Terraform ruling exposed an early split over crypto sales and securities law

A federal judge on July 31, 2023 denied Terraform Labs and Do Kwon’s motion to dismiss the Securities and Exchange Commission’s civil case in its entirety. The decision allowed the agency’s fraud and unregistered-securities claims involving TerraUSD, LUNA and related products to proceed.

The 50-page opinion from Judge Jed Rakoff of the U.S. District Court for the Southern District of New York did not establish liability. At the dismissal stage, the court was required to accept the SEC’s well-pleaded factual allegations as true and draw reasonable inferences in the agency’s favor. Rakoff concluded that those allegations were sufficient to support jurisdiction and plausible claims under federal securities law.

The decision mattered beyond Terraform because Rakoff expressly rejected part of the reasoning another judge in the same district had applied to Ripple Labs on July 13, 2023. That disagreement left the digital-asset industry with competing district-court approaches to exchange-based token transactions at a moment when trading platforms, issuers and regulators were searching for clearer boundaries.

The disagreement over secondary-market sales

In the Ripple ruling, Judge Analisa Torres distinguished between certain institutional sales of XRP and “programmatic” sales conducted through exchanges. Her analysis found that purchasers in the latter category could not necessarily know whether their money went to Ripple, affecting whether they reasonably expected profits from Ripple’s efforts.

Rakoff declined to apply that distinction to the SEC’s allegations against Terraform. His opinion reasoned that the Supreme Court’s Howey investment-contract test did not categorically divide purchasers according to whether they bought directly from an issuer or through a secondary transaction. The relevant inquiry, in his analysis, was whether a reasonable purchaser would understand the promoter’s conduct and representations as promising profits derived from its efforts.

That conclusion was tied to the facts alleged in the Terraform complaint. The SEC claimed Terraform and Kwon promoted an interconnected ecosystem and represented that continued development would increase the value or profitability of its products. Rakoff found those allegations sufficient to support an investment-contract theory covering UST, LUNA, wrapped LUNA and MIR at the pleading stage.

The opinion did not reverse or modify the July 13 Ripple decision. One federal district judge does not bind another, and the two cases involved different alleged statements, products, transaction structures and procedural records. The immediate significance was therefore uncertainty rather than a settled nationwide rule.

Fraud allegations also survived

The SEC’s complaint alleged that Terraform and Kwon misrepresented the use of the Terra blockchain by the Korean payments application Chai. It also alleged that they attributed UST’s May 2021 return to its dollar peg to the protocol’s algorithm while failing to disclose intervention by a third-party trading firm.

Rakoff ruled that the complaint described the alleged statements, their purported falsity and the defendants’ alleged benefit with enough specificity to proceed. That finding meant only that the SEC had stated plausible fraud claims; it did not prove the allegations.

The court also rejected Terraform’s arguments that the major-questions doctrine, inadequate notice and administrative-law principles prevented the SEC from bringing the case. Rakoff characterized the use of established securities statutes against allegedly investment-like arrangements as ordinary enforcement rather than a transformative expansion of agency power.

What the order established

As of July 31, 2023, the verified development was procedural but important: every count in the SEC’s amended complaint remained alive, and the court had articulated an approach to secondary-market token sales that conflicted with a prominent part of the Ripple analysis.

No reliable inference about same-day token or cryptocurrency prices follows from the order alone. Digital assets trade continuously across venues, and this reconstruction makes no price, return or causal market-movement claim. The institutional consequence was clearer: the ruling demonstrated that the application of Howey to exchange-based crypto transactions remained contested and fact-dependent, even within one federal judicial district.