Why the Ripple XRP Ruling Changes Everything (John Deaton Explains)

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1:28what's going on guys it's ash bennington welcome to real vision crypto daily briefing before we introduce our guests i have something special that i want to talk to you about today i just want to speak from the heart for a minute about this you guys know that real vision is more than just a job for me it's a huge part of my life it's an honor to get to do this to get to create content and to interact with all of you one of the amazing things about working at real vision is that we are all constantly forcing ourselves to grow, always experimenting with new things. This is one of them that I want to talk to you about today.

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3:10This is something that I think is going to be just incredibly useful and incredibly powerful. Right now on the platform, we've got a kind of traditional comment system where you can go and post comments, of course, on our videos. But under the new system, it's going to be much more interactive. There's going to be notifications. I think this is going to facilitate the conversation on Real Vision, which is really what matters most to us. Getting the network engaged, getting our members engaged in the conversation. Some really cool functionality coming there soon. And as I said, for the rest of the week, we're going to be featuring a new feature every day to tell you about what's coming.

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4:19I think you're going to find it really cool. I know that I do. Okay. With all that said, onto today's show, joining me today is John Deaton, managing partner at Deaton Law Firm and founder of Crypto Law. John, welcome to the show. So thanks, Ash. I appreciate it. And congratulations to you, Raul, and the whole Real Vision team. This isn't the, you know, when people are building in this environment, you're doing a great thing. So congratulations. Oh, thanks, man. It's really cool. I've been playing around with some of the beta versions and just the ability of people to interact with each other, to interact with the content.

4:54There's just so much interesting stuff that's coming. And I think it's going to be just a huge shift forward for Real Vision. And I'm excited to keep doing content here. John, we were saying before the show, you were the man of the hour, the person I most want to talk to about everything that's happening with the Ripple XRP lawsuit. Let's begin at the very beginning. What's this all about? What's the big picture? Give us the backstory so that people who haven't been following the story as closely as you have can know what's going on. Okay. Well, Thursday was a monumental decision. But as you said, you have to back up.

5:25In December, on December 22nd of 2000, the SEC filed a lawsuit against a company called Ripple. Ripple had introduced XRP. They owned about half of it. And at the time, XRP was the third largest crypto asset after Bitcoin and Ethereum. And at first, I didn't think much about that because, you know, companies get sued. Amazon's been sued by the SEC, Mark Cuban, everyone. And so I was like, OK, well, maybe Ripple sold XRP as a security at some point. But when I read the complaint, the SEC's theory was basically saying that all XRP cells going back for seven and a half years, that they were all illegal transactions, including the XRP that I own.

6:11And at the time, XRP was a minor possession of mine as far as asset. Bitcoin was 10 times larger in my portfolio. So Ethereum was four times larger. But when I saw that they were claiming that XRP sold on Coinbase or other exchanges, that they were claiming those were illegal securities as well, then basically I sued the SEC. And to make a long story short, 75 ,000 XRP holders joined me from around the world, the United States, about 55 % of the United States, 45 % internationally. internationally and we challenged the SEC and we asked to be named defendants in the case, which was an exceptional thing to ask.

6:52The judge said, well, I won't let you go that far, John, but you can be a meek as counsel and, you know, and we'll listen to what you have to say from the individual retail holders perspective. And our perspective was always this SEC. If you can prove Ripple violated the securities laws. Go all at it. We don't take a position. But the claim that what we own, the asset we own is an unregistered security is absurd. And you're stretching this Howey case beyond recognition into the secondary market. And you're acting just because an asset was originally sold in one instance, it was a security that it would forever in perpetuity be security.

7:36And that's just not supported by the law. And Thursday, after two and a half long years of litigation and all kinds of things happening, the judge came down and she found what essence we predicted that Ripple, when it sold directly to certain people, hedge funds and others, that it did in those early years constitute an unregistered security. But that XRP itself, the token is just a digital asset. It doesn't represent an investment contract with Ripple or anyone else. And that secondary market sells because the purchaser doesn't know who they're buying it from. And one of the essential factors in order to be a security is that you have to rely on the efforts of a company or others.

8:23And if you don't know who's selling you the token, you're just buying a token. And that's in essence what the judge said. And it's been a huge news because it implicates the Coinbase lawsuit and all the other things that the SEC is trying to pursue. Okay, so now we get to spend the next 22 minutes unpacking all that because there's a tremendous amount of information there. I think particularly for people like me who are not lawyers, it's difficult to understand all the legal nuance in this case. Let's start with the basics. Let's talk about the Howey test and why this is or is not a security. My understanding of the Howey test is essentially it's an extension from the 1950s.

8:59on the 1933 Securities Act that establishes kind of the basic framework for securities laws. And there are four principal tenets of the Howey test, or prongs as they're called, an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others. Folks who watch this show have heard that ad nauseum because it is a court case that is so fundamental to understanding how the federal courts view securities in the the United States. Talk a little bit about that in relationship to the decision we got on Thursday. Right. And one of the things, Ash, that we were saying that I put in our amicus brief, is I was saying that there isn't a case that the SEC or anyone can cite in 80 years that held an investment contract when the buyer had absolutely no privity, no relationship, no communication between the promoter who's selling it and the buyer, yet they were claiming that.

9:53And so what the judge did is she applied, she did a strict Howey analysis, those factors that you just articulated. She said, okay, the SEC is basically saying these three types of cells all constitute securities. And so she applied that test to each cell. One cell was institutional cells. The second was programmatic, which just means Ripple sold on an exchange. And then the third type of cell was more of like a distribution where Ripple offered XRP to employees or to independent contractors, developers to build and facilitate utility on the XRP ledger. And so she just went, let's apply those factors to each test, to each cell.

10:40And institutional sales, she said it met all the factors because they entered written contracts with Ripple. So they definitely got privity, right? There's written contracts where Ripple says, you know. What's privity, John? Privity is just a relationship. In other words, there's communication of some sort. I know you. You buy me a car. We're in privity. If we sign a contract between you and I, privity. You and Real Vision are in privity because you have a relationship with them, right? And so when a person buys XRP, many of them had never heard of the company Ripple. They may have heard Ripple because XRP and Ripple was used interchangeably, but they didn't know that there was this company that sold software to banks.

11:27They just bought XRP because it was the third largest crypto asset, and it was cheap, as an example, right? And so there's no knowledge of Ripple in that situation. So when you talked about common enterprise, just for your viewers, you don't have to be a lawyer. Just think of this. Can you enter a common enterprise and rely on something or someone that you are oblivious to, that you're not aware that they exist? So how do you rely on the efforts of someone that you're not aware of? How are you in a common enterprise with people that you are unaware of? And so that's sort of a simplistic way to look at it.

12:08But the institutional sales, Ripple gave them contracts to sign, brochures. They talked about Ripple's business model and how Ripple was expanding and trying to enter the cross-border payment system and relationships with banks and trying to replace SWIFT. And so when those institutional buyers bought XRP from Ripple, they clearly were relying on the efforts of Ripple to build out the ecosystem, which would increase the price. There's your reasonable expectation of profits derived from the efforts of Ripple. So she said, boom, that test is satisfied. That's unregistered security. Then when she got to Ripple selling or the executives, doesn't matter, when they went to sell on Coinbase or Binance or BitTrue or any exchange, it's a blind bid ask situation.

13:00So when I go on Coinbase and I'm trying to buy XRP and I see that it's 75 cents and I buy it, I don't know who I'm buying it from. Am I buying it from Raul? Am I buying it from you? Am I buying it from Ripple? Am I buying it from Coinbase because they own some? I have no idea. And so how can I rely on the efforts of those that I don't know exist? And so that's basically what she said. And she said in that type of transaction, that third, that prong of reasonably relying on the efforts of other is not satisfied. So therefore, in the Howey case, the Howey test, you have to meet all those factors that you articulated.

13:47If you meet three out of the four that you articulated, not good enough, right? You have to meet all. So when she said you didn't meet the prong of reasonably relying on the efforts of others, that meant how we test is not satisfied. She didn't even have to analyze the other factors because you have to have them all. So that's what she ruled. And obviously, that has huge implications for the Coinbase case. Let's just talk about that because Coinbase is an intermediary who is just, you know, providing a platform between a buyer and a seller in a blind situation. And that's why you saw Celebration.

14:29Yeah, it really is interesting. And we saw Paul Graywell, the chief legal officer of Coinbase, tweeting about this as well, as you point out, in relation to the case, potentially, I guess, at least in the broader context of the case on Coinbase. It really is so interesting because I think a lot of us who are not attorneys struggle to get our head around two things. One, the point that you just made there. How can a thing not be a security where the sale of it was security? And the second sort of unusual aspect of this. Well, let me just give you the context. On Thursday, I'm on this show, Real Vision Crypto Gathering, having a conversation with three hedge fund managers, institutional folks in the space who are involved in the digital asset space.

15:08None of them, to my knowledge, is a lawyer. I'm literally reading this stuff as I'm seeing it come out live. And one of the hedge fund managers used a very technical legal term to describe the nature of essentially something being a security when it's sold to institutions but not to individuals. He referred to that as back-ass word. We were all kind of scrapping our heads trying to figure out how can a thing be a security when it's sold to institutional investors rather than retail investors who SEC and other regulators here in the United States obviously have an obligation to protect. It's an unusual circumstance.

15:44How do you think about that aspect of the case? Well, that's a fantastic question. And just so you know, you've had a lot of people come out and say, well, this result is perverse. They've used that word, dead-ass wrong, whatever you want to call it, because they say it violates the whole policy behind securities laws that are meant to protect the little guy, the unsophisticated investor, not the sophisticated hedge fund. And I say hogwash to that. And I'll tell you why that I say that, because this judge isn't there. She's there to apply the law. This is what happens, Ash, when you take a 1934 Securities Act that was defining and that all it said was investment contracts, stocks, bonds, promissory notes, and then this term investment contract.

16:36And then 10 years later, the Supreme Court defines what that investment contract term means and gives us the Howey test. So we are applying 1930s and 40s law to modern day blockchain technology. When that policy was determined, we didn't have the Internet. We didn't have Google. So think about the disclosures that they were talking about in the 30s. Do they equally apply to today's investor who has massive information at the tip of their hands through the Internet? And so what this judge did was apply that test. And the fact that the result seems inconsistent, well, that's for Congress to take up.

17:20Right. That's for the SEC. But when the SEC engages in regulation by enforcement and just starts blindly filing these lawsuits, trying to pigeonhole and make a jurisdictional land grab for this asset class, you're going to get rulings that seem inconsistent. But what this judge did was a strict application of that test. Her job is not to say, well, let me think what they wanted to do and protect in the 30s and 40s and then make my ruling. That would be a judge not following the law. You understand what I'm saying? And so I get what they're saying, but this judge did the right thing, in my opinion.

18:04it. Yeah, it is so interesting when you talk about that, this idea that we have these securities laws that are many, many decades old, the cases that define them slightly less old, but still a much earlier vintage prior to the technology. It is interesting as we all try to get our heads around this. I think the one thing that Democrats and Republicans, liberals and conservatives and progressives and libertarians all seem to agree on right now is that Congress is immensely dysfunctional. And the challenge of getting legislation that addresses 21st century technology and 21st century legal and business issues is really a challenge.

18:36It's very challenging. And, you know, it is true that the Howey test is supposed to be this flexible test that can meet modern day cases. But, you know, here's the problem. And this is why people and I understand some of it, I think, is intentional and some of it's genuine where they say, well, how can the judge find XRP in one cell as a security and not in another? That's been the law asked for 80 years. In 2013, in the USV shavers, Bitcoin was packaged and marketed, offered and sold in an investment contract. But no one claims Bitcoin is in and of itself a security. Orange groves, beavers, whiskey, chinchillas and condos have all been packaged in a way that meets the Howey test.

19:30So the asset itself that underlines the investment contract has never been a security, unless it's a stock or bond or promissory note. That stays a security because that was named. This investment contract was this term that no one understood what Congress meant, and the Supreme Court in 1946 defined it. And so we have a judge applying a 1946 test to modern day blockchain technology. And some people don't like the result because they say that it makes no sense considering the policy implications. And I reject it. I mean, I don't reject it. I agree that they're making that point. That's a valid point.

20:17But that's not for this judge. That doesn't make her decision wrong. You understand? That's what I'm making, the point I'm making. Yeah, in the sense that her job is to apply the law and not to write it. Listen, I should say, by the way, put down your questions in the chat. We'll ask the best ones on air. Remember, Real Vision members take priority. If you're not a Real Vision member yet, go to realvision.com forward slash crypto to sign up. It's free and it will remain so. We're committed to doing content like this for free and getting it out to as many people as we possibly can. And this way, if you subscribe, you'll be able to watch the latest Rouse Adventures in Crypto before anyone else.

20:54A new episode appeals every Friday. John, I want to ask you one more question before we move on to our viewer questions. And this is an important one. It's a topic that lots of people are buzzing about right now, which is the potential appeals in this case. Talk a little bit generally for people who don't have a legal background about the appellate process in cases like this. and then talk specifically to what your view is the likely outcome of an appeal if one is filed would be. Okay. Well, here's the thing to know that the judge, this decision, as we know, was a split decision, meaning that Ripple was found responsible for these institutional cells.

21:35But there were two executives who were also sued. And the SEC was charging them with aiding and abetting Ripple, the company, in violating Section 5 of the 1934 Security Act. Was this Mr. Garlinghouse and Mr. Larson? Yes. So the defendants in the case are Ripple, Brad Garlinghouse, CEO, Chris Larson, co-founder and chairman of the board. And so the judge found that it's up for a jury to decide whether Brad Garlinghouse and Chris Larson were reckless in aiding and abetting or whether they're not reckless. That's for the jury to decide regarding institutional sales. Their individual sales on exchanges has been found in favor of them.

22:28The judge ruled just like when Ripple sold an exchange is not a security. So that jury trial has to take place first. The SEC or Ripple, they don't have an immediate right to appeal this case. Now, one of them or both of them could go to the judge and say, we're asking you, judge, for an interlocutory appeal. We don't want to do that jury trial. Will you certify that we can go up to the Second Circuit? And then the Second Circuit would have to agree to hear it. So it would require the judge to say, yes, I'll allow it and be the Second Circuit to accept it. So unless that happens, which I don't think it will happen, then we have to get that jury verdict first and then an appeal.

23:21And that jury verdict isn't going to take place in the next six months. So you're talking about a jury trial sometime next year and a decision sometime next year and then the appellate process. So the thing to know is that this judge's decision, unless there's an interlocutory appeal, is going to be the law of the land in this case for the next two to three years because it's going to take that much time before it gets to the Second Circuit. That's extremely interesting, John. Let me just ask you this, just to clarify. Because the case against the Ripple executives, the civil case, we should say, against the Ripple executives, is significantly more sort of narrow in scope.

24:04It applies to them in relation to the institutional sale. Is there a possibility that SEC can ask for some type of ruling from the judge to deal with this broader question of whether or not these types of tokens are securities? Because it obviously appears to me, at least from a non-legal perspective, that this is something that they believe very strongly. And is it possible that we'll see an appeal on the question of whether or not Ripple is a security aside from the institutional sales component? Yes. Well, I have to correct you to say XRP, not Ripple, is a security. Just if I didn't, the XRP holders would crucify me.

24:42Yes. Or not. It happens. By the way, let's talk about the distinction between Ripple and XRP, since you make the point, and it is a very important one. Well, yes. If Ripple could go back and change one thing in its history, this is me speculating, I would imagine that it would be not to call the XRP token the Ripple token in the very beginning, because people use Ripple and XRP on exchanges when it was listed. Sometimes it would say Ripple and then parentheses XRP. And so there's a distinction between the token, which is the native crypto asset of the XRP ledger, to say the blockchain, like ETH is Ethereum, Bitcoin is Bitcoin network.

25:25And so Ripple is the company that sells software that's trying to replace SWIFT, the payment messaging and system system in the world. And so Ripple is the company. And so that issue that you were talking about is that interlocutory appeal. The SEC could go and say, judge, this is a major issue. We think you got it wrong. There's a lot of inconsistency. We're asking you to certify that this goes up. But if I'm Ripple, now here's the thing, Ash. If I represent Ripple or the executives, am I going to object to that or agree? Yes, let's go get it up to the Second Circuit. and possibly get a worse ruling?

26:11Or am I going to say, wait, this has been hanging over our head, these two executives, for two and a half years. That doesn't count the 30 months that they were under investigation. So really we're at five years that this has been hanging over these two executives. They have their right in court, Judge, before we go up on appeal. All you did was apply the standard test that we all agreed to. The SEC came to you and said, apply the Howey test and you'll determine that XRP is a security. You did. They don't like the result. We shouldn't have an appeal immediately. That's what I would do. That's what I would do.

26:51And so I think that unless Ripple is going to concede and agree with the SEC that it should go up earlier, I don't see it going up earlier. Oh, very interesting. And I think that clarifies the question for a lot of people. John, I want to jump in here because we're about to run out of time, but I want to get at least a few questions in. Maybe we could do a speed round, some really quick answers here. I'll try to make you do it. For some of these questions, because I know our viewers have a lot of them, and unfortunately, we're running out of time. The first one comes to us from Ralph on the Real Vision website.

27:19Is it better to consider whether someone has entered a securities transaction rather than to try to define the thing they're trading as a security? Very interesting question from Ralph. Can you repeat it? I'm sorry. Is it better to consider whether someone has entered a securities transaction rather than trying to define the thing they're trading as a security? Absolutely. And that's what this judge did. It's the circumstances surrounding the cell that matter, not the underlying asset. And the Howey case said the same thing, actually. The Supreme Court said that whether or not the underlying asset is speculative or has intrinsic value is immaterial.