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2 April 2023
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Attorney Kevin Chen: SEC Does Not Fully Understand Ripple’s ‘Fair Notice’ Defense

Earlier this week, Kevin Chen, an attorney at Homiak Law LLC, took a closer look at the “fair notice” defense used by Ripple Labs in the lawsuit (over the sale of XRP tokens) brought against it by the U.S. Securities and Exchange Commission (SEC).

Homiak Law is “a full-service boutique law firm that specializes in civil litigation, private equity and venture capital transactions, business formation, and regulatory compliance.”

As for Chen, he is “a corporate attorney with a diverse portfolio, having served as both outside and in-house counsel for several large companies.” He has “handled complex cases involving securities law, class actions, employment law, and breach of contract.”

As you may remember, on 22 December 2020, the SEC announced that it had “filed an action against Ripple Labs Inc. and two of its executives, who are also significant security holders, alleging that they raised over $1.3 billion through an unregistered, ongoing digital asset securities offering.”

On Monday (March 15), Chen took to Twitter to explain why he ffelt that the SEC might be missing one important nuance of the “fair notice” (or “due process”) defense used by Ripple’s legal team:

He then went on to say:

  • Constitutional due process generally requires that persons/entities must receive fair notice of conduct that is legally forbidden. This applies to criminal laws and civil laws imposing penalties.
  • Defendants making a due process challenge usually argue a statute fails to give fair notice because the statute is vague.
  • Although as the SEC has pointed out courts have in the past rejected the vagueness of the Securities Act and the Howey test as a valid defense, Ripple “is not (only) making this argument.”
  • Ripple’s point is that the SEC actively created confusion over XRP’s status through conflicting guidance. E.g., Director Hinman made a public statement that the SEC does not consider bitcoin or ether to be securities.
  • Ripple might be relying on FCC v. Fox Television Stations, Inc., a 2012 SCOTUS case.
  • The SEC is arguably doing something similar to Ripple—giving tacit approval of XRP and then changing course.

Chen closes his Twitter thread by acknowledging that “Ripple’s argument here is a harder sell, given that the SEC has perhaps not given ‘formal’ guidance to create confusion (as the FCC did in Fox).” He also points out that “this seems to be an untested argument in the crypto space.”

In an article for Law360 published on January 25, Joseph A. Hall, a former executive at the SEC, explained why “there’s a good chance” his former employer loses its lawsuit against Ripple Labs. In this article, Hall explained how inadequate the SEC’s Howey test is for deciding whether a particular cryptoasset is a security:

Imagine trying to explain what an iPhone is in language your great-grandfather would have understood just after World War II. That’s how easy it is to predict which digital assets are securities under the postwar Howey test.

He then argued that this lack of regulatory clarity significantly hurts the development of blockchain technology in the U.S.:

It’s difficult to overstate the impact this uncertainty has on the development of blockchain technology in the U.S. Outside the venture capital community, corporations, major investors and banks are understandably skittish about risking serious sums of money on technologies their lawyers can’t assure them comply with law — even when a technology holds the potential to improve the efficiency of managing vast amounts of data across countless industries, or the potential for frictionless, inexpensive transfers of value over smartphones and other widespread consumer tools.

As for the SEC’s lawsuit against Ripple over the sale of XRP tokens, Hall said that after William Hinman’s speech at the Yahoo Finance All Markets Summit in June 2018, where he said that Ethereum (ETH) “might have been born a security but later morphed into a nonsecurity”, it was “a fair bet that XRP would get the same treatment”, i.e. “maybe there were some issues with early sales of XRP, but at this point surely XRP itself was in the clear”.

Hall argued that the SEC’s decision to bring an enforcement action against Ripple Labs for ongoing sales of XRP is “remarkable on several levels”:

  • … the timing — the day before Clayton stepped down — suggests the possibility of a rift among the commissioners as opposed to a case everyone agreed had to be brought immediately in order to avert looming investor harm.
  • … whatever one’s views on the merits, before news of the SEC’s intentions broke, XRP traded with a market cap in the $25 billion to $30 billion range, meaning that any precipitous action by the SEC would surely result in heavy investor losses…
  • Why on earth did the agency bring a case that was considerably less a slam dunk than its previous crypto enforcement actions?

The views and opinions expressed by the author are for informational purposes only and do not constitute financial, investment, or other advice.

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