SEC v. Terraform Labs: SDNY Holds UST and Certain Other Crypto Assets Are Securities | Practical Law

SEC v. Terraform Labs: SDNY Holds UST and Certain Other Crypto Assets Are Securities | Practical Law

Judge Jed Rakoff of the United States District Court for the Southern District of New York (SDNY) issued an opinion and order granting the motion for summary judgment filed by the SEC charging Terraform Labs Pte. Ltd., and its founder, Do Hyeong Kwon, (collectively, defendants) offered and sold unregistered securities, granting summary judgment for defendants on the SEC's claims of offering and effecting transactions in security-based swaps (SBS), and denying both the SEC's and defendants' respective cross-motions for summary judgment on the SEC's fraud claims.

SEC v. Terraform Labs: SDNY Holds UST and Certain Other Crypto Assets Are Securities

Practical Law Legal Update w-041-8499 (Approx. 9 pages)

SEC v. Terraform Labs: SDNY Holds UST and Certain Other Crypto Assets Are Securities

by Practical Law Finance
Published on 03 Jan 2024 • USA (National/Federal)
Judge Jed Rakoff of the United States District Court for the Southern District of New York (SDNY) issued an opinion and order granting the motion for summary judgment filed by the SEC charging Terraform Labs Pte. Ltd., and its founder, Do Hyeong Kwon, (collectively, defendants) offered and sold unregistered securities, granting summary judgment for defendants on the SEC's claims of offering and effecting transactions in security-based swaps (SBS), and denying both the SEC's and defendants' respective cross-motions for summary judgment on the SEC's fraud claims.
On December 28, 2023, Judge Jed Rakoff of the United States District Court for the Southern District of New York (SDNY) issued an opinion and order (December order) in SEC v. Terraform Labs Pte Ltd. and Do Hyeong Kwon, (S.D.N.Y. Dec. 28, 2023):
  • Granting the motion for summary judgment filed by the SEC on the claim that Singapore-based Terraform Labs Pte. Ltd. (Terraform) and its founder, Do Hyeong Kwon (Kwon) (collectively, defendants), offered and sold unregistered securities.
  • Granting summary judgment for defendants on the SEC's claims involving offering and effecting transactions in security-based swaps (SBS).
  • Denying both the SEC's and defendants' respective cross-motions for summary judgment on the SEC's fraud claims.
In February 2023, the SEC charged 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) (see Legal Update, SEC Charges Terraform and Its CEO with Securities Fraud in Connection with Terra USD (UST) Stablecoin and Other Crypto Assets). In August 2023, Judge Rakoff issued an opinion and order denying defendants' motion to dismiss the charges (see Legal Update, SEC v. Terraform Labs: SDNY Judge Denies Motion to Dismiss, Declines to Follow Ripple Labs Ruling).
The SEC alleged in its complaint that defendants:
  • Committed fraud in the sale of their crypto assets in violation of:
    • Section 17(a) of the Securities Act, which prohibits fraud in the offer or sale of securities;
    • Section 10(b) of the Exchange Act, which prohibits fraud in connection with the purchase or sale of securities; and
    • Rule 10b-5 under the Exchange Act, which prohibits deceptive or manipulative acts in furtherance of an alleged scheme to defraud in connection with the purchase or sale of securities.
  • Failed to register the offer and sale of Terraform’s crypto assets as required under the US securities laws.
  • Offered, sold, and effected transactions in SBS, specifically Terraform's "mAssets" product, to individuals who were not eligible contract participants (ECPs) under the Commodity Exchange Act (CEA).
The court found is no genuine dispute that four of Terraform's crypto assets – UST, LUNA, wLUNA, and MIR – qualify as investment contracts under the Howey test, established in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (see Practice Note, Regulation of Crypto-Asset Securities in USA: SEC Approach to Digital Asset Regulation: Howey Test and FinHub Framework). According to the December order, Terraform's UST, LUNA, wLUNA, and MIR crypto assets qualify as investment contracts because:
  • UST: Beginning in March 2021, holders of UST could deposit their UST tokens in Terraform's protocol, which was developed through defendants' efforts and which Kwon himself publicly announced would generate "by far the highest stablecoin yield in the market," with a "target" of "20% fixed APR." Once launched, returns from the protocol were paid out in proportion to the amount of UST tokens a person or entity had deposited. According to the order, it is of no legal consequence that not all holders of UST deposited tokens in the protocol, and thus that some holders chose not to accept the full offer of an investment contract.
  • LUNA and wLUNA: Kwon and others made specific, repeated statements that would lead a reasonable investor in LUNA and wLUNA to expect a profit based on defendants' efforts to further develop the Terraform blockchain, including that a person could invest in a common enterprise and be led to expect profits solely from the efforts of Terraform and Kwon.
  • MIR: Defendants led holders of MIR to expect profit from a common enterprise based on Terraform's efforts to develop, maintain, and grow Terraform's Mirror Protocol.
According to the December order, there is no genuine dispute that defendants offered and sold unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act because:
  • Terraform sold LUNA tokens directly to institutional investors through sales agreements that expressly contemplated Terraform's development of a secondary market.
  • Terraform sold MIR tokens directly to purchasers through "Simple Agreements for Farmed Tokens" that did not restrict purchasers from reselling their MIR tokens in secondary trading markets or to US investors.
  • Terraform sold both LUNA and MIR tokens to secondary market purchasers on Binance and other crypto trading exchanges and the record provides no evidence that Terraform took steps to determine whether those trading platforms were available to US investors.
  • Neither Terraform nor its institutional investors had any intent to simply hold onto LUNA or MIR without further trades, and it is immaterial that the vesting period in certain sales agreements prohibited "immediate resale" or that LUNA was not listed on any trading platform at the time of the purchases by those institutional investors.
The court also found that, as a matter of law, defendants did not offer or effect transactions in SBS in violation of Section 5(e) of the Securities Act because an mAsset does not meet the statutory SBS definition under the CEA because there was no evidence that a holder of an mAsset would transfer any financial risk associated with a future change in the value of a security to or from a counterparty in a transaction.
According to the December order, both the SEC and defendants did not meet their burdens of proof on their respective summary judgment motions on the SEC's fraud claims because:
Jury trial on the SEC's fraud claims against defendants is set to commence at 9:30am on January 29, 2024.
This case is the latest in a growing list of recent SEC crypto-asset securities enforcement matters, as the SEC has brought charges against many major global crypto players for violations of US securities laws. See Legal Updates: