On July 31, 2023, Judge Jed Rakoff of the United States District Court for the Southern District of New York (SDNY) issued an opinion and order (order) denying defendants' motion to dismiss charges in SEC v. Terraform Labs Pte. Ltd. and Do Hyeong Kwon, (S.D.N.Y. July 31, 2023), a case brought by the SEC against Singapore-based Terraform Labs Pte. Ltd. (Terraform), which develops, markets, and sells crypto-assets, and Terraform founder and CEO Do Keyong Kwon (collectively, defendants) (see Legal Update, SEC Charges Terraform and Its CEO with Securities Fraud in Connection with Terra USD (UST) Stablecoin and Other Crypto Assets).

In the order, Judge Rakoff expressly declined to follow last month's ruling by SDNY Judge Analisa Torres in SEC v. Ripple Labs on the application of the US securities laws to the offer and sale of crypto-asset securities (see Legal Update, SEC v. Ripple Labs: SDNY Holds Unregistered Sales of XRP Token Directly to Institutional Investors Violated US Securities Laws but Retail XRP Sales on Public Crypto Exchanges Did Not).

According to the order, the SEC complaint alleges that defendants:

Defendants are best known for developing and selling the TerraUSD stablecoin, known as UST, and its algorithmic companion cryptocurrency, the LUNA coin (see Practice Note, Stablecoins and Central Bank Digital Currencies (CBDCs): Overview: Noteworthy Activity in Stablecoin Markets and Legal Update, Stablecoins Tether and TerraUSD Break Dollar Pegs Attracting Regulatory Scrutiny).

Judge Rakoff found that the SEC asserted in its complaint a plausible claim that crypto-assets issued by defendants qualify as securities under the US securities laws because the SEC adequately pled that:

US securities laws. In the order, Judge Rakoff declined to draw a distinction between digital tokens based on their manner of sale, rejecting the approach adopted by Judge Torres in SEC v. Ripple Labs Inc., (S.D.N.Y. July 13, 2023), which made the distinction between "programmatic" crypto-asset sales on exchanges, which were held by Judge Torres not to be securities, and sales to institutional investors, which were held to be securities. Judge Rakoff's order asserts that Howey makes no distinction between purchases and that a purchaser bought the coins directly from defendants or, instead, in a secondary re-sale transaction has no impact on whether a reasonable individual would objectively view defendants' actions and statements as evincing a promise of profits based on their efforts.

Major questions doctrine. The court also addressed the "major questions doctrine" argument raised by defendants, which requires that in the extraordinary case where an agency claims the power to regulate a significant portion of the American economy that has vast economic and political significance, it must point to clear congressional authorization for that power (Util. Air Regul. Grp. v. EPA, 573 US 302, 324 (2014)). The court found that the major questions doctrine does not independently prevent the SEC from alleging Terraform's digital assets are investment contracts. On this point, the court found:

Due Process Clause. The court also found defendants' assertion in its motion that the SEC violated the Due Process Clause of the US Constitution to be an attempt to "manufacture" a fair notice defense because the SEC has, through its regulations, written guidance, litigation, and other action, provided a reasonable person within defendants' industry fair notice that their conduct may prompt an enforcement action by the SEC.

Other administrative arguments. The court also addressed other administrative arguments defendants posed, noting that:

For more information on SEC enforcement activity relating to digital assets, see Practice Note, Regulation of Crypto-Asset Securities in USA.