On July 31, federal judge Jed Rakoff denied Terraform Labs’ motion to dismiss the SEC’s lawsuit against their company and founder, Do Kwon. He refused to apply the logic from the recent ruling in favor of Ripple Labs, which determined that Ripple’s XRP sales did not violate federal securities laws because the sales were made to institutional investors and not to the general public.
The judge ruled that, according to the Howey legal test, it doesn’t matter how Terraform Labs initially sold their UST and LUNA cryptocurrencies (whether to wholesale or retail investors, in primary or secondary markets). What matters is whether those sales constituted the offering of securities that should have been properly registered with the SEC under U.S. securities laws.
It’s worth noting that under the Howey test, if a cryptocurrency involves investing money in a common enterprise with the expectation of profits derived from the efforts of others, it is considered a security.
Judge Rakoff rejected Terraform Labs’ arguments against the SEC
The judge dismissed Terraform Labs’ claim that the SEC needed explicit congressional authorization to regulate stablecoins. He also considered that the SEC provided enough evidence that the company had allegedly fabricated adoption data of their cryptocurrencies to fraudulently promote them.
Rakoff stated that although the cryptocurrency industry holds some global significance, it is still “far from being a ‘part of the U.S. economy’ with ‘substantial economic and political importance’”.
On February 16, the U.S. Securities and Exchange Commission (SEC) sued Terraform Labs and its founder, Do Kwon, for alleged securities fraud. The SEC accused Terraform of selling the stablecoin TerraUSD without properly registering it as a security and misleadingly promoting it to the public.
Additionally, they accused Do Kwon, who is currently out on a $430,000 bond, of allegedly orchestrating a billion-dollar fraud through the sale of TerraClassicUSD (USTC) and its connected cryptocurrency, Terra Luna Classic (LUNC), formerly known as Terra (LUNA) and TerraUSD (UST).
The SEC seeks restitution of illegally obtained investor funds from Terraform Labs and the imposition of civil penalties.
Although Judge Rakoff’s decision might be seen as a significant victory for the SEC in their campaign against the cryptocurrency industry, the lawsuit could still be dismissed on appeal or if a mutual agreement is reached.
Therefore, it is still too early for the thousands or millions of investors who lost their money due to the colossal fall of Terra to claim victory and rest easy. While regulators are assisting in recovering the lost funds, so far that money remains missing, and it is very difficult for it to be fully recovered. The complex legal and financial situation surrounding the collapse of Terra means it could take years to completely resolve it.