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  • Writer's pictureS Pettigrove and M Bacina

Judge Rakoff rejects Ripple ruling in Luna litigation



On 31 July 2023, Justice Rakoff (Rakoff J) of the United States District Court (Southern District of New York), rejected Terraform Labs’ (Terraform) summary motion to dismiss a complaint brought by the Securities and Exchange Commission (SEC). The SEC alleges that the company and its infamous founder and CEO, Do Kwon:

orchestrated a multi-billion-dollar fraud involving the development, marketing, and sale of various cryptocurrencies

and:

used false and materially misleading statements to entice U.S. investors to purchase and hold on to defendants' products...[which] were unregistered investment-contract securities

In their defence, Terraform and Kwon argue, among others:

  • the SEC lacked jurisdiction to bring the claim against the Singapore based group;

  • the SEC lack Congressional authority to regulate crypto-assets relying on the "major questions" theory as a matter of constitutional law;

  • the SEC had failed to give sufficient notice or guidance on its treatment of crypto-assets as securities as a matter of due process; and

  • the TerraUSD stablecoin and other crypto-assets issued by Terraform including Luna, wLuna, MIR and so-called mAssets were not unregistered securities under US securities laws.

Rakoff J rejected the defendant's motion to dismiss and accepted that the SEC's case is properly pleaded.


On the jurisdictional aspects, the SEC alleged that the company's direct sale of crypto-products to US firms, involving the US banking system as well as the defendants' marketing efforts in the US showed "an intent to conduct business in the United States". Hence, Rakoff J found that the SEC had 'the better of the argument' and that the SEC had jurisdiction over the defendants.


The judge also rejected the application of the "major questions" doctrine as inapplicable to the case, noting the breadth of the SEC's jurisdiction to deal with novel investment schemes and the relative size of the crypto-asset industry. He also rejected a due process argument, finding that the SEC had given sufficient notice through previous enforcement actions of its view that certain crypto assets may constitute securities depending on the facts and circumstances.


Significantly, Justice Rakoff rejected the approach taken by another Justice of the District Court for the Southern District of New York, Justice Torres, in the recent summary judgment application in SEC v Ripple Labs Inc. While Rakoff J agreed that tokens may not inherently be securities, just like orange groves in Florida in the original Howey case, he apparently rejected Justice Torres' finding that Ripple Labs sales of the XRP coin to retail investors did not evolve an investment contract. Justice Rakoff questioned the validity of the Ripple judgment in commenting that the Howey test "makes no such distinction" between institutional purchasers and purchasers in secondary transactions.


In any event, Rakoff J concluded in this case that the defendant had embarked on a public campaign to induce both retail and institutional investors to buy their crypto-assets by:

by touting the profitability of the crypto-assets and the managerial and technical skills that would allow the defendants to maximize returns on the investors’ coins

His Honour also declined to dismiss SEC's claims concerning fraud and securities registration requirements and stated that the SEC had a "plausible" claim grounded on factual allegations that the relevant crypto-assets qualified as securities.


Investigations of Terraform and its CEO Do Kwon have been ongoing for some time, involving collaboration between prosecutors in the US and South Korea. Kwon has consistently denied allegations of fraud, making this clear through his social media comments as well as in public interviews. Kwon was arrested in Montenegro earlier this year on charges of using a false passport and is facing extradition to the US and South Korea.


Motions to dismiss of this nature are extremely difficult for a defendant to succeed on. While this is a preliminary decision of a first instance judge, and certain of the judge's findings may be subject to debate in higher courts or depending on the facts and circumstances, the comments in the decision show the multiple ways that the courts can consider crypto assets. The contrast with the recent Ripple decision further underscores the urgent need for legislative action establishing clear regulation for the industry in the US and abroad.


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