Happy New Year! A quick scheduling note, in 2024, the DEF Weekly will be publishing on Monday mornings.
SEC vs Terraform
On December 28th, Judge Rakoff of the U.S. District Court of the Southern District of New York issued an Order in U.S. Securities and Exchange Commission v. Terraform Labs and Do Kwon ruling on both parties’ motions for summary judgment and allowing certain claims to proceed to trial. As a reminder, in its complaint, the SEC accused Terraform Labs and Do Kwon of “perpetrat[ing] a fraudulent scheme that led to the loss of at least $40 billion of market value, including devastating losses for U.S. retail and institutional investors” and violating the federal securities laws by offering and selling unregistered securities and offering and effecting transactions in unregistered security-based swaps.
First, Judge Rakoff denied defendants’ motion for summary judgment on the fraud claims, which means the parties will proceed to trial on those charges at the end of this month. Second, Judge Rakoff also ruled on both parties’ motions to exclude or limit the testimony of the other side’s proposed expert witnesses, allowing the SEC to call the two witnesses they proposed and defendants to call one of the three witnesses they proposed.
Most significantly, the ruling granted the SEC’s motion for summary judgment related to its claims that Terraform Labs and Do Kwon offered and sold unregistered securities: “There is no genuine dispute that the elements of the Howey test – “(i) investment of money (ii) in a common enterprise (iii) with profits to be derived solely from the efforts of others” (id.) – have been met for UST, LUNA, wLUNA, and MIR.” The defendants had challenged the applicability of the Howey test to modern cryptocurrencies, arguing it was outdated and overshadowed by more recent precedent. Additionally, defendants argued that UST was a stablecoin, designed to maintain a constant value of $1 and not to generate profit, rendering it not an investment contract. Judge Rakoff rejected this argument, finding that a significant portion of UST tokens were deposited in Anchor Protocol developed by defendants in order to generate yield, making the combination of UST and the Anchor Protocol an investment contract.
On the other hand, the Court granted summary judgment to defendants, dismissing the SEC’s claim alleging that defendants offered unregistered security-based swaps to non-eligible contract participants in the form of mAssets. mAssets are a synthetic asset that represents the value of a real-world financial asset within a blockchain environment. Judge Rakoff held that an mAsset “does not meet the statutory definition of a security-based swap” under the Commodities Exchange Act.
What does it mean?
While this ruling has limited precedential value because it is one district judge’s opinion in one case regarding specific digital assets, it is important because it represents one of only a handful of times a court has actually analyzed digital asset transactions under the Howey test. From the SEC’s perspective, the decision represents a win in that the court held that defendants engaged in the unregistered offering and selling of securities with respect to certain cryptocurrencies in the Terra ecosystem (UST, LUNA, wLUNA, and MIR), and they can proceed to trial on their fraud claims. However, from the defendants’ perspective, the ruling that mAssets are not security-based swaps is a win for the utilization of blockchain-based synthetic assets. Overall, this opinion should be understood in the context in which it was decided and specific to the facts at issue, as every securities analysis requires.
Warren Attacks Former Nat Sec Officials’ Participation in Policy Debates
On December 18, Senator Elizabeth Warren (D-MA) sent letters to the Blockchain Association, Coin Center, and Coinbase demanding details on their “association” with “former defense, national security and law enforcement officials,” arguing that it is unethical for former national security and military service members to seek out jobs and work in the crypto industry after concluding their government service. Senator Warren uses the term “revolving door” throughout her letter to describe the common practice of former government employees choosing to use the expertise they developed during their government employment in the private sector, insinuating the crypto industry has “abused” such a pattern for its own benefit.
"Engaging like-minded experts to advocate against legislative proposals that one sincerely believes are unconstitutional and detrimental to the nation's welfare does not constitute 'undermining bipartisan efforts in Congress.' Rather, it is the exercise of the fundamental right to freely associate and petition the government. It's everyone's right and no one should apologize for doing it. Resorting to questioning motives often reflects an inability to prevail on the merits of an argument itself," Jerry Brito, the Executive Director of Coin Center replied to Senator Warren’s letter.
Blockchain Association CEO Kristin Smith said that “people are drawn to work in the crypto industry because they value freedom, sovereignty of the individual, and permissionless innovation.”
In their response, Coinbase issued a public statement rejecting these allegations, pointing to their close collaboration with government officials and compliance with US law, and arguing that former government employees who are experts in national security issues play a significant role in “fighting terrorist financing and protecting Americans daily from malicious actors.”
What does it mean?
Despite Senator Warren’s efforts to make a common practice look unethical, the concept of a “revolving door” is actually quite common across most industries. Government employees who have previously regulated a field become experts in those fields and provide valuable insight and guidance to private companies. For example, earlier this year Google hired former DOJ antitrust lawyers to join its legal team and assist it in facing the antitrust suits filed against it, and to take an example outside of tech, a 2016 study found that of all the reviewers who left the FDA in the previous ten years, 57% later worked or consulted for the biopharmaceutical industry, meaning they left their federal oversight posts to work for the industry they previously regulated. Moreover, each government agency has specific rules and guidelines about where its employees may work after they leave and what they must do to ensure they don’t have conflicts of interest. It is disappointing to see Senator Warren try to utilize it as a tool in her war on crypto. And frankly it is offensive to the former defense, national security, and law enforcement officials who have served our country to be maligned for seeking employment in the fields in which they have spent their careers.