Which Cryptocurrencies Are “Securities”? SEC Request to Appeal Highlights Split Decisions in the Southern District of New York

By Rachel Berger

Digital-asset investors have long faced uncertainty regarding the protections afforded to their investments by United States law. On August 18, 2023, citing split between two judges in the United States District Court for the Southern District of New York, the SEC filed a motion that requests permission to file an appeal in the United States Court of Appeals for the Second Circuit seeking clarity on whether sales by crypto issuers on trading platforms qualify as securities transactions.[1] The motion additionally also seeks appeal on the related issue of whether an exchange of services for crypto payments can constitute a securities transaction.[2]

In late July, Judge Jed S. Rakoff of the Southern District of New York issued an opinion in SEC v. Terraform Labs Pte. Ltd, et al., 23-cv-1346 (JSR), 2023 WL 4858299 (S.D.N.Y. July 31. 2023) (“Terraform”), providing a victory for regulators and U.S. investors and supporting that investors do have recourse for losses from investments in digital tokens or currencies that were fraudulently promoted or not properly registered with the SEC.  In May of 2022, Terraform’s digital asset ecosystem collapsed, wiping out an estimated half a trillion dollars from crypto markets.[3] In Terraform, Judge Rakoff upheld claims against Terraform Labs and its cofounder Do Kwon under the Securities Act of 1933 and the Securities Exchange Act of 1934. Specifically, the opinion found that the SEC set forth plausible allegations that Defendants violated Section 5 of the Securities Act by distributing unregistered tokens to accredited, institutional investors, knowing that the tokens would be resold, and by selling other assets (mAssets) directly to the public, including to investors who were not “eligible contract participants,” as the law defines them.[4]  The Court separately refused to dismiss fraud claims asserting violations of both Acts alleging that Terraform and Kwon: (a) falsely stated that certain transactions were processed on the Terraform blockchain when they were actually processed in Korean Won; and (b) misleadingly omitted that the stablecoin UST was repegged in May 2021 via third party intervention, not by “self-healing” as their prior statements suggested.[5]

The Terraform decision expressly declined to follow an opinion issued in the same District just weeks earlier, SEC v. Ripple Labs Inc., 2023 WL 4507900 (S.D.N.Y. July 13, 2023) (“Ripple”), which had excluded a narrow segment of crypto transactions from the definition of “security.” Because federal law typically only regulates “securities,” the Ripple decision, authored by Judge Analisa Torres, left certain investments unprotected. Like Terraform, Ripple recognized that sales of digital assets can constitute investment contracts and form the basis for securities fraud liability.[6] However, Ripple distinguished between direct sales by issuers to institutional buyers and public sales by issuers on digital exchanges, finding liability only for the former.[7] Applying the Supreme Court’s seminal Howey test,[8] Ripple reasoned that the “Programmatic Buyers” did not purchase Ripple’s digital assets (“XRP”) with the “expectation of profit” to be derived “from Ripple’s efforts,” because (a) the sales were not made pursuant to detailed contracts; (b) Ripple’s promotional materials and brochures may not have been as widely distributed to these buyers as to the institutional buyers; and (c) in the Court’s view, these buyers were “generally less sophisticated as [] investor[s]” and may not have been able to “parse through the multiple documents and statements…across multiple social media platforms and news sites.”[9] Ripple’s reasoning is limited to blind bid/ask transactions, and the opinion expressly declined to rule on secondary market sales.[10] The direct holding in Ripple, therefore, only expressly limited liability for sales by crypto issuers on digital asset exchanges via trading algorithms. Separately, Ripple held that distribution of XRP to employees or third parties as compensation did not involve an “investment of money” and therefore were also not securities transactions under Howey.[11]

In Terraform, Judge Rakoff roundly rejected Ripple’s institutional/retail investor split and its reasoning, observing that the Supreme Court’s seminal Howey opinion “made no such distinction” and “it makes good sense that it did not.”[12] Further, Judge Rakoff found that the SEC had sufficiently alleged that the defendants “embarked on a public campaign to encourage both retail and institutional investors to buy their crypto-assets” and that the misleading “representations would presumably have reached individuals who purchased their crypto-assets on secondary markets –- and, indeed, motivated those purchases -- as much as it did institutional investors.”[13]

By rejecting the Ripple precedent, Terraform created a clear split within the same federal judicial district on the issue of whether “programmatic” offers and sales by issuers on digital asset trading platforms can be actionable as offers and sales of securities. Generally, appeals courts only hear appeals of “final decisions.” Interlocutory review, however, is warranted where (1) “[an] order involves a controlling question of law,” (2) “as to which there is substantial ground for difference of opinion,” and (3) “an immediate appeal from the order may materially advance the ultimate termination of the litigation.” SEC v. Rio Tinto PLC, 2021 WL 1893165, at *1 (S.D.N.Y. May 11, 2021). Citing Terraform, which reached the opposite result, the SEC is seeking permission to appeal the Ripple decision.[14]

In addition to prompting likely review of the Ripple decision by the Second Circuit, the Terraform decision is separately noteworthy because it identifies several classes of digital assets that can give rise to securities fraud liability, including certain stablecoins and derivative assets. Applying the longstanding Howey test, Terraform found that the SEC had sufficiently alleged fraud liability for assets in the below categories:[15]

  • Altcoins: Terraform upholds fraud claims arising from the offer and sale of the altcoins LUNA and MIR. The Court noted that the coins’ values were linked to the growth of the Terra ecosystem and the “Mirror Protocol,” respectively, such that investors expected to derive profit from others’ efforts toward their development.[16]
  • Stablecoins: Terraform upholds fraud claims involving the offer and sale of the stablecoin, UST, which was meant to be algorithmically pegged to the U.S. dollar on a 1-1 basis. In reaching this decision, the Court found it dispositive that: (a) UST was linked to LUNA, which was pitched as a yield-bearing investment; and (b) purchasers often deposited UST on Terra’s savings protocol, “Anchor,” which Defendants touted could yield up to 20% returns.[17] Critically, the Court points to the statutory definition of the term “security,” which includes a “right to…purchase” another security—in this case, LUNA.[18] 15 U.S.C. § 77b(a)(1).
  • Derivative assets: Terraform upholds fraud claims involving the offer and sale of “mAssets” (or “mirrored assets”), which were “security-based swaps” intended to mirror the value of other crypto assets.[19] Because the value of mAssets rose and fell with the value of other securities, the Court found it not relevant that mAsset transactions did not identify specific counterparties for future swaps.[20]

Moreover, Terraform confirms that federal courts can have personal jurisdiction over foreign cryptocurrency issuers and related parties.[21] This holding is significant because cryptocurrency companies are often incorporated in foreign jurisdictions and may not have physical headquarters, which complicates personal jurisdiction analysis. To establish personal jurisdiction over a defendant, a plaintiff must show that the defendant “purposefully directed” activities within the forum state and that the allegations “arise out of” that directed activity. Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472-73 (1985). In Terraform, these factors are held to be sufficiently established because of (1) direct sales of the relevant coins or products to United States companies carried out through the United States banking system and (2) that Defendants marketed their products in meetings in the United States.[22]  This decision builds on a similar holding by the United States Court of Appeals for the Second Circuit and aligns with notable cases in the Southern District of New York. See U.S. Sec. & Exchange Comm. v. Terraform Labs Pte Ltd., 2022 WL 2066414, at *4 (2d Cir. June 8, 2022); Owens v. Elastos Found., 2021 WL 5868171, at *8 (S.D.N.Y. Dec. 9, 2021).

Accordingly, Terraform is a positive result for digital-asset investors which could become the law for the entire Second Circuit if the SEC receives permission to appeal Ripple.


[1] SEC v. Ripple Labs Inc., Case 1:20-cv-10832-AT-SN, ECF No. 893 (Filed August 18, 2023).

[2] Id.

[3] CFI Team, What Happened to Terra? (October 13, 2022, updated: February 1, 2023).

[4] See 7 U.S.C, § 1a(18). “Eligible contract participants” include, for example, financial institutions, regulated insurance companies, and employee benefit plans with assets exceeding $5 million. Id.

[5] Terraform, at *15-17.

[6] Id., at *14-15; Ripple, at *6-8.

[7] Ripple, at *13.

[8] Howey defines an investment contract subject to securities laws as 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 promotor or a third party,” SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[9] Ripple, at *12.

[10] Id., at *11 n. 16 (“The Court does not address whether secondary market sales of XRP constitute offers and sales of investment contracts because that question is not properly before the Court. Whether a secondary market sale constitutes an offer or sale of an investment contract would depend on the totality of circumstances and the economic reality of that specific contract, transaction, or scheme.”).

[11] Id., at *13.

[12] Terraform, at *15; SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[13] Terraform, at *15.

[14] SEC v. Ripple Labs Inc., Case 1:20-cv-10832-AT-SN, ECF No. 893 (Filed August 18, 2023).

[15] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[16]  Terraform, at *15-16. These holdings mirror the results in a considerable number of cases that found similar coins to be “securities.” See e.g., Owen v. Elastos Found., No. 1:19-CV-5462-GHW, 2021 WL 5868171 (S.D.N.Y. Dec. 9, 2021); U.S. Sec. & Exch. Comm'n v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020); Sec. & Exch. Comm'n v. Telegram Grp. Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020); Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019).

[17] Terraform, at *12.

[18] Id.

[19] Id., at *16.

[20] Id.

[21] Id., at *5-6.

[22] Id.

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