Judge Rakoff denied that motion on July 31, 2023, holding that the SEC had sufficiently alleged the assets in question were sold as securities. Terraform and its CEO moved to dismiss the complaint, arguing, as relevant here, that the assets in question were not sold as securities. The SEC further alleged that Terraform and its CEO engaged in a fraudulent scheme to mislead investors through certain false and misleading statements about the business. The SEC sued Terraform and its CEO in February 2023, alleging that they engaged in unregistered sales of securities with regard to LUNA, UST, and certain other crypto assets. dollar by virtue of an algorithm (until it de-pegged from the dollar in May 2022, leading its value and that of LUNA to plummet). These assets included LUNA, a token which once had a market value among the ten highest for crypto assets, and UST, a “stablecoin,” the value of which was pegged to the U.S.
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Terraform Labs is a software development firm that created the “Terraform ecosystem,” which includes a blockchain and a series of interconnected crypto assets. Securities and Exchange Commission seal hangs on the facade of its building (Photo by Chip. This distinction would soon be rejected by one of Judge Torres’s colleagues. This set up an unusual dichotomy wherein sales to sophisticated investors are regulated while sales to retail investors are not.
In contrast to sales of XRP to public buyers on exchanges, Judge Torres ruled that Ripple’s direct sales of XRP to institutional investors were investment contracts. Judge Torres’s ruling was not a complete victory for Ripple and its industry counterparts, however. The SEC recognized the ruling’s significance too, as it sought to appeal, stating that the issue is of “programmatic concern to the SEC’s enforcement of the securities laws and potentially to a large number of pending litigations.” While Judge Torres stated that her decision was limited to these sales of XRP by Ripple, crypto observers quickly emphasized the enormous consequences this reasoning would have for the broader industry: by this logic, blind bid/ask transactions on centralized crypto exchanges would generally not be sales of securities, effectively removing these exchanges and their users from the SEC’s domain. Judge Torres reasoned that because these were blind bid/ask transactions, buyers of XRP did not know whether their payments went to Ripple or to a third-party seller, and therefore the buyers could not reasonably have expected to profit from Ripple’s efforts. She held that exchange-based sales to public buyers were not “investment contracts” because the SEC had failed to establish Howey’s third prong-that buyers of XRP had a reasonable expectation of profits from the efforts of others. Judge Torres granted Ripple’s motion for summary judgment as to this category on July 13, 2023. The latest in this line is crypto assets. Since that decision, courts have applied the Howey test to determine whether all manner of investment schemes – involving everything from whiskey casks to chinchillas – are securities. It held that an economic arrangement qualifies as an “investment contract” when a person (1) “invests his money ” (2) “in a common enterprise ” and (3) “is led to expect profits solely from the efforts of the promoter or a third party.” While the orange groves themselves were not securities, the economic arrangement was an “investment contract” because of the cultivator’s promise to share in the profits from the orange sales.
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The SEC alleged that this arrangement constituted an “investment contract” and thus a “security,” the sale of which was subject to SEC registration requirements.
In the Howey case, a company sold orange groves to individuals, who then leased the land back to the commonly owned and managed service company for maintenance of the groves in return, the individuals were promised a share in the profits from the orange sales.
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