- US District Judge Jed Rakoff permits the SEC to proceed with its lawsuit against Terraform Labs Pte and its founder, rejecting the Ripple ruling.
- This decision, while not overturning the Ripple ruling, brings back the uncertainty around the definition of a digital asset as a security.
SEC vs Terraform Labs: Unsettling the Ripple Ruling
In a surprising turn of events, US District Judge Jed Rakoff has allowed the Securities and Exchange Commission (SEC) to proceed with its lawsuit against Terraform Labs Pte and its founder, Do Kwon. This decision contradicts an earlier judgment by US District Judge Analisa Torres, who ruled that Ripple’s XRP token was not a security when sold to the public on secondary markets. The ongoing regulatory uncertainty regarding cryptocurrencies is set to reignite discussions on the need for specific legislation to clear these ambiguities.
The ruling in the Ripple case on July 13 was considered a victory for the cryptocurrency industry, causing a spike in most coins’ prices. Despite Rakoff’s recent decision not overruling the Ripple case, it does highlight the unsettled nature of defining a digital asset as a security.
SEC’s Argument: Applying the Howey Test
The SEC contends that Ripple’s XRP should be classified as a security using the ‘Howey test,’ named after a 1946 Supreme Court ruling. The test defines an investment contract as a security if it involves an
“investment of money in a common enterprise with a reasonable expectation of profits derived from others’ efforts.”
Judge Torres found the Howey test applicable for institutional sales of the token under securities laws. According to her, Ripple’s sales of its XRP token to sophisticated investors met the test for an investment contract as they were pitched a speculative value proposition for XRP with potential profits.
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However, she argued that XRP sales to the general public did not fall under the test due to a lack of evidence suggesting that those buyers expected a share in the company’s profits. This is particularly true for blind transactions conducted by trading algorithms on exchanges.
Terra Case: Spotlight on the Ripple Ruling
Rakoff’s decision on the Terra case disagrees with Torres’ judgment. In his ruling, Rakoff stated,
“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.”
The SEC’s allegations against Terraform and Kwon applied to both institutional and retail investors. The defendants were accused of promising token profitability and stating that proceeds from token sales would be reinvested into the Terraform blockchain for further profit generation.
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