Judge denies Terraform Lab’s request for dismissal, also rejects XRP ruling

(Kitco News) – The judge overseeing the Securities and Exchange Commission’s (SEC) lawsuit against Terraform Labs has ruled that the case will proceed after denying the firm’s motion to dismiss on Monday.

Terraform Labs is the company behind the Terra/Luna stablecoin pair whose collapse led to a series of cascading bankruptcies and the onset of the ‘crypto winter’. In February, the SEC filed a lawsuit against Terraform Labs and their former CEO Do Kwon, alleging they orchestrated “a multi-billion dollar crypto asset securities fraud.”

Legal representatives from the firm filed a motion for the dismissal of the suit in April, with supplemental materials for the motion provided in June that cited developments in the SEC vs. Ripple case.

In his ruling on the request for dismissal, Judge Jed Rakoff of the Southern District Court of New York said, “Because the defendants used false and materially misleading statements to entice U.S. investors to purchase and hold on to defendants’ products, and because those products were unregistered investment-contract securities that enabled investors to profit from the supposed investment activities of defendants and others, the motion to dismiss must be denied.”

As part of his ruling, Judge Rakoff also rejected the July 13 ruling from U.S. District Judge Analisa Torres that Ripple did not violate securities laws by selling its XRP token on public exchanges.

“It may also be mentioned that the Court declines 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,” Judge Rakoff wrote. “In doing so, the Court rejects the approach recently adopted by another judge of this District in a similar case, SEC v. Ripple Labs Inc.”

Rakoff specifically pushed back against the distinction between individual investors and retail investors, where Judge Torres ruled that “institutional buyers reasonably expected that Ripple would use the capital it received from its sales to improve the XRP ecosystem and thereby increase the price of XRP,” while those who purchased their coins through secondary transactions had no reasonable basis to expect the same.

“According to that court, this was because the re-sale purchasers could not have known if their payments went to the defendant, as opposed to the third-party entity who sold them the coin,” Judge Rakoff wrote. “Whatever expectation of profit they had could not, according to that court, be ascribed to defendants’ efforts.”

“But Howey makes no such distinction between purchasers,” he argued. “And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary resale 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.”

“Indeed, if the Amended Complaint’s allegations are taken as true – as, again, they must be at this stage – the defendants embarked on a public campaign to encourage both retail and institutional investors to buy their crypto-assets by touting the profitability of the cryptoassets and the managerial and technical skills that would allow the defendants to maximize returns on the investors’ coins,” he said.

“Simply put, secondary-market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf,” Judge Rakoff said.

For these reasons, he denied Terraform Labs’ motion to dismiss, and ruled that the case will move forward. “For purposes of this motion, all well-plead allegations must be taken as true, and all reasonable inferences therefrom must be drawn in the SEC’s favor,” he wrote.

John Reed Stark, an expert in digital regulatory compliance and a former SEC enforcement attorney, applauded Rakoff’s decision, and anticipates there will be more rejection of Judge Torres’ decision.

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“For SEC lawyers like myself, Judge Jed Rakoff is arguably considered the most respected and experienced securities law jurist not only in the SDNY but perhaps in the entire U.S. federal court system,” Stark said. “My take (and please don’t shoot the messenger): Judge Rakoff’s decision might be the first, but will certainly not be the last, rejection of the Ripple decision.”

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Stark previously warned about this possibility when the XRP decision was first issued, saying, “The decision resides on shaky ground, will likely be appealed at some point, will likely result in reversal and is not necessarily a cause for celebration.”

“The Ripple Decision holds that the same exact token can be a security sometimes but not a security other times,” Stark said. “And the more ignorance and willful blindness by retail investors, then the less protection the retail investors will receive. And the less disclosure about the token, then the less liability for the token issuer. That just can’t be right.”