On February 16, 2023, in a complaint filed in the US District Court for the Southern District of New York (SDNY), the SEC charged Singapore-based Terraform Labs PTE Ltd (Terraform) and its CEO, Do Hyeong Kwon (collectively, with Terraform, defendants), with orchestrating a multi-billion dollar crypto-asset securities fraud involving an algorithmic stablecoin and other crypto-asset securities in violation of the registration and anti-fraud provisions of the Securities Act of 1933, as amended (Securities Act) and the Securities Exchange Act of 1934, as amended (Exchange Act).

According to the complaint, from April 2018 until the Terraform scheme collapsed in May 2022, defendants raised billions of dollars from investors by offering and selling an inter-connected suite of crypto-asset securities in unregistered transactions that included:

The complaint further alleges the defendants offered and sold investors other means to invest in Terraform, including the MIR or "mirror" tokens, which the SEC asserts are crypto-asset securities, and LUNA itself. The SEC also alleges that defendants claimed these tokens would appreciate in value. Both Terraform and Kwon touted and marketed UST as a "yield-bearing" stablecoin, which the defendants advertised as paying as much as 20 percent interest through what Terraform dubbed its Anchor Protocol. The complaint further alleges that, while marketing the LUNA token, defendants repeatedly misled and deceived investors by asserting that a popular Korean mobile payment application called "Chai" used the Terra blockchain to settle transactions that would accrue value to LUNA. The SEC asserts that these statements were materially false and misleading since Chai transactions were neither processed nor settled on the Terraform blockchain.

Terraform and Kwon further allegedly misled investors about the stability of UST, when in May 2021, the value of UST became "unpegged" from the US dollar, Terraform, through Kwon, secretly made plans with a third party, "US trading firm," to buy large amounts of UST to restore its value. However, in May 2022, when UST unpegged from the US dollar for a second time the price of UST and its other Terraform tokens plummeted to close to zero and never recovered.

The SEC complaint alleged that by the end of May 2022, UST, LUNA, and MIR were essentially worthless, wiping out more than $40 billion in combined market value. According to the SEC, the 2022 Terraform collapse devastated both retail and institutional investors and sent shock waves through the crypto markets (see Legal Update, Stablecoins Tether and TerraUSD Break Dollar Pegs Attracting Regulatory Scrutiny and Practice Note, Stablecoins and Central Bank Digital Currencies (CBDCs): Overview: Noteworthy Stablecoin Activity).

The SEC previously had announced on June 8, 2022, in connection with a prior SEC action, that the Second Circuit US Court of Appeals affirmed a district court order requiring compliance by Terraform and Kwon with investigative subpoenas served by the SEC for documents, as well as testimony from Kwon, as part of an SEC investigation into whether Kwon and Terraform violated federal securities laws in their participation in the creation, promotion, and offer to sell various digital assets related to Terraform's blockchain technology.

As a result of the conduct alleged in the SEC complaint, defendants violated the securities offering registration provisions of the Securities Act along with certain SBS provisions of the Securities Act and the Exchange Act when defendants offered and sold crypto-asset securities to investors without registering those offers and sales with the SEC as required by the federal securities laws.

Defendants further violated the federal securities laws by offering, selling, and effecting transactions in SBS – the mAssets, which were based on the value of underling equity securities – to parties that were not eligible contract participants (ECPs) as required under US law for transactions not executed on a national securities exchange without an effective registration statement filed with the SEC covering those offers and sales. According to the complaint, SBS, which are themselves securities, include any agreement, contract, or transaction that is a swap as defined in the Commodity Exchange Act (CEA) and is based on a single security, including on the value of such security.

According to the complaint, the offer and sale of the various Terraform tokens is considered an offer and sale of investment contracts under the Howey test, developed in the 1946 US Supreme Court case SEC v. W.J. Howey Co., 328 U.S. 293, 299 (see Practice Note, SEC Regulation of Digital Assets: The Howey Test).

The specific relief sought by the SEC against defendants includes:

For additional information on stablecoins, see Practice Note, Stablecoins and Central Bank Digital Currencies (CBDCs): Overview.