A federal judge has sided with the Securities and Exchange Commission in the case against Terraform Labs and its former CEO, Do Kwon.
Judge Jed Rakoff of the U.S. District Court Southern District of New York filed the decision on Thursday, December 28. According to the court’s decision, the four crypto tokens offered by Terraform Labs and Kwon are securities.
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Earlier this year, the SEC accused Terraform Labs and Kwon of “orchestrating a multi-billion-dollar fraud related to the development, marketing, and sale of cryptocurrencies.” The SEC alleged that Terraform offered unregistered securities and security-based swaps.
The securities sold by Terraform Labs include LUNA, TerraUSD (UST) and Mirror (MIR). UST, which was supposed to maintain a 1:1 peg to the U.S. dollar, experienced a dramatic loss of its peg in 2022. With their prices plummeting, both UST and LUNA’s failure led to an estimated loss of $40 billion or more.
Court’s Howey test analysis
The court, referencing a prior statement from Kwon urging LUNA holders to “[s]it back and watch [him] kick ass,” concluded that LUNA met the Howey test. The ruling clarified that individuals could invest in a common enterprise and expect profits solely from Terraform and Kwon’s efforts.
Regarding the MIR token, the court determined that the defendants couldn’t effectively dispute that they led MIR holders to anticipate profits from a common enterprise tied to Terraform’s efforts in developing, maintaining and growing the Mirror Protocol. The court affirmed that MIR unequivocally passed the Howey test.
Additionally, the court denied Terraform Labs and Kwon’s motion to exclude the testimony of SEC experts Bruce Mizrach and Matthew Edman. Simultaneously, it also rejected the SEC’s motion to exclude the testimony of defense expert Terrence Hendershott.
While the court has now granted summary judgment for the securities status, a summary judgment from both parties regarding the SEC’s multi-billion fraud allegations has yet to be given.
A jury trial, scheduled to commence on January 24, 2024, will determine the outcome of the fraud claims.
If not settled earlier, the jury will focus on deciding other aspects of the securities fraud charges. This includes assessing whether Kwon misled or deceived customers about the security of Terraform’s financial products, including the algorithmic stablecoin UST.
In the face of the court’s decision to side with the SEC, a spokesperson from Terraform Labs expressed disagreement.
“We strongly disagree with the decision and do not believe that the UST stablecoin or the other tokens at issue are securities,” the spokesperson said. “Further, the SEC’s fraud claims are not supported by evidence, and we will continue to vigorously defend against those meritless allegations at trial.”
Kwon under multiple legal pressures
The UST’s massive collapse in May of last year erased approximately $60 billion in value and initiated an enduring crypto winter.
The SEC, aiming to designate Terraform’s issuance of multiple cryptocurrencies as illegal unregistered securities offerings, has accused Kwon of deceiving investors about UST’s peg.
In late October, however, Kwon’s attorneys sought to dismiss the case. They argued the SEC hadn’t proven Terraform’s wrongdoing, but the judge remained unconvinced on at least one point.
The trial is set to commence on January 29, next year, in lower Manhattan. As of now, Kwon faces additional legal problems, including eight fraud charges from the Department of Justice in March, leading to his arrest in Montenegro after fleeing charges in South Korea.
American, South Korean and Montenegrin prosecutors are all pursuing cases against him. Recently, a Montenegrin judge halted the U.S. government’s extradition request, currently under review.
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