Company behind crypto TerraUSD, whose collapse cost investors $40 billion and set off an industry-wide crisis, is sued for fraud by SEC

The SEC alleged in federal court on Thursday that Terraform Labs, the company behind the token, and its co-founder Do Kwon offered and sold unregistered securities and carried out a fraudulent scheme that wiped out at least $40 billion worth of market value, including serious losses for both retail and institutional investors. 

The agency accused the company and Kwon of misleading investors, including about the stability of the TerraUSD stablecoin, which was marketed as maintaining a 1-to-1 peg to the US dollar. 

“Terraform Labs has not been contacted about such a proceeding by the SEC and thus cannot comment,” the company said in a statement to Bloomberg when asked prior to the SEC filing the lawsuit.

TerraUSD, or UST, was supposed to maintain its peg through an algorithm and trading in a sister token called Luna — an experiment that failed spectacularly when the stablecoin crashed last May, sparking a massive selloff. The token’s implosion kicked off a domino effect across crypto markets. It directly, or indirectly, fueled bankruptcies in high-profile companies, including hedge fund Three Arrows Capital, Voyager Digital, and, most prominently, Sam Bankman-Fried’s Alameda Research and FTX. 

Meanwhile, the SEC’s case is a significant development in Washington’s mushrooming regulatory crackdown as Wall Street’s main regulator would effectively be asserting its jurisdiction over certain stablecoins, which are a key part of how crypto markets function. 

Even before FTX’s collapse, the US government was grappling with how best to regulate stablecoins, which the Treasury Department and other agencies have warned could pose risks to the broader financial system if people begin using them more as a form of payment. A 2021 report called for the token issuers to be regulated like banks and lawmakers have been working on legislation to set guardrails.  

Jostling between US agencies over jurisdiction is ongoing and attempts by the SEC to assert more control has generated some criticism. Anxiety over the agency’s efforts is running high after Paxos Trust Co. Revealed this week that the agency had told it that was likely to face an enforcement action over its issuance of a stablecoin branded as Binance USD. 

Unlike UST, which used algorithms and trader incentives to maintain its price, that Paxos-issued token purports to be fully backed by cash and other liquid assets.

Under securities law, a virtual currency may fall under the SEC’s remit if Americans buy it to fund a company or project with the expectation of profiting from the efforts of those involved in it. That determination is based on a 1946 US Supreme Court decision defining investment contracts. 

The SEC ratchets up pressure on co-founder Kwon, who in a separate matter famously received an SEC subpoena while attending an industry conference in New York in 2021. 

Kwon’s whereabouts are currently unknown. South Korean authorities have been looking for him in connection with a warrant for his arrest that was issued last September on allegations including breaches of capital-markets law. He has denied wrongdoing previously on social media.