On December 28, 2023, the Southern District of New York granted summary judgment in favor of the Securities and Exchange Commission (“SEC”) on their claim that Terraform Labs Pte Ltd. and DO Hyeong Kwon (“Defendants”) offered and sold unregistered securities in violation of Section 5(a) and 5(c) of the Securities Act of 1933[1] (“Securities Act”). This SEC action stems from a complaint, filed on February 16, 2023, alleging, inter alia, that Defendants raised billions of dollars from investors by selling various crypto-asset securities-UST, LUNA, wLUNA and MIR- through unregistered transactions. Amended Complaint (“AC”) ¶ 1. The court found these assets to be securities subjecting them to the registration requirements of the Securities Act. Sec. & Exch. Comm'n v. Terraform Labs Pte. Ltd., No. 23-CV-1346 (JSR), 2023 WL 8944860 (S.D.N.Y. Dec. 28, 2023).
This decision conflicts with the recent outcome of Sec. & Exch. Comm'n v. Ripple Labs, Inc., No. 20 CIV. 10832 (AT), 2023 WL 6445969 (S.D.N.Y. Oct. 3, 2023), finding XRP, a digital token comparable to those at issue in Terraform, to not in and of itself be a “'contract, transaction [,] or scheme embodying the Howey[2] requirements of an investment contract." Id. at *2.
In Terraform, the court found the AC stated a plausible claim that purchasers of the Defendants’ crypto-assets were investing in a common enterprise because their investors’ returns were tied to the fortunes of the other investors by the pooling of assets with an expected “pro-rata” distribution of profits thereby qualifying the assets as “securities” under Howey. See id. at *13-16.
Then, the court addressed the SEC’s Section 5 allegations and found the Defendants to be necessary participants in the unregistered public distributions of these securities. Because the SEC satisfied its prima facie burden under Section 5(a) and 5(c) and no appropriate exemption applied, the court found that liability attached. Id. at *15-16.
Soon after Justice Rakoff issued the Terraform decision, the SEC used this ruling to persuade the court in Sec. & Exch. Comm'n v. Binance Holdings Ltd., 1:23-cv-01599, (D.D.C.), that the digital assets at issue are also “investment contracts” under the Howey test by submitting a Notice of Supplemental Authority.
Terraform’s novel precedent may be used in future cases to impute registration requirements on otherwise unregulated crypto-assets.
____________________________________
[1] Section 5 of the Securities Act of 1933 provides:
(a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly-
to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or
to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.
(c) It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8.
[2] In S.E.C. v. W.J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100 (1946), the court established the following three-prong test to determine whether an asset is an investment contract and thus a security: (1) the investment of money; (2) a common enterprise; (3) the reasonable expectation of profit derived from others.
About Faruqi & Faruqi, LLP
Faruqi & Faruqi, LLP focuses on complex civil litigation, including securities, antitrust, wage and hour and consumer class actions as well as shareholder derivative and merger and transactional litigation. The firm is headquartered in New York, and maintains offices in California, Georgia and Pennsylvania.
Since its founding in 1995, Faruqi & Faruqi, LLP has served as lead or co-lead counsel in numerous high-profile cases which ultimately provided significant recoveries to investors, direct purchasers, consumers and employees.
To schedule a free consultation with our attorneys and to learn more about your legal rights, call our offices today at (877) 247-4292 or (212) 983-9330.
About Matthew A. Conrad
Matthew A. Conrad is an associate in the New York office of Faruqi & Faruqi. Mathew is focused on F&F's securities litigation practice.
Matthew A. Conrad
Associate at Faruqi & Faruqi, LLP
New York office
Tel: (212) 983-9330
Fax: (212) 983-9331
E-mail: mconrad@faruqilaw.com
Social: LinkedIn