including Hinman and SEC chair Jay Clayton that they were taking the wrong path against the company.

The SEC’s position was simple and steadfast: Ripple and XRP are intrinsically linked, they were created by the same people, and XRP had granted Ripple billions of dollars in the digital coin that executives used to build out the platform, and become incredibly wealthy.

As a result, XRP met the Howey test and sales of it needed to be registered with the commission. If it didn’t, Ripple would face the music in the form of an SEC enforcement action.

But Ripple and its lawyers argued that the commission was applying its regulatory authority unevenly; if the SEC was playing it straight, it would also classify Ethereum’s ether as a security since its 2014 ICO was issued specifically to finance the Ethereum platform.

Why didn’t Ripple just register with the SEC? SEC disclosures are costly, time-consuming and would also put Ripple at a competitive disadvantage in a business that exists as an alternative to the government control of the money supply and banking.

As the two sides bickered, the company continued to sell XRP through the third quarter of 2020. They hired power players in the legal community. One was Joseph Grundfest, a former SEC commissioner and a prominent legal academic who wrote a letter to Clayton and his fellow commissioners urging them to back down because retail investors, who had purchased XRP for years, would be crushed by an SEC case.

The letter, which has been reviewed by FOX Business, also states: "The staff has articulated no material distinction between the operation of Ether and of XRP ... Ether and XRP should be treated similarly: if Ether is to be allowed to trade freely in the market, so too must XRP…"

Grundfest’s advice didn't have much impact inside the commission, and later in 2020, the SEC lived up to its threats — the last official act of the Clayton commission issued on his last day as SEC chair with a civil lawsuit that charged Ripple, Larsen and Garlinghouse for the illegal XRP sales. According to the SEC lawsuit, aside from funding Ripple illegally, Larson and Garlinghouse personally cashed in on the sale of $600 million of the unregistered digital coin.

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As this article goes to press, Ripple executives say they have no intention of settling without the SEC giving the greenlight to XRP in the same way it did for ether.

Legal arguments aside, Ripple has launched a savvy PR campaign attacking what it calls inequities in the crypto regulator’s scheme. It contends there is no clear regulatory authority; the SEC is engaged in a turf battle to win control over the industry from the CFTC.

Garlinghouse, Ripple’s CEO, has said publicly that Clayton and now Gensler, have given a "hall pass" to the likes of bitcoin and ether while penalizing Ripple and XRP holders. Ripple’s U.S. business, he notes, has come to a near standstill, and it was forced to expand overseas to make up for the losses here while Ethereum, with its connections to people associated with the case, continues to flourish.

There is also no doubt that average XRP holders have been caught in the crossfire. Prior to the lawsuit, XRP had a market cap of just under $27 billion; today it’s around $50 billion. Sounds good until you consider the following: Most crypto exchanges available to retail holders in the U.S have suspended trading in XRP since the lawsuit, making them unable to cash out on their investments. Since the lawsuit, Ripple has been putting more XRP into the market through sales of the digital coin, thus inflating the apparent value of XRP even as it trades around $1.

Garlinghouse and Ripple, meanwhile, are using the publicity from the lawsuit to influence Congress to rewrite crypto regulations. They advocate that an outside working group be created with representatives from the lead agencies and key industry players in order to come up with a more well-rounded form of regulation.

The company has also been lobbying lawmakers to adopt a policy recommendation from SEC commissioner Hester Peirce for the "safe harbor" that would essentially grandfather-in XRP as a crypto not under the SEC regulatory umbrella.

John Deaton, the former Marine, is ready for battle

"I think I’m going to sue the SEC," John Deaton groaned as he read the news just before Christmas in 2020 that Wall Street’s top cop had filed securities violation charges against Ripple, and its top executives for failing to register sales of the XRP digital coin as a security.

Just days after the SEC case, Deaton, a relatively unknown litigator in Providence, Rhode Island, filed one of his own, a class-action suing the commission for overstepping its authority in declaring XRP a security.

"In January, someone asked me how long I’ve been practicing securities law," Deaton said. "My response: Two weeks."

The case is ongoing and currently seeking class-action status. 

Deaton’s journey into securities law is certainly unconventional. The 53-year-old former U.S. Marine attorney was now in private practice specializing mostly in asbestos-related litigation. He never argued a securities-law case, though he liked to invest. After reading Satoshi Nakamoto’s famous Bitcoin treatise, he got hooked on crypto, actively trading bitcoin, ethereum, and most recently the XRP digital coin because he considered it the most user-friendly of all the cryptos to trade.

"When I purchased XRP, it appeared in my wallet immediately," Deaton tells FOX Business. "The others took hours to clear."

But XRP would have other more significant problems as a target of a high-profile SEC regulatory action. After the SEC filed the case, XRP fell 70% in just a few days. Today it trades around $1 after hitting a high of $3.84 in 2018.

Deaton was incensed as he watched his $600,000 in XRP go up in smoke. But as he began to read up on securities law, he quickly concluded that he had a case since the SEC’s actions while directed at Ripple and its leadership, had a more disparate impact, crushing passive holders of XRP who aren’t involved in the company’s platform.

"It’s one thing for the SEC to sue Ripple for what they did," he said. "But they were now attacking XRP holders who bought the crypto in the secondary market without knowledge of what Ripple was doing."

Deaton is certainly no Ripple fanboy. He is critical of the fact that Ripple itself has sold about $800 million in XRP since the SEC’s lawsuit. 

Nor is he a big fan of the regulatory apparatus surrounding XRP. "If the SEC really believes XRP is an unregistered security, why are they allowing the sale of the token during an ongoing lawsuit?" he said.

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In the case of Bill Hinman, the former corporation finance chief under Clayton and a key architect of the SEC’s past views on crypto, Deaton says regulatory filings show that he received $15 million while at the SEC from his previous law firm, Simpson Thacher & Bartlett, the same Simpson Thacher & Bartlett that is part of the Enterprise Ethereum Alliance. Plus, Hinman rejoined the firm in his post-SEC career. (A person close to Hinman says this money was part of Hinman’s pension from the firm and he had no idea the law firm was part of the alliance while at the SEC).

Deaton also says that the former head of SEC enforcement when the Ripple lawsuit was brought, Marc Berger, left the commission just three weeks later to join Simpson, Thacher & Bartlett. Berger didn’t return calls for comment and Hinman had no comment on this matter.

One additional coincidence involves the nation’s biggest bank, JPMorgan, which sold its digital token, the JPMorgan coin, to ConsenSys in August 2020. Deaton says that JPMorgan coin is a direct competitor to XRP; ConsenSys and JPMorgan are also members of the Enterprise Ethereum Alliance. He also pointed out that Clayton’s old and new law firm, Sullivan & Cromwell, advised ConenSys on the deal.

Drawing attention to these issues on social media and in the press has transformed Deaton from obscurity to celebrity in the XRP community. He is a frequent podcast guest where he expounds about the inequities of the case including how he believes many members of the regulatory community have close ties to XRP’s competitors.

His website, CryptoLaw, has become the go-to place for XRP holders to get information on SEC crypto enforcement actions.

Deaton’s once relatively small Twitter following has exploded to over 140,000 followers, and the class he’s seeking to represent in his suit against the SEC (the case has yet to officially certified) has grown from a relative handful to 62,000 XRP holders.

On Oct. 5, a federal judge granted Deaton permission to enter the SEC case as amicus curiae ("friends of the court") and represent the interest of XRP holders. The judge said Deaton’s knowledge of XRP will help educate the court on how the lawsuit has harmed both individuals and businesses.

Not bad for a guy who just started practicing securities law.