Terraform Labs, Do Kwon agree to $4.5B SEC settlement that they can’t pay

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Terraform Labs and founder Do Kwon have agreed to a multi-billion dollar settlement of their court fight with U.S. securities regulators, although collecting on these damages may prove a far tougher slog.

On June 12, the Securities and Exchange Commission (SEC) filed a proposed final consent judgment with Judge Jed Rakoff of the U.S. District Court for the Southern District of New York. The SEC filed its fraud complaint against Terraform/Kwon in February 2023, nearly a year after Terra’s ‘crypto’ ecosystem collapsed in a heap of its own making, signaling the start of the ‘crypto contagion’ that felled numerous other entities.

In April, a jury in Manhattan found Terraform and Kwon liable on civil fraud charges, including lying about the stability of its LUNA token and UST algorithmic’stablecoin, each of which was (theoretically) supposed to ensure the other’s stability. This theory ultimately proved to be so much handwavy BS, resulting in what the SEC called “one of the largest securities frauds in U.S. history.” At least $40 billion in ‘market value’ was wiped out in the process.

Attorneys representing Terraform/Kwon had tried to claim that the securities laws didn’t apply to their tokens, and thus, the SEC had no right to target the company. But late last year, Judge Rakoff issued a ruling that granted the SEC summary judgment on its claim that Terraform/Kwon had indeed sold unregistered securities to the public, leading to this spring’s trial and this month’s settlement.

The settlement, which Rakoff approved on June 13, will impose “significant remedial, punitive, and deterrent remedies, including a multi-billion dollar judgment” against the defendants. Terraform has agreed to pay $4,473,828,306 ($3,586,875,883 in disgorgement, $466,952,423 in prejudgment interest, plus a $420 million civil penalty).

Kwon, who didn’t attend this spring’s trial, agreed to pay $204,320,196 ($110 million in disgorgement, $14,320,196 in prejudgment interest, and an $80 million civil penalty). Kwon agreed to transfer “at least” $204 million to Terraform’s bankruptcy handlers for distribution to the rank-and-file holders of LUNA/UST left high and dry by the company’s collapse.

The proposed settlement also prohibits Terraform/Kwon from ever involving themselves in anything remotely resembling securities transactions. The SEC claims the deal will “put Terraform out of business for good” while providing “meaningful and speedy recovery for investor victims.”

Finally, the SEC claims the judgement sends the “unmistakable deterrent message to not only those who engage in brazen misconduct, but also to all those who seek to evade the requirements of the federal securities laws.” A noble sentiment, but this is crypto, a clown car in which there will always be room for one more.

Blood from a Swiss stone

It’s anyone’s guess how much Terra/Luna’s former customers will actually see of the settlement’s nearly $4.5 billion but, given Terraform’s bankruptcy filing, the final figure is likely to be a small fraction of that sum.

The settlement makes plain that the agreed-upon billions “will be treated as an allowed general secured claim of the SEC against Terraform” and that the regulator will collect only “after harmed investors and other general unsecured creditors recover in full.”

In April, a Delaware bankruptcy court filing indicated that Terraform retained just over $430 million in total property, both real-world and digital. The SEC’s original complaint claimed that the defendants “transferred over 10,000 [BTC tokens] from Terraform and Luna Foundation Guard crypto asset platform accounts to an un-hosted wallet, or ‘cold’ wallet.”

The complaint added that the defendants “continue to transfer” some of the BTC “from this wallet to a financial institution based in Switzerland” and convert it into cash. Over $100 million in fiat had been withdrawn from that Swiss bank at the time of that February 2023 complaint.

All the Kwon’s horses and all the Kwon’s men

Kwon is currently in Montenegro, where he and a fellow suspect were detained in March 2023 for attempting to travel with forged Costa Rican passports. Ever since, American authorities have been trying to extradite Kwon to the U.S. to face criminal charges related to his Reign of Terra(r).

The U.S. extradition efforts have been complicated by similar efforts by South Korea, the land of Kwon’s birth, which wants to prosecute Kwon for the pain he inflicted on local ‘investors’ swindled by the Terraform scam.

Following four months in a Montenegro prison, local authorities released Kwon in April. But he’s prohibited from leaving the country until the extradition slap-fight is finished and either the U.S. or South Korea whisks him away to face the legal music.

In February, South Korea successfully extradited Terraform’s former chief financial officer, Han Chang-joon, from Montenegro after he served his own four-month sentence. Han was nabbed by Montenegrin authorities while trying to leave the country on a private jet to Dubai with Kwon. Han reportedly faces a potential life sentence for his role in the Terraform fraud.

Terraform co-founder Hyun-Seong ‘Daniel’ Shin made a preliminary court appearance in South Korea late last year on charges of fraud and violating local capital markets laws. Shin’s defense centers on his claims that (a) it’s all Kwon’s fault, and (b) the fact that Shin left Terraform in 2020 to launch a new digital payments firm (Chai Corporation).

The Chai app claimed to process payments on the Terra blockchain but this was later exposed as yet another fraud, as the payments were allegedly made using traditional methods and then ‘mirrored’ (aka manually copied) on the chain to make it look like Terraform’s products had actual use cases.

What is dead may never die

News of the SEC settlement was swiftly followed by an X/Twitter post by Terraform CEO Chris Amani confirming that the company “will be winding down operations completely.” Amani stated (without evidence) that Terra had been “well positioned to accelerate [its alleged ‘building’ process] if we had won the trial, but unfortunately, we lost and, as a result, can no longer operate.”

Amani, who assumed control of Terraform in July 2023, added that the Terra “community will need to take over ownership of the chain” and claimed that “there are a couple teams and devs who want to do this.” Amani added that he will “be here for the full wind down to ensure all goes smoothly.”

Terraform is proposing to “burn” all of its unvested LUNA tokens, along with “anything that remains vested in our wallets.” Amani also stated that Terra will “run a process to sell” its various appendages, including Pulsar Finance (a ‘crypto’ portfolio manager), Station Wallet and Enterprise DAO (the latter two are part of the Cosmos blockchain ‘interchange’ ecosystem).

None of these developments seemed to have helped either the LUNA or LUNC (Luna ‘Classic’) tokens, both of which suffered 6-8% fiat value declines in the 24 hours following news of the settlement. It’s perhaps more amazing that people are still clinging to these crumpled lottery tickets long after the draw has been exposed as a sham, but hope springs eternal, we guess.

Me too

Paul Grewal, chief legal officer at the Coinbase (NASDAQ: COIN) exchange, tweeted his dismissive response to the Terraform settlement, saying it would bring “zero meaningful relief to fraud victims.” Grewal further claimed that this hollow chest-thumping was “predictably on-brand” for the SEC, with which Coinbase is locked in a similar legal fight over the sale of unregistered securities.

Another firm engaged in a long-term war with the SEC, XRP issuer Ripple Labs, filed a “notice of supplemental authority” with the same District Court on June 13. The notice argues that the SEC’s demand for Ripple to pay a $2 billion fine for selling unregistered securities is excessive, given the Terraform settlement.

Ripple says the settlement “demonstrates the unreasonableness” of the SEC’s $2 billion demand. The Terraform settlement “fits [the] pattern” of the SEC imposing civil penalties of 0.6%-1.8% of a defendant’s gross revenues. But the SEC wants Ripple to pay a penalty “far exceeding that range, even though there are no allegations of fraud in this case” and Ripple customers “did not suffer substantial losses.”

The settlement’s financial terms are a little less than the $5.3 billion the SEC originally sought but far greater than the $1 million that Terraform’s attorneys originally argued the entity should pay. The nearly $4.5 billion is also slightly higher than the penalty U.S. authorities imposed on the Binance exchange and its founder Changpeng ‘CZ’ Zhao, who recently began his four-month prison sentence for violating U.S. anti-money laundering laws.

It’s worth remembering that while other U.S. federal agencies agreed to conclude their respective legal actions against Binance/CZ following last November’s settlement, the SEC’s civil complaint against Binance remains ongoing. In April, a joint status report indicated that Binance was belatedly complying with requests for documents but that the SEC anticipated “identifying a few discrete issues” with Binance’s U.S. affiliate over what the SEC found in these documents. We bet.

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