The jury in Manhattan ruled against Terraform Labs and its CEO Do Kwon in a notable legal case, siding with the U.S. Securities and Exchange Commission (SEC). The SEC had charged them with civil fraud, accusing them of deceiving investors about the stability and safety of their cryptocurrency offerings before the collapse of their stablecoin in 2022. This collapse had far-reaching effects, significantly destabilizing the cryptocurrency markets. The verdict came at the end of a two-week trial, with the jury delivering their decision on the same day as the closing arguments were presented.
During the trial, the SEC's allegations against Terraform and Kwon focused on their activities in 2021. They were accused of providing misleading information to investors regarding the stability of TerraUSD, a stablecoin that was purported to maintain a constant value of $1. Additionally, the SEC claimed that they falsely asserted the usage of Terraform's blockchain technology in a popular Korean mobile payment app, misleading investors and the public about the application and reach of their technology.
The crux of the SEC's case centered around two of Kwon's creations: TerraUSD and Luna. TerraUSD was designed as a stablecoin, while Luna was a more traditional cryptocurrency whose value was subject to market fluctuations but remained closely intertwined with TerraUSD. The SEC estimated that the collapse of these tokens in May 2022, particularly when TerraUSD failed to maintain its peg to the dollar, resulted in a staggering loss of over $40 billion for investors as we read in Reuters. This significant financial impact underscored the severity of the situation and the high stakes involved in the trial.
The SEC's pursuit in the aftermath of this case involves seeking substantial civil financial penalties against both Terraform and Kwon. Additionally, the SEC aims to bar them from participating in the securities industry, a move that would have long-term implications for their careers in the financial sector. The determination of these penalties and restrictions is in the hands of U.S. District Judge Jed Rakoff, who is set to deliberate on the matter, taking into consideration arguments from both the SEC and the defendants.
Terraform's response to the verdict was one of disappointment. A spokesperson for the company expressed their dissatisfaction with the jury's decision and hinted at potential future actions, stating that they are currently evaluating their options. They also reiterated their stance that the SEC lacked the legal authority to initiate the case, challenging the jurisdiction and scope of the SEC's regulatory powers in this matter.
On the other side, the SEC, particularly through the words of Gurbir Grewal, the Division of Enforcement Director, expressed satisfaction with the jury's decision. Grewal highlighted the significance of the case in the broader context of the cryptocurrency industry, pointing out the real-world consequences of non-compliance with regulatory standards. He underscored the importance of crypto markets adhering to registration and compliance requirements, suggesting that the verdict serves as a reminder and warning to the industry at large.
Do Kwon, the CEO of Terraform, faced legal challenges beyond this trial. Arrested in Montenegro in March 2023, Kwon was absent from the trial due to his detainment. His situation is further complicated by the fact that both the United States and South Korea are seeking his extradition on criminal charges, a development that highlights the international ramifications of his and Terraform's actions.
The collapse of TerraUSD and Luna had a domino effect on the wider cryptocurrency market. Their failure not only affected their own value but also led to a significant downturn in the value of other major cryptocurrencies, including Bitcoin. This turbulence in the crypto market triggered a wave of bankruptcies among various crypto-related companies throughout 2022, underscoring the interconnectedness and vulnerability of the crypto ecosystem.
Adding to the company's woes, Terraform itself filed for bankruptcy protection in January, a move that often indicates severe financial distress and an attempt to reorganize and manage debts. This filing was a clear sign of the struggles the company faced in the wake of the collapse of its cryptocurrencies.
The SEC's attorney, Laura Meehan, emphasized during closing arguments the importance of transparency and honesty in financial dealings. She argued that Terraform's narrative of success was fundamentally flawed and deceptive, being "built on lies." She pointed out that failure in business, when not openly acknowledged and disclosed, constitutes fraud. This argument was key to the SEC's case, as it framed the actions of Terraform and Kwon not just as business misjudgments, but as deliberate acts of deception.
The SEC's accusations against Kwon and Terraform included claims of covert operations to artificially inflate the price of TerraUSD. According to the SEC, in May 2021, when TerraUSD deviated from its peg, a third party was secretly arranged to buy large quantities of the stablecoin to support its price. Kwon was accused of falsely attributing this recovery to the reliability of TerraUSD's algorithms, rather than acknowledging the market manipulation.
Furthermore, the SEC charged that Kwon and Terraform falsely promoted Terraform's blockchain as being integral to the Chai payment app's transaction processes. This claim was presented as another facet of their deceptive practices, where they overstated the utility and adoption of their blockchain technology.
In defense, Terraform's attorney, Louis Pellegrino, argued that the SEC's case was based on a misinterpretation of statements and that Terraform and Kwon had been transparent about their products, including their failures. Pellegrino's defense attempted to counter the narrative of deliberate deception, suggesting instead that any failures were part of the inherent risks in innovative ventures and not due to fraudulent intent.
The legal debate extended beyond the specific accusations of fraud to broader questions about the applicability of securities laws to cryptocurrencies. Earlier in the case, Terraform had argued that the cryptocurrencies they developed should not be subjected to traditional securities laws. However, Judge Rakoff dismissed this argument in December, ruling that Terraform had unlawfully sold digital assets without registering them as securities. This decision was significant as it set a precedent for how cryptocurrencies might be regulated and classified under existing securities laws.
Following the final judgment in the case, Terraform will have the option to challenge Judge Rakoff's ruling through an appeal process. This potential appeal could further explore and possibly influence the legal understanding and treatment of cryptocurrencies within the framework of securities laws.
06.04.2024
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