In an unfortunate turn of events, Federal Judge Jed Rakoff of the U.S. District Court for the Southern District of New York, dismissed a motion to dismiss a lawsuit by Terraform Labs from the U.S. Securities and Exchange Commission (SEC). The case, alleges that Terraform Labs mislead investors about the nature of TerraUSD (UST), a stablecoin backed by the LUNA token, and potential securities law violations, has been stirring waves in the cryptocurrency world.
At the heart of the lawsuit is Terraform Labs’ claim that there was no contract in the sale of UST to retail investors, and that the buyers were motivated by practical use, not investment potential. Further, Terraform Labs pointed to the precedent set in a recent ruling in which Ripple Labs, another blockchain-based financial technology company, was found to not have violated securities laws when selling their native token, XRP, through exchanges to retail investors.
In an interesting twist, Judge Rakoff rejected the application of the Ripple ruling to Terraform Labs’ case. The argument made by Terraform Labs hinged on the idea that retail investors couldn’t have known they were purchasing XRP directly from Ripple, given the transactions took place on secondary markets via intermediary exchanges. However, Judge Rakoff dismissed this distinction, suggesting that the manner in which the tokens were purchased didn’t alter the fundamental perception of a promise of profits being tied to the efforts of the defendants.
“Whether 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,” Judge Rakoff wrote.
Judge Rakoff’s ruling has wider implications, as it seems to redefine how the securities laws apply to transactions involving cryptocurrencies. It seems to suggest that the traditional Howey Test – a test to determine whether certain transactions qualify as investment contracts – applies equally to purchases from initial issuers as well as secondary transactions.
Terraform Labs also invoked the “major questions doctrine”, an argument employed by several other crypto defendants against the SEC, which basically argues against regulatory overreach. Judge Rakoff also dismissed this objection, suggesting that the crypto industry falls short of the “vast economic and political significance” criterion required for the doctrine’s application.
“While the Supreme Court has repeatedly emphasised that the Major Questions Doctrine should apply only in extraordinary circumstances involving industries of ‘vast economic and political significance’, the crypto industry doesn’t meet this standard,” Judge Rakoff commented.
The SEC, as hinted earlier, may consider an appeal against the ruling, adding another layer to this ongoing legal saga. Regardless of the outcome, the lawsuit’s progression will be closely watched by many within and outside the crypto industry, as it may influence the future course of cryptocurrency regulation.
