On Monday, a U.S. federal judge denied Terraform Labs founder Do Kwon’s motion to dismiss an ongoing lawsuit against the crypto company. The ruling by Judge Jed Rakoff allows the Securities and Exchange Commission (SEC) to proceed with the case.
The SEC’s legal battle against Terraform Labs began on February 16. The commission accused the company and Kwon of “orchestrating a multi-billion dollar crypto asset securities fraud.”
In April, Terraform Labs’ legal representatives attempted to have the case dismissed. Terraform Labs claimed that the SEC lacked jurisdiction over the company and Kwon, who is a South Korean citizen.
Terraform Labs also disputed the federal agency’s classification of tokens like Mirror Protocol (MIR), Terra Classic (LUNA) and TerraUSD Classic (USTC) as securities. It pointed out that Congress was still discussing how to regulate cryptocurrencies and asked the SEC to wait for Congress’s decision.
Additionally, Terraform Labs highlighted a procedural issue in the SEC’s case against Coinbase, involving emails from former SEC director William Hinman that were relevant to the Ripple Labs case.
Hinman expressed the viewpoint that certain cryptocurrencies, like Bitcoin and Ether, might initially be considered securities. However, they can eventually transform into commodities as they achieve a higher level of decentralization.
Former chief of SEC Office of Internet Enforcement John Reed Stark said that the court’s ruling was based on the uncertainty faced by purchasers in secondary resale transactions regarding the destination of their payments, whether to Terraform Labs or a third-party entity.
As per the court, any expectation of profit in such transactions could not be solely attributed to Terraform Labs’ efforts or Kwon. Terraform Labs conducted a public campaign to attract retail and institutional investors to buy their crypto-assets, highlighting the assets’ profitability and managerial and technical skills to maximize returns.
The company assured that all sales from crypto-asset purchases, regardless of the origin of the coins, would generate additional profits for all holders. This information would have reached individuals who purchased their crypto assets on secondary markets.
In other words, secondary-market buyers had legitimate reasons to believe that Terraform Labs would utilize their capital contributions to generate profits on their behalf.
Judge Rakoff also rejected a previous ruling by U.S. District Judge Analisa Torres, who concluded that Ripple Labs’s XRP cryptocurrency should not be considered a security when sold to the general public except for institutional sales.
According to the judge, there should not be a differentiation between public and institutional sales. He analyzed the Howey test, a legal standard to ascertain whether a transaction can be classified as an investment contract and fall within the security category defined by the law. Judge Rakoff asserted that meeting the test does not always require a formal contract.
The Rakoff court’s refusal to differentiate between different coins (MIR and LUNA) based on how they are sold may convince other judges to follow the same path. While the court’s decision does not overturn the previous ruling by Judge Torres, analysts point out that it brings back uncertainty about the classification of digital assets. As a result, the price of XRP experienced fluctuations during trading, going as low as $0.69 from $0.72, but still up around 46 percent from a month ago.
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