Ex-SEC Lawyer Praises Judge Rakoff: Warns of More Trouble Ahead for Ripple & XRP

On 31 July 2023, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York made a significant ruling in the case “SEC v. Terraform Labs Pte. Ltd. and Do Hyeong Kwon” that could have much broader implications for the crypto space.

According to an article by The Block, in their defense, Terraform argued that the recent split decision in the SEC’s case against Ripple Labs invalidated the agency’s case against them. However, Judge Rakoff rejected this argument, allowing the civil case against Terraform and Kwon to proceed.

Judge Rakoff dismissed the notion of drawing a distinction between coins based on their manner of sale, a stance that directly contradicts the approach adopted by another judge in the Ripple case. He emphasized that the law does not support the idea that a coin sold directly to institutional investors is considered a security, while the same coin sold through secondary market transactions to retail investors is not.

Judge Rakoff wrote:

It may also be mentioned that 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. In doing so, the Court rejects the approach recently adopted by another judge of this District in a similar case.

Judge Rakoff also dismissed Terraform’s invocation of the major questions doctrine, a legal argument gaining traction in the industry, as a reason to dismiss the SEC’s case. He argued that the cryptocurrency industry, while important, does not bear the vast economic and political significance required to invoke this doctrine.

He wrote:

Because the doctrine is reserved for the most extraordinary cases where the agency claims broad regulatory authority and the area to be regulated is one invested with particular economic and political significance, it has been rarely invoked … With this standard in mind, the crypto-currency industry – though certainly important – falls far short of being a ‘portion of the American economy’ bearing ‘vast economic and political significance.’

Furthermore, Judge Rakoff argued that limiting the SEC to regulating only investment products that label themselves as securities would be contrary to Congress’s intent in passing current securities laws. He concluded that there is no indication that Congress intended to hinder the SEC’s ability to resolve new and challenging questions posed by emerging technologies impacting markets that resemble securities markets.

John Reed Stark, a seasoned expert in digital regulatory compliance and a former SEC enforcement attorney, has provided a detailed analysis of Judge Rakoff’s recent decision in the SEC’s case against Terraform Labs and its founder, Do Kwon. Stark’s commentary, shared on LinkedIn and Twitter, discusses the implications of Judge Rakoff’s ruling and its potential impact on the Ripple case.

Stark begins by highlighting the significance of Judge Rakoff’s decision to allow the SEC to proceed with its case against Terraform Labs. He underscores that Judge Rakoff explicitly rejected the distinction made in the Ripple case between public and institutional sales. This decision, Stark notes, is a clear rebuke of the Ripple case, and he suggests that the SEC is likely to appeal the Ripple decision.

Stark then quotes extensively from Judge Rakoff’s decision, emphasizing the judge’s rejection of the argument that the Howey test, which determines whether a transaction is an investment contract, should distinguish between direct and secondary purchasers of crypto-assets. According to Judge Rakoff, both sets of purchasers would have been influenced by the defendants’ promises of profitability. Stark points out that Judge Rakoff’s argument challenges the reasoning in the Ripple case, which suggested that secondary market traders could not reasonably expect profits based on the efforts of the defendants.

Stark also discusses Judge Rakoff’s dismissal of Terraform Labs’ invocation of the “major questions doctrine,” a legal principle that prevents regulatory agencies from dramatically exceeding their mandate. Judge Rakoff argued that the crypto industry, while important, does not have the “vast economic and political significance” that would trigger this doctrine. Stark notes that this argument could have significant implications for other crypto defendants who have invoked this doctrine against the SEC.

In his commentary, Stark also praises Judge Rakoff’s expertise and independence in securities law. He describes Judge Rakoff as one of the most respected and experienced securities law jurists in the U.S. federal court system. Stark concludes by suggesting that Judge Rakoff’s decision may be the first of many rejections of the Ripple decision, indicating a potential shift in the legal landscape for cryptoassets.

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