Judge rules Terra ‘stablecoin’ and other tokens are securities in victory for the SEC and departure from Ripple case
Leo Schwartz
Thu, December 28, 2023
AFP/Getty Images
A federal judge sided with the U.S. Securities and Exchange Commission in a closely watched crypto case on Thursday, ruling that four crypto tokens offered by the failed Terraform Labs company—including UST and LUNA—constituted unregistered securities.
As the crypto industry battles regulators over how to classify digital assets, the decision is a setback for the sector’s interpretation of securities law and a departure from a separate decision by a different judge in the Southern District of New York over the token XRP.
In his 71-page decision, Judge Jed Rakoff wrote that there is “no genuine dispute” that the four crypto tokens offered by Terraform were securities because “they are investment contracts,” arguing that defendants wanted to “cast aside decades of settled law,” citing the seminal Supreme Court precedent called the Howey test.
“Howey’s definition of ‘investment contract’ was and remains a binding settlement of the law, not dicta,” wrote Rakoff.
The trials of Do Kwon
During crypto’s bull run of 2021, Terraform Labs represented one of the most successful projects in the sector, raking in billions of dollars and backed by prominent investors in the space. With its so-called algorithmic stablecoin, UST, Terraform cofounder Do Kwon promised a crypto token that could maintain a $1 peg through a complicated system of distributing a secondary cryptocurrency called LUNA.
Less than a year later, UST lost its $1 peg in a spectacular meltdown in May of 2022, causing investors—including retail traders across the world—to lose their money. The prices for both UST and LUNA plummeted in a death spiral. Kwon was soon arrested in Montenegro, triggering an ongoing extradition fight between the U.S. and his home country of South Korea, with fraud charges brought by the U.S. Department of Justice.
In February 2023, the SEC sued Terraform Labs and Kwon, alleging that they orchestrated a multibillion-dollar securities fraud by offering unregistered securities, including UST and LUNA, as well as two other crypto tokens tied to the ecosystem, MIR and wLUNA.
In response, lawyers for the defendants made an argument similar to that of other crypto companies currently in legal battle with the SEC: U.S. securities law is antiquated, and crypto tokens do not fall under the traditional definition of the Howey test because they did not represent an investment in a common enterprise with the expectation of profit derived from the effort of others. UST, after all, was meant to maintain a $1 peg.
After U.S. District Judge Analisa Torres ruled in a separate court case involving the crypto company Ripple—finding that its crypto token XRP itself was not a security, and that its sale only constituted an investment contract in certain contexts—lawyers for Terra filed a motion to dismiss.
Rakoff, the judge overseeing the Terra case, threw cold water on his colleague’s decision, dismissing the motion and rejecting the approach used by Torres to distinguish how different digital assets are sold.
Thursday’s decision furthers Rakoff’s argument that the sale of Terraform’s crypto assets constituted an unregistered security. Even with UST, the token meant to be pegged to $1, Rakoff argued that holders of the token could deposit the tokens in a proprietary protocol developed by Terraform to earn back a yield. The distinction, however, seems to support the argument that stablecoins that do not offer a yield would not constitute a security.
Rakoff left one matter of the case unsettled—the question of fraud claims related to UST’s depeg brought by the SEC. In his decision, Rakoff wrote that the SEC’s evidence for its allegations comes from third-party whistleblowers that should be heard before a jury. Furthermore, he argued that defendants have shown a “genuine dispute” over whether a “reasonable investor” would have found statements around UST’s depeg to be misleading. Part of the pending case will relate to the involvement of Jump, a prominent trading firm that served as one of Terra’s main backers.
“We strongly disagree with the decision and do not believe that the UST stablecoin or the other tokens at issue are securities. Further, the SEC’s fraud claims are not supported by evidence, and we will continue to vigorously defend against those meritless allegations at trial," said a spokesperson for Terraform Labs in a statement shared with Fortune.
The jury trial is scheduled to begin in January 2024.
This story was originally featured on Fortune.com
Judge sides with US SEC, says Terraform Labs crypto founder Do Kwon violated law
Thu, December 28, 2023
Thu, December 28, 2023
The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C.
By Jonathan Stempel
NEW YORK (Reuters) -A federal judge ruled on Thursday that cryptocurrency entrepreneur Do Kwon and his company Terraform Labs violated U.S. law by failing to register two digital currencies that collapsed in 2022.
U.S. District Judge Jed Rakoff in Manhattan sided with the Securities and Exchange Commission in its case stemming from the implosion of the TerraUSD and Luna currencies.
Rakoff also denied summary judgment to both sides on the SEC's fraud claims, which will proceed toward a scheduled Jan. 29, 2024 trial. He dismissed SEC claims that the defendants illegally offered security-based swaps.
A Terraform spokesman said the company strongly disagreed with the decision, did not believe its tokens were securities, and would continue defending against the SEC's "meritless" fraud claims at trial.
The SEC had no immediate comment.
Kwon, a South Korea native, has also been charged with fraud by U.S. prosecutors in Manhattan.
He has been fighting extradition to the United States from Montenegro, where he was arrested in March several hours before the criminal fraud charges were announced.
Kwon had designed TerraUSD, a "stablecoin" designed to maintain a constant $1 price, and Luna, a more traditional token whose value fluctuated but was closely linked to TerraUSD.
Both cryptocurrencies lost an estimated $40 billion or more when TerraUSD proved unable in May 2022 to maintain its $1 peg.
Their collapse also dragged down the value of other cryptocurrencies, including bitcoin.
The SEC contended that four of the defendants' crypto assets, including TerraUSD and Luna, were unregistered securities because they qualified as "investment contracts."
It also accused Terraform and Kwon of repeatedly misleading investors about the stability of TerraUSD, including by claiming that their cryptocurrencies would increase in value.
'NO GENUINE DISPUTE'
In a 71-page decision, Rakoff said there was "no genuine dispute" that the four crypto assets were securities under a 1946 U.S. Supreme Court decision defining investment contracts.
The Court ruled in that case, SEC v WJ Howey Co, that an investment of money in a common enterprise, with profits to come solely from others' efforts, was an investment contract.
But the judge also said reasonable jurors could disagree over whether the defendants intended to defraud investors in multiple statements about Terraform's business.
These included statements about TerraUSD's temporary May 2021 failure to maintain its $1 peg, and how a popular Korean mobile payment app used the Terraform blockchain to settle transactions and supported Luna's value.
Rakoff said the SEC's remedies for the sale of unregistered securities would be decided once the defendants' liability on the fraud claims has been resolved.
The cryptocurrency industry has fiercely denied that its tokens qualify as securities.
It won a victory in July when another judge on the Manhattan federal court said some tokens sold by Ripple Labs did not qualify as securities, because purchasers did not know if their money went to Ripple or third parties.
The case is SEC v Terraform Labs Pte Ltd et al, U.S. District Court, Southern District of New York, No. 23-01346.
(Reporting by Jonathan Stempel in New York and Tom Hals in Wilmington, Delaware; Editing by Diane Craft, Matthew Lewis and Jamie Freed)
By Jonathan Stempel
NEW YORK (Reuters) -A federal judge ruled on Thursday that cryptocurrency entrepreneur Do Kwon and his company Terraform Labs violated U.S. law by failing to register two digital currencies that collapsed in 2022.
U.S. District Judge Jed Rakoff in Manhattan sided with the Securities and Exchange Commission in its case stemming from the implosion of the TerraUSD and Luna currencies.
Rakoff also denied summary judgment to both sides on the SEC's fraud claims, which will proceed toward a scheduled Jan. 29, 2024 trial. He dismissed SEC claims that the defendants illegally offered security-based swaps.
A Terraform spokesman said the company strongly disagreed with the decision, did not believe its tokens were securities, and would continue defending against the SEC's "meritless" fraud claims at trial.
The SEC had no immediate comment.
Kwon, a South Korea native, has also been charged with fraud by U.S. prosecutors in Manhattan.
He has been fighting extradition to the United States from Montenegro, where he was arrested in March several hours before the criminal fraud charges were announced.
Kwon had designed TerraUSD, a "stablecoin" designed to maintain a constant $1 price, and Luna, a more traditional token whose value fluctuated but was closely linked to TerraUSD.
Both cryptocurrencies lost an estimated $40 billion or more when TerraUSD proved unable in May 2022 to maintain its $1 peg.
Their collapse also dragged down the value of other cryptocurrencies, including bitcoin.
The SEC contended that four of the defendants' crypto assets, including TerraUSD and Luna, were unregistered securities because they qualified as "investment contracts."
It also accused Terraform and Kwon of repeatedly misleading investors about the stability of TerraUSD, including by claiming that their cryptocurrencies would increase in value.
'NO GENUINE DISPUTE'
In a 71-page decision, Rakoff said there was "no genuine dispute" that the four crypto assets were securities under a 1946 U.S. Supreme Court decision defining investment contracts.
The Court ruled in that case, SEC v WJ Howey Co, that an investment of money in a common enterprise, with profits to come solely from others' efforts, was an investment contract.
But the judge also said reasonable jurors could disagree over whether the defendants intended to defraud investors in multiple statements about Terraform's business.
These included statements about TerraUSD's temporary May 2021 failure to maintain its $1 peg, and how a popular Korean mobile payment app used the Terraform blockchain to settle transactions and supported Luna's value.
Rakoff said the SEC's remedies for the sale of unregistered securities would be decided once the defendants' liability on the fraud claims has been resolved.
The cryptocurrency industry has fiercely denied that its tokens qualify as securities.
It won a victory in July when another judge on the Manhattan federal court said some tokens sold by Ripple Labs did not qualify as securities, because purchasers did not know if their money went to Ripple or third parties.
The case is SEC v Terraform Labs Pte Ltd et al, U.S. District Court, Southern District of New York, No. 23-01346.
(Reporting by Jonathan Stempel in New York and Tom Hals in Wilmington, Delaware; Editing by Diane Craft, Matthew Lewis and Jamie Freed)
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