On The Case

SEC's failed bid for Ripple execs' bank records shows government's crypto suspicions

The current and former CEOs of the blockchain payments company Ripple won't have to bare their financial lives to the U.S. Securities and Exchange Commission after a ruling on Friday from U.S. Magistrate Judge Sarah Netburn of Manhattan.

Netburn granted a motion by Ripple CEO Brad Garlinghouse and co-founder and former CEO Chris Larsen to quash SEC subpoenas for eight years' of banking records that the government said it needed to prove that Garlinghouse and Larsen engaged in the sale of unregistered securities when they traded XRP, digital tokens that were originally distributed on the Ripple platform. The SEC also alleges that the two executives aided and abetted Ripple in the sale of more than $1 billion in unregistered XRP between 2013 and 2020.

The judge agreed with Garlinghouse counsel Matthew Solomon of Cleary Gottlieb Steen & Hamilton and Larsen lawyer Martin Flumenbaum of Paul, Weiss, Rifkind, Wharton & Garrison that the government can make do with the XRP transaction records that the defendants have already agreed to produce. Because the SEC has not offered evidence that Garlinghouse and Larsen have withheld trading information or otherwise attempted to mislead the government, she said, there’s no call for “the disclosure of an immense trove of private financial information with no relevance” to the SEC’s allegations.

Garlinghouse and Larsen, as I've reported, deny all of the SEC's allegations, arguing, among other things, that XRP are not securities under the U.S. Supreme Court's test in 1946's SEC v. WJ Howey Co. They are expected to file motions to dismiss the SEC's suit on Monday. Neither Solomon, Flumenbaum nor a Ripple spokeswoman responded to my email request for comment on Netburn's ruling last week. A SEC spokesman declined to comment.

The blockchain industry is watching the Ripple case as the SEC's latest and largest enforcement action against the original distributer of a digital currency, following the commission's wins in 2020 against the cryptocurrency developers Kik and Telegram. In that context, it's worth looking back at the SEC's now-failed justifications for access to the Garlinghouse and Larsen financial records as a reflection of the government's view of defendants who successfully trade digital assets.

That view, in a word, is skeptical – and that skepticism seems to be rooted in the anonymity of blockchain transactions. I've told you recently about the Internal Revenue Service going after cryptocurrency exchanges for the records of customers suspected of underreporting taxable income from payments and trading in digital assets. The same suspicion underlies a March 17 letter brief from SEC lawyer Jorge Tenreiro in the Ripple case.

The SEC told the magistrate judge, Netburn, that Larsen and Garlinghouse had apparently netted vast sums of money – at least $450 million for Larsen and $159 million for Garlinghouse – from their personal sales of XRP. Garlinghouse was allegedly involved in at least 115 transactions, transferring XRP from 25 blockchain addresses on the XRP Ledger. Larsen allegedly engaged in at least 535 transactions, using at least 28 XRP blockchain addresses.

But those are just the sales that the SEC has been able to trace, Tenreiro said in the March 17 letter brief. The XRP ledger, like other blockchains, shows the movement of digital assets between digital addresses, but those digital “wallets” can be created without identifying information. Cryptocurrency traders, in other words, can buy and sell under the protection of pseudonyms, according to the SEC.

Larsen allegedly took advantage of pseudonymity, according to the SEC’s March 17 letter. The government said it had obtained information showing that even after the SEC filed its initial complaint against Ripple and individual defendants in December, Larsen allegedly continued trading XRP “using pseudonymous, cross-border blockchain transactions (via) intermediary and custodial wallets at offshore digital asset platforms.”

The SEC said that it needed access to bank records for Larsen and Garlinghouse to “deanonymize” their XRP transactions by checking when the defendants converted their XRP into dollars. “Without the bank records, the SEC would have to take (Larsen and Garlinghouse) at their word,” the brief said, “with no guarantee that the SEC has been able to identify the complete universe of their sales and blockchain movements of XRP.”

In their joint letter brief to Netburn, counsel for Larsen and Garlinghouse called the SEC's demand for bank records "wholly inappropriate overreach." The defendants had already agreed in good faith to turn over all of their data involving XRP transactions, their lawyers said, and the SEC had offered no good reason why their privacy should be compromised with subpoenas for every detail of their financial lives, down to grocery store receipts. (The SEC later said it would waive its demand for information on transactions of less than $1,000, presumably exempting most trips to the grocery store.)

If the SEC’s pursuit of banking records from Garlinghouse and Larsen is a portent of the government’s plans to scrutinize crypto traders’ pseudonymous transactions in future cases, Netburn’s ruling on Friday is a warning that those plans may come to nought. Not only did the magistrate reject the SEC’s premise that the Ripple defendants could not be trusted to produce the records they pledged without verification, but she also said the bank records wouldn’t provide the back-up that the SEC said it needed.

Even if the defendants’ bank records showed a deposit on a particular date from a cryptocurrency exchange, she pointed out, the reports would not show the deposit was the result of a sale of XRP – let alone whether the XRP sale was from a digital wallet with a known owner or a pseudonymous account. In short, Netburn said, the bank records wouldn’t solve the problem for which the SEC said they were needed.

The SEC appears to be determined to prevent crypto defendants from hiding behind anonymous trading – but it seems, at least for now, that it can’t rely on bank records to do the job.

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