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On July 31, 2023, United States District Court Judge for the Southern District of New York Judge Rakoff, denied cryptocurrency company Terraform Labs, Pte Ltd. (“Company”) and its founder’s motion to dismiss a suit that had been brought against them by the Securities and Exchange Commission (the “SEC”). The SEC sued the Company and its founder in February 2023 after the Company’s algorithmic stablecoin collapsed in May 2022, contributing to multiple bankruptcies. The SEC alleged that the Company and its founder made false and materially misleading statements to entice U.S. investors to purchase and hold on to the Company’s products, which the SEC claimed were unregistered investment-contracts that qualified as securities under Section 5 of the Securities Act of 1933 (the “Securities Act”). SEC v. Terraform Labs Pte. Ltd., 2023 WL 4858299, at *1 (S.D.N.Y. July 31, 2023). The Court held that the SEC had alleged a plausible claim for relief, and enough facts to establish the cryptocurrencies at issue were investment contracts requiring registration under the securities laws.

The Company and its founder argued that the complaint against them should be dismissed for various reasons – making arguments akin to many other cryptocurrency companies that have been challenged in recent months and years. But of greatest interest was their attempt to rely in part on the recent ruling in SEC v. Ripple Labs, Inc. As we previously reported, just last month the United States District Court for the Southern District of New York issued a summary judgment decision in Ripple Labs, holding that Ripple Labs, Inc. (“Ripple”) unlawfully sold unregistered securities in violation of the Securities Act by selling its cryptocurrency token, XRP, to certain institutional buyers, while at the same time holding XRP was not a security within the meaning of the Securities Act when sold on digital asset exchanges, given the different circumstances and expectations of buyers in those transactions. The Company and its founder argued that the Ripple decision was fatal to the SEC’s allegations that the Company’s algorithmically stabilized stablecoin, and other tokens, were sold as investment contracts.

Judge Rakoff explicitly “reject[ed] the approach recently adopted by [Ripple Labs],” and “decline[d] to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not.” Terraform Labs, 2023 WL 4858299, at *15. The court held that there was no difference between whether the Company’s assets were sold directly to a purchaser or in a secondary resale transaction because it does not affect whether a reasonable individual would objectively view the Company and its founder’s allegedly misleading statements as promising profits. The court noted that the representations allegedly made by defendants about their cryptocurrencies and expected profits “would presumably have reached individuals who purchased their crypto-assets on secondary markets – and indeed motivated those purchases – as much as it did institutional investors.” Id. Accordingly, the court concluded that “secondary-market purchasers have every bit as good a reason to believe that defendants would take their capital contributions and use it to generate profits on their behalf.” Id.

In contrast to Ripple, which was decided at the summary judgment stage, Terraform was a decision on a motion to dismiss and taking the facts alleged as true. But the two judges – both in the Southern District of New York – took plainly different approaches on a key issue of law, making clear once again how needed further guidance is in this area. Both Ripple and the Company are almost certain to be appealed in due course, but until then the law remains uncertain.

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SEC v. Terraform Labs Pte. Ltd.

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