Paradigm Files Amicus Brief in SEC vs Terra

TLDR: On Friday, Paradigm filed an amicus brief in the SEC lawsuit against Terraform Labs and Do Kwon. Paradigm was not an investor in the Terra ecosystem and our brief was filed in support of neither party’s motion—our only interest was to push back against the SEC’s continued attempts to expand their jurisdiction over crypto.

Through its enforcement action against Terra, the SEC attempts to bring stablecoins under its remit by advancing the boundless theory that if any instrument can be exchanged for a so-called “crypto asset security,” the instrument itself becomes a “crypto asset security.” This theory contradicts decades of guidance from federal courts and would result in any barterable good becoming a “security.”

On February 16, 2023, more than eight months after the collapse of terraUSD (“UST”) and its companion token LUNA, the SEC sued Terraform Labs PTE LTD and Do Kwon (together, the “Terra Defendants”) with a range of charges, including fraud. Like cavalry charging a field of beaten survivors, the SEC’s enforcement action came too late to protect any investors in Terra or contain the effects of the Terra collapse on the broader crypto market. Instead, in what has become an emblematic tactic of the SEC under Chair Gensler, the agency filed a late complaint against an incapacitated defendant to expand the agency’s jurisdiction over crypto.

To support the allegations that the Terra Defendants conducted an unregistered offering of securities, the SEC claimed in the Complaint that five different crypto assets were “crypto asset securities”: UST, LUNA, “wrapped” LUNA, MIR Tokens, and mAssets. Our brief focused on responding to the SEC’s novel theory that UST, an algorithmic stablecoin, was a security. The SEC’s theory about UST is ancillary to the central claims in the Complaint. Nonetheless, we believed it was critical that Judge Rakoff, who is overseeing the case, avoid inadvertently endorsing this unsupported theory, which the SEC could seek to apply broadly to other stablecoins.

According to the SEC, a type of crypto asset that is profitless by design a—stablecoin—becomes a “crypto asset security” because it can be exchanged for another crypto asset that is alleged to be a security. But the Supreme Court has already cautioned that an asset’s classification as a security should not be based on “speculative” uses, i.e., what could be done with an asset. United Hous. Found. Inc. v. Forman, 421 U.S. 837 at 865 (rejecting as “too speculative and insubstantial” the notion that co-op shares could be securities because the co-op had commercial facilities that could be leased out at a net profit). Moreover, by the SEC’s reasoning, virtually every good or property in the world can be a security merely because that good or property can be used to buy a security. While the Securities Laws are broad and flexible, they do not allow the SEC to turn any barterable good into a security.