U.S. District Court in Terraform Labs Motion to Dismiss Rules: Crypto Sales to Public Can be Securities; Rejects Ripple Ruling Precedent
The U.S. District Court for the Southern District of New York, has rejected a fellow Judge Analisa Torres’s recent ruling SEC vs. Ripple Labs, Inc., (2023) that XRP was not a security when sold to the public on secondary markets.
The Judge Jed Rakoff denied Terraform Labs’ motion to dismiss the lawsuit from the U.S. Securities and Exchange Commission (SEC), stating that the regulatory agency has sufficiently argued it has jurisdiction and ‘asserted a plausible claim’ that TerraUSD (UST), the Anchor Protocol and LUNA may have violated securities law.
In the present case, the SEC alleged that Terraform Labs and its founder, Do Kwon, defrauded investors and sold digital assets in unregistered securities offerings.
In its motion to dismiss, Terraform Labs argued that purchasers of UST did not have an expectation of it being an investment. In allowing the SEC’s case to proceed against Terraform Labs and Kwon, Judge Rakoff declined to follow the recent ruling in SEC vs. Ripple.
During the motion to dismiss stage, the facts in the SEC’s complaint must be assumed to be true, he noted, and the SEC said in its filing that Terraform had “embarked on a public campaign to encourage both retail and institutional investors” to buy UST.
In Ripple case (Supra), the Court had found that, that Ripple’s XRP token sales to retail investors did not violate securities laws because those buyers purchased on secondary markets.
However, Rakoff said this distinction between purchasers does not apply under the legal Howey test that governs whether crypto assets are securities.
In denying the motion to dismiss, Judge Rakoff stated, “Howey makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary re-sale transaction has no impact on whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.”
The judge also rejected Terraform Labs' ‘major questions doctrine’ objection. The doctrine stems from a Supreme Court ruling which functionally blocks regulatory agencies from dramatically exceeding their mandate, and is an argument a number of crypto defendants have invoked against the SEC, including crypto exchange Coinbase.
“As the doctrine’s name suggests and the Supreme Court has, in case after case, emphasized, the Major Questions Doctrine is intended to apply only in extraordinary circumstances involving industries of 'vast economic and political significance,” the Judge observed.
Therefore, while acknowledging the doctrine limits agency overreach into major political issues, the judge ruled it does not apply to the crypto asset markets.
Moreover, The Court while determining the issue of whether an industry subject to regulation is of vast economic and political significance, held that it should not be resolved in a vacuum. Rather, an industry can be considered to have vast economic and political significance’ only if it resembles, in these two qualities, the industries that the Supreme Court has previously said meet this definition, opined the Judge.
Apropos to the fraud charges, the Court noted that SEC had provided enough evidence regarding Terraform and Kwon and had established its motive to mislead investors about the utility of their crypto-assets on allegations they fabricated adoption data.
The SEC had contended that the UST token and related protocol constituted an unregistered investment security.
Therefore, on the securities registration issues, the Court ruled the SEC ‘pled sufficient facts’ to plausibly allege Terraform unlawfully offered and sold unregistered securities.