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SEC vs. Terraform Labs: Digital Asset Classification in US Remains Uncertain

2 mins
Updated by Kyle Baird
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In Brief

  • The judge in the SEC vs. Terra case believes that the Howey test should apply to all buyers of digital assets, institutional and retail.
  • Judge Jed Rakoff approved the SEC's request to continue its case against Terraform Labs and its co-founder Do Kwon.
  • The court rejected the previous ruling in the Ripple case that noted XRP retail sales did not break any securities regulations.
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After a federal judge issued a conflicting decision in a Terra case that the SEC had filed, the classification of digital assets in the US is still up in the air. The court rejected the judge’s ruling that Ripple’s XRP sales did not break any securities regulations in the Terra case.

Terraform Labs and its co-founder Do Kwon attempted to leverage the Ripple decision in their own legal battle with the SEC.

Terra Ruling in Conflict With Ripple Case

Judge Jed Rakoff approved the Securities and Exchange Commission’s (SEC) request. The agency will continue with its case against Terraform Labs and its co-founder, Do Kwon, according to a July 31 ruling. Judge Rakoff disagreed with Judge Analisa Torres’ decision regarding the security status of XRP when sold to the general public.

The cryptocurrency community applauded the earlier decision, but the new ruling has further muddied the security debate.

According to the SEC, XRP should be classified as a security based on the Howey test. Per this test, an investment contract qualifies as a security if there is an “investment of money in a common enterprise” and/or “a reasonable expectation of profits to be derived from the efforts of others.”

The Howey Test. Source: Kyrian Alex / Medium
The Howey Test. Source: Kyrian Alex / Medium

In the Ripple case, Judge Torres found that securities regulations governed institutional XRP sales. Contrarily, the public transactions were not part of the law.

Judge Rakoff disagreed and contended that the court should not make distinctions between coins based on their sales method.

The judge in the Terra case believes that the Howey test does not make any distinctions between different types of buyers. As per the court document, Rakoff said,

“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 ruling notes whether the coins were sold directly to big investors or through secondary transactions should not affect their classification as securities. The ruling indicates that both types of buyers should receive equal treatment under the law.

Read more about the SEC lawsuit against Ripple Labs: Everything You Need To Know About Ripple vs SEC

Uncertainty Around Asset Classification

In February, the SEC filed a lawsuit against Terraform and its former CEO over an alleged scam. The SEC accuses Terraform Labs and Kwon of engaging in a fraudulent scheme by offering and selling unregistered securities. The company asserts that it was not at fault.

Notably, the depegging of the Terra USD (UST) stablecoin destroyed at least $40 billion in market value.

The uncertainty surrounding the classification of digital assets as securities fueled calls for new legislation. The SEC could challenge the decision by filing an appeal.

Last week, the House Financial Services Committee approved the Financial Innovation and Technology for the 21st Century Act (FIT Act). The comprehensive legislation designs a new regulatory approach for digital assets. It grants clarity on how SEC and the CFTC could regulate the space.

The proposal clarifies how the SEC and the CFTC could oversee the crypto space under a common framework. However, the outcome of these ongoing legal battles could take years.

Top crypto platforms in the US | February 2024

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Shraddha Sharma
Shraddha is an India-based journalist who worked in business and financial news before diving into the crypto space. As an investment enthusiast, she has also has a keen interest in understanding crypto from a personal finance standpoint.
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