USA's SEC gets firm with Terra's de facto "statutory underwriter" in the latest twist in a long running saga.

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USA's SEC gets firm with Terra's de facto "statutory underwriter" in the latest twist in a long running saga.

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Mon, 23/12/2024 - 06:35

Terraform Labs PTE limited, a company registered in Singapore, was wound up in July 2024, several months after one of its founders, Do Hyeong Kwon, was found liable in a civil fraud case brought by the USA's Securities and Exchange Commission. But that's not the end of the story. Has the SEC's latest action brought this sorry affair to an end?

Last Friday, 20th December, 2024, the Commission issued civil proceedings (it calls them "charges" but they aren't) against Tai Mo Shan Limited. Tai Mo Shan is a company registered in the The Cayman Islands and with a British Companies House registration.

The company was established in the UK in May 2018 and closed in June 2021. Keep those dates in mind.

There were no "persons with significant control registered. That's important because the company is said to be a wholly owned subsidiary of Jump Crypto Holdings LLC. Crunchbase, which doesn't originate its own descriptions, says "Jump Crypto is building a cryptocurrency infrastructure to help the blockchain and all things Web3 grow. It was founded in 2015 and is based in Chicago."

Tai Mo Shan is Hong Kong's highest peak, higher than "The Peak", and a country park, a fact that flabbergasts many who think the Island is covered in concrete. Once an active volcano, it had its last hurrah about two million years ago and even in tropical Hong Kong sometimes sees temperatures below freezing. It is also very often covered in cloud. One has to wonder if the name given to the company was the opposite of auspicious.

Jump has its own problems: in October this year, a game developer sued the company according to CoinTelegraph. The company alleges that Jump conspired with a crypto exchange to freeze USD1.4m of the developer's funds and refuses to return it; this on top of allegedly "orchestrating a pump and dump scheme using its in-game currency, DIO." It is alleged that "Jump agreed to provide market-making services for the launch of the game’s token, DIO. Fracture Labs originally intended to launch the token on the KuCoin exchange. However, it moved the launch to HTX after Jump allegedly advised it to do so. As part of the deal, Fracture Labs agreed to loan 30 million DIO tokens to Jump Crypto’s subsidiary, J Digital. These funds were supposed to be used to provide a market for the token so that traders could always find a buyer or seller. " It's a lot more complicated, as the CoinTelegraph story (link below) demonstrates.

The Jump story is relevant because, according to the SEC "Tai Mo Shan negligently engaged in a course of conduct in May 2021 that misled members of the investing public about the efficacy of Terraform’s so-called “algorithmic stablecoin,” UST, when it dropped in value from its $1 peg (“de-peg”). In [the] light of prior statements by Terraform that its algorithmic mechanism would maintain UST’s USD1 peg, Tai Mo Shan acted negligently by trading UST in a manner that deceived the market that Terraform’s algorithmic mechanism was working as intended to stabilise UST’s price at USD1. "

There seems to be some commonality of approach.

What seems particularly interesting is that Tai Mo Shan was more closely associated with Terraform, incorporated in Singapore. Terraform was at the forefront of the so-called "algorithmic stablecoin" fad and created one called "UST". Lovers of hubris, stay tuned.

The proposal was that UST would have a fixed exchange rate of one to 1USD. Here's where the fiction takes hold. That "peg" would be maintained by an automated trading strategy that would buy or sell so as to keep the peg intact.

The Hong Kong Dollar has been pegged at 1USD=HKD7.75-7.85 since 1983 and for all practical purposes it's assumed to be 7.8. Pegs are a good idea that are difficult to maintain in practice. Around the world pegs have maintained stability until they don't, most famously, perhaps, when the UK crashed out of "The Snake" created in 1972 as an early attempt at currency stability and economic convergence in the nascent European Union, still the European Economic Community or EEC at the time. The variance, 2.25 either side of a fixed rate, then the EEC's central banks would intervene. The GBP, Irish Punt and Danish Kroner all came under speculative attack and countries could not remain within the band and left the scheme.

In Hong Kong, it was reported in November 2023, the Hong Kong Monetary Authority, Hong Kong's Central Bank and banking regulator, "int]ervened 49 times over a 12 month period to keep the Hong Kong Dollar with its official trading band."

So, if Terraform and its associates wanted to keep UST trading at UST=USD, it had to be prepared to make transactions to maintain the balance. That might become very, very expensive and Terraform didn't have the money, even after launching its own currency, Luna.

There is some confusion over the name "LUNA" because there is a Singpore-based crypto exchange called "LUNO." There is no connection between the two.

The money for the support of the UST came from Terraform which entered into an arrangement with Tai Mo Shan in relation to options it held on Luna.

According to the SEC's Order (link below) " From January 2021 to May 2022, Tai Mo Shan, directly or indirectly, offered and sold securities through the use of interstate commerce when no registration statement was in effect with respect to these offers and sales. Specifically, Tai Mo Shan acted as a statutory underwriter with respect to certain of its offers and sales of LUNA, a crypto asset issued by Terraform Labs PTE Ltd. (“Terraform”) and offered and sold as a security. As a result of this conduct, Tai Mo Shan violated Sections 5(a) and (c) of the Securities Act."

What the SEC says is this: "

On May 23, 2021, Tai Mo Shan entered into an agreement with Terraform that incentivised Tai Mo Shan to purchase UST in exchange for Terraform “vesting” Tai Mo Shan’s existing option to purchase LUNA at a discount to the then-prevailing market price of LUNA. On that day and subsequent days, Tai Mo Shan traded in a manner consistent with trying to restore the price of UST toward its USD1 peg, including by purchasing more than USD20 million worth of UST. Tai Mo Shan should have known that statements made by Terraform, prior to the de-peg, regarding how its arbitrage mechanism operated led reasonable investors to believe that swapping of UST and LUNA on Terraform’s blockchain through the algorithmic arbitrage mechanism acted alone to automatically stabilize UST’s price at USD1, instead of the price being stabilised, at least in part, by large purchases of UST incentivised by Terraform. As a result of its negligent conduct, Tai Mo Shan violated Section 17(a)(3) of the Securities Act. A violation of Securities Act Section 17(a)(3) does not require scienter (knowledge) and may rest on a finding of negligence.

This is interesting on many levels: negligence, by definition, means failing to pay adequate attention and it is therefore indicative of a state of mind. Thus the Commission takes the view that a company can have a state of mind. This is not a commonly held view. People have minds, companies don't.

Nigel Morris-Cotterill is at www.countermoneylaundering.com

Terraform Labs, the Singapore company, failed in May 2022.

One its founders, South Korean national Kwon Do-hyung (known as Do KWON) was accused of fraud in the USA and, when criminal charges were laid, extradition proceedings were begun. He had been found in Montenegro. At the time, it was reported that KWON had said he would prefer to be extradited to South Korea rather than the USA: indictments had been laid in both countries and both sought his delivery to them. In February, 2023, KWON was sued by the SEC alleging fraud. Criminal charges were laid in the USA in April 2023. Eventually, in February 2024, KWON was extradited to South Korea.

But on the corporate front, things had been moving on. Terraform's collapse in 2022, had led to an estimated 40,000 million loss to the crypto markets as jitters took hold. In January 2024, the Singaporean company applied to a US court for protection from its creditors under Chapter 11 of the US Bankruptcy Code: it's basically an insolvency procedure short of liquidation, intended for re-organisation or division of the company and its assets. The company paid a lump sum in respect of future legal fees to Dentons, a City of London law firm. That annoyed an American judge who refused to allow Dentons to represent the company unless USD48 million of pre-paid legal fees was returned to the company.

The Commission launched the hearing of its civil fraud trial in March, 2024 in the absence of Do KWON, alledging that Terraform and Do KWON had built a "house of cards" . Two weeks later, a Manhattan jury found against the company and its founder and six weeks later, the company and KWON agreed to forfiet USD4,700 million. The class actions appeared to have not been covered by that settlement.

In September, 2020, the US Court agreed that Terraform's insolvency proceedings could be wound down but that is a US decision. The company is not a US company so the company continued in existence.

That didn't orphan Tai Mo Shan Limited which remains alive and that's how the settlement of 20th December was arrived at.

The SEC wrapped it up saying

The SEC’s Order also documents that, from at least January 2021 to May 2022, Tai Mo Shan acted as a statutory underwriter with respect to LUNA, a crypto asset offered and sold as a security. Tai Mo Shan acquired certain LUNA crypto assets from Terraform with a view toward distribution after it offered and resold LUNA as securities into the market on U.S.-based crypto asset trading platforms shortly after acquiring it from Terraform.

“This case reminds us that, too many times in the crypto markets, we’ve seen significant investor losses due to fraud,” said outgoing SEC Chairman Gary Gensler. “Here, the impact reverberated throughout the crypto markets, eventually costing the savings of countless investors. Regardless of the labels, crypto market participants should comply with the securities laws where applicable and not deceive the public. Otherwise, investors get hurt.”

As part of the settlement, Tai Mo Shan agreed to surrender USD73,452,756, USD12,916,153 in prejudgment interest, and a USD36,726,378 civil penalty. Without admitting or denying the SEC’s findings, Tai Mo Shan agreed to cease and desist from breaches of the registration and fraud provisions it broke.

This part of the case, then, has generated USD123 million in penalties and other payments.

All aspects of the case related to foreign companies and persons, although Terraform had people in the USA.