Federal judge rules against Terraform Labs in SEC’s fraud charges

Category: Crypto Regulatory

Manhattan District Judge Jed Rakoff ruled on Thursday that price-stable cryptocurrency company Terraform Labs and its co-founder Do Kwon have violated U.S. law.

The ruling was based on the company’s failure to register two digital currencies, TerraUSD and Luna, which ultimately resulted in a massive collapse in 2022.

The federal judge sided with the Securities and Exchange Commission (SEC) in the case, which accuses Terraform Labs and Kwon of “a multi-billion-dollar fraud involving the development, marketing, and sale of various cryptocurrencies.”

We also allege that they committed fraud by repeating false and misleading statements to build trust before causing devastating losses for investors,” SEC Chair Gary Gensler said in a statement at the time.

The SEC argued that TerraUSD and Luna, among four other crypto assets, were unregistered securities, qualifying as “investment contracts.”

Terraform and Kwon were also accused of misleading investors about TerraUSD’s stability, including false claims about potential value increases.

In response to the Manhattan court’s decision, a Terraform Labs spokesman has shared the company’s strong disagreement.

Insisting that its tokens were not securities, the spokesperson assured that the company would continue defending against the SEC’s “meritless” fraud claims during the upcoming trial.

SEC remedies pending

Fraud claims from the SEC will proceed to trial on January 29, 2024, as Rakoff denied summary judgment to both parties. The judge dismissed SEC claims of the defendants’ illegal offerings of security-based swaps.

In a 71-page decision, Judge Rakoff affirmed that the four crypto assets met the criteria of securities under a 1946 U.S. Supreme Court decision, SEC v WJ Howey Co.

However, he also acknowledged potential disagreement among reasonable jurors regarding the defendants’ intent to defraud investors in various statements about Terraform’s business.

Rakoff indicated that the SEC’s remedies for the sale of unregistered securities would be determined once the liability on the fraud claims is resolved.

Despite the industry’s firm denial that tokens qualify as securities, a prior Manhattan federal court ruling in July favored the cryptocurrency sector, stating that certain tokens sold by Ripple Labs did not qualify as securities.

Fugitive of two countries

Kwon is the architect of TerraUSD, a “stablecoin” intended to maintain a constant $1 price, and Luna, a more conventional token with fluctuating value closely tied to TerraUSD.

The collapse of both cryptocurrencies last year, with a loss of over $40 billion, impacted the broader cryptocurrency market, including Bitcoin.

Now at the center of the SEC’s allegations, Kwon is contesting extradition from Montenegro. The South Korean native was arrested earlier this year in March at the airport in Podgorica for attempting to travel with forged documents.

Detained alongside Kwon was Terraform Labs CFO Han Chang-joon, who was also found carrying falsified Costa Rican and Belgian passports.

In June, both Kwon and his associate received a four-month prison sentence for using forged passports.

Kwon, who had been a fugitive for several months, had an arrest warrant issued in his name by his home country in September. South Korean prosecutors issued the warrant through Interpol, which then globally broadcast a red notice to signal Kwon’s wanted status.

Along with five others linked to Terraform, Kwon faced allegations of fraud and financial crimes.

The collapse of the Terra stablecoin and the associated Luna reserve asset cryptocurrency resulted in the eradication of tens of billions of dollars in value. South Korean officials asserted that those implicated in the project illicitly gained over $340 million in profits.

Subsequently, a Montenegro court approved Kwon’s extradition to either South Korea or the U.S., both of which are seeking his return. The final decision will be determined after Kwon completes his prison term for document forgery.