The issue of whether the sales of digital assets constitute investment contracts (and therefore securities) remains at the forefront of SEC regulatory issues. Yesterday, in SEC v. Terraform Labs, a federal judge in New York rejected a fellow judge’s recent ruling in SEC v. Ripple Labs[1] that XRP was not a security when sold to the public on secondary markets.

On Monday, U.S. District Judge Jed Rakoff denied Terraform Labs’ motion to dismiss an SEC enforcement action.[2] In that case, the SEC alleged that Terraform Labs and its founder, Do Kwon, defrauded investors and sold digital assets in unregistered securities offerings. In its motion to dismiss, Terraform Labs argued that purchasers of UST did not have an expectation of it being an investment. In allowing the SEC’s case to proceed against Terraform Labs and Kwon, Judge Rakoff declined to follow the recent ruling in SEC v. Ripple.

In Ripple, the court found that “[w]hereas … [i]nstitutional [b]uyers reasonably expected that [the defendant crypto-asset company] would use the capital it received from its sales to improve the [crypto-asset] ecosystem and thereby increase the price of [the crypto-asset],” those who purchased their coins through secondary transactions had no reasonable basis to expect the same.[3]  “According to that court, this was because the re-sale purchasers could not have known if their payments went to the defendant, as opposed to the third-party entity who sold them the coin. Whatever expectation of profit they had could not, according to that court, be ascribed to defendants’ efforts.”[4]

In denying the motion to dismiss, Judge Rakoff stated, “Howey[[5]] makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary re-sale transaction has no impact on whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.” 

As a significant win for the SEC, the lawsuit will proceed against Terraform Labs.  Perhaps more importantly, the Terraform ruling sets up two competing rationales in the Southern District of New York for determining whether the sales of digital assets constitute investment contracts under the Howey test. 

[1] SEC v. Ripple Labs, Inc., 2023 U.S. Dist. LEXIS 120486, __ F.Supp.3d __, 2023 WL 4507900 (S.D.N.Y. July 13, 2023).

[2] SEC v. Terraform Labs Pte. LTD, 2023 U.S. Dist. LEXIS 132046 (S.D.N.Y. July 31, 2023), available at gov.uscourts.nysd.594150.51.0.pdf (

[3] Ripple, at *11-12.

[4] Terraform Labs, at *45.

[5] The U.S. Supreme Court’s well-known test in SEC v. Howey Co., 328 U.S. 293 (1946) outlines the standard for an “investment contract.”  Under the Howey test, an investment contract is “a contract, transaction[,] or scheme whereby 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.” 328 U.S. at 298-99.