In the past few weeks, the Web3 legal space has seen multiple disputes and investigations seemingly come to an end, while others are just getting started. Terraform Labs is seeking to settle its dispute with the SEC and move on to focus exclusively on its ongoing bankruptcy proceedings, and the SEC has closed the door on its investigation into “Ethereum 2.0” (for now). While Ripple was able to defeat most of the private actions against it, some issues remain for trial, and the Kraken litigation against the SEC is on track for a busy year of discovery.

These developments and a few other brief notes are discussed below.

Terraform Labs and Founder Settle With SEC: June 12, 2024

Background: Terraform Labs has agreed to forgo its appeal and damages hearings after a jury found the company and its founder, Do Kwon, liable for securities fraud in April of this year. Instead, the company and founder have asked the Court to approve a settlement of ~$5 billion in fines, interest, and civil penalties. Do Kwon is personally on the hook for $204 million of the penalties, so I guess his size is not size anymore either.

Analysis: The SEC is getting basically everything it asked for in its damages briefing so this is about as white flag and waving a white flag gets. Terraform Labs already filed for bankruptcy in January of this year with estimated assets being under $500 million and the same amount of outstanding liabilities. The funds owed to the SEC under this settlement will be an unsecured claim in the bankruptcy matter, and the SEC will be left to seek its portion of whatever is left after Terraform Labs’ assets are used to pay secured creditors, administration expenses, and post-petition legal fees. So Terraform likely figured out that the difference between their proposed $3.5 million and the SEC’s suggested $5.3 billion was close to zero since the company would not be able to pay a significant portion of either of those fine options. Apparently, Terraform Labs has handed off control to the “community.” Following the settlement announcement, Ripple and the SEC exchanged jabs on whether this should change the analysis for damages in their case.

SEC Calls off Investigation into Ethereum 2.0: June 18, 2024

Background: The SEC sent a letter to Consensys Software stating that the Commission staff does not intend to recommend enforcement action against Consensys relating to the SEC’s investigation into what the SEC is calling “Ethereum 2.0.” The investigation seems to be related to the switch by the Ethereum Network from validating transactions that occur on the network from “proof-of-work” to now using “proof-of-stake” for those validation functions. This switch in validation methodology inspired SEC to revisit the agency’s then director of enforcement statement in 2018 that proof-of-work Ether was not a security. The June 7 letter referred by the SEC is available here.

Analysis: Is it a coincidence this decision comes within a week of the head of the SEC’s Crypto Asset and Cyber Unit in the Division of Enforcement announcing his departure? It is currently unclear if this decision is really the SEC deciding not to investigate Ethereum 2.0 or if this is just a temporary tactical strategy possibly to moot the Consensys lawsuit pending in Texas. Such a strategy would be similar to the SEC attempting to moot the Coinbase rulemaking request by stating it was “under consideration” despite ample evidence to the contrary. It will also be interesting to see if Consensys and separate Lejilex Administrative Procedures Act challenges to the SEC have the same success as a recent decision in that same federal district challenging a separate administrative agency action.

Ripple Labs Mostly Defeats Securities Class Action but Issues Remain: June 20, 2024

Background: Ripple Labs mostly won on its Motion for Summary Judgement in a securities class action which was filed by various individuals shortly after the SEC brought a lawsuit against the developer of $XRP. The Court found that the plaintiffs’ federal securities claims were barred by the applicable statute of repose and that the state law claims also could not continue because the named plaintiffs lacked the necessary privity of contract with Ripple. The Court did, however, allow the individual claims for misleading statements to continue to trial.

Analysis: While this is an important win for Ripple, the Order itself has some sub-optimal language on the Howey issue for surviving claims and it does not save Ripple from going to trial on the remaining claim. The Court found that plaintiffs sufficiently stated a claim that the $XRP tokens themselves are potentially securities which could give rise to a claim for misleading statements in connection with a security, even though plaintiffs bought the tokens on secondary marketplaces.

Kraken’s Motion to Dismiss SEC Case Likely to be Denied Following Hearing: June 20, 2024

Background: On June 20, 2024, the Court overseeing the SEC’s lawsuit against Payward Inc. (d/b/a, Kraken) telegraphed its intent to deny Kraken’s Motion to Dismiss during oral arguments on the motion. The Court was especially unphased with the Major Question Doctrine issue, denying the parties’ offers to present oral arguments at all on that issue. While Judge Orrick heard arguments on many of the remaining issues, he stated at the onset of the hearing that he was inclined to deny the Motion to Dismiss and follow the Order of Judge Failla in the agency’s lawsuit against Coinbase which the Polsinelli team provided a breakdown of in our April 15, 2024 Bi-Weekly update.

Analysis: Attorneys for Kraken tried to distinguish the binding case law that Judge Failla was bound by in the Second Circuit as compared to the Kraken case in the Ninth Circuit, but that did not appear to sway Judge Orrick during the hearing as they focused on scheduling issues after oral arguments concluded (giving at least some indication that the Court expects the case to continue into discovery).

Briefly Noted:

PleasrDAO Sues Martin Shkreli: PleasrDAO is suing Martin Shkreli (AKA, “Pharma Bro”) regarding the never publicly released Wu Tang album purchased by the DAO during the latter’s DOJ-forced asset forfeiture and sell-off. This comes after the DAO hosted the first ever listening party for the album. Martin Shkreli has also claimed to be behind the $DJT “meme-coin,” with the alleged backing of Barron Trump.

Crypto Campaign Funding Continues to Grow: Fairshake, the pro-crypto super PAC, now has a total funding number of $169 million, with over $100 million still in its war chest, after Jump Crypto adds another $10 million to the pot.

Another Major Departure in SEC Crypto-Enforcement Unit: David Hirsh, the head of the SEC’s Crypto Asset and Cyber Unit in the Division of Enforcement is leaving the agency. This follows the departure of Laden Stuart, who was involved with many of the agency’s heist profile digital asset cases.

Ether ETFs Expected Approval This Summer: Gary Gensler said he expects the Ether ETF S-1 forms for issuers should be approved by this summer. Despite that, there is still seemingly lagging activity in those various S-1 applications.

District Court Enforces Subpoena Against “Meme-Coin” Creator: A judge in the U.S. District Court for the Southern District of Florida has agreed to enforce a subpoena issued against the issuer of “Let’s Go Brandon” Coin (“LGBCoin”). The creator has asked for a stay in enforcement of the Order.