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Federal Judge Rules Against Terraform Labs and Do Kwon on Unregistered Securities Claims

In a significant legal decision impacting the cryptocurrency landscape, a United States federal judge sided with the Securities and Exchange Commission (SEC) in their claims against Terraform Labs and its former CEO, Do Kwon, for offering and selling unregistered securities.

District Court Judge Jed Rakoff issued a ruling on December 28, delivering a mixed verdict that favored the SEC’s allegations. The court granted summary judgment in favor of the SEC concerning Terraform Labs and Kwon’s purported offering and sale of LUNA and MIR unregistered securities. However, the judgment differed on the alleged unregistered offer and sale of security-based swaps, as the court ruled in favor of the defendants on this particular aspect.

The heart of the SEC’s argument lay in the creation and operation of the Mirror Protocol, a platform facilitating the creation of blockchain assets known as “mAssets.” The SEC contended that through this mechanism, Kwon and Terraform Labs engaged in transactions involving security-based swaps. Yet, the court disagreed, ruling that the mAssets failed to meet the statutory definition of a security-based swap.

The judge’s decision referenced a previous statement made by Kwon, wherein he mentioned that LUNA holders could essentially sit back and watch him excel. This statement played a pivotal role in the court’s determination that LUNA satisfied the Howey test. The Howey test assesses whether an investment involves “money in a common enterprise” with expectations of profits primarily from the efforts of others, such as the promoter or a third party—in this case, Terraform and Do Kwon himself.

In the case of the MIR token, the court concluded that the defendants couldn’t reasonably refute that they led MIR holders to expect profits from a collective endeavor based on Terraform’s active role in developing, maintaining, and nurturing the Mirror Protocol.

The ruling shed light on the court’s view of MIR’s compliance with the Howey test, stating that it passed “with flying colors.”

While the court denied Terraform Labs and Kwon’s motion to exclude the testimony of two SEC experts, Dr. Bruce Mizrach and Dr. Matthew Edman, it also rejected the securities regulator’s motion to exclude the testimony of defense expert Dr. Terrence Hendershott.

This judgment carries substantial implications for the cryptocurrency sector, marking a significant legal milestone in defining the boundaries and regulatory oversight concerning digital assets. The nuanced decision underscores the complexities involved in classifying these novel financial instruments within existing regulatory frameworks and sets a precedent for future cases within the evolving landscape of cryptocurrency regulation.

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