Terra Called ‘House of Cards’ by SEC at Start of Fraud Trial (1)

Terraform Labs Pte. began trial Monday over civil fraud claims tied to the 2022 implosion of its TerraUSD stablecoin, while co-founder Do Kwon remains in Montenegro waiting to learn whether he’ll be extradited to the US or South Korea to face criminal charges.

“Terra was a fraud, a house of cards,” a lawyer for the US Securities and Exchange Commission told jurors in Manhattan federal court. “And when it collapsed, investors lost nearly everything.”

The jury is considering SEC fraud allegations tied to the collapse, which wiped out $40 billion in investor assets, shook the crypto world and contributed to the failure of the FTX crypto exchange.

Police escort Do Kwon from court in Podgorica, Montenegro, on March 23.

Photographer: Savo Prelevic/AFP/Getty Images

The trial is the latest in a series of high-profile legal confrontations in which US prosecutors and regulators seek to assert greater control over the crypto industry. On Thursday, a judge in the same federal courthouse will decide on the sentence for Sam Bankman-Fried, who was convicted in November of a massive fraud at FTX.

Kwon faces criminal charges in both the US and South Korea. On Saturday he was released from a Montenegro prison while the country’s Supreme Court reviews earlier court decisions that he be extradited to South Korea.

Unusual Trial

Kwon’s entanglement in the Montenegro justice system has set up an unusual trial for SEC enforcers. Civil suits by regulators are usually delayed to allow prosecutions to go first. But a criminal trial can’t take place until Kwon is in the US.

The regulator is seeking a court order forcing Terraform and Kwon to pay civil penalties and return alleged ill-gotten gains.

The SEC lawyer, Devon Staren, told jurors investors were defrauded by Kwon’s claim that a popular Korean payment app, Chai, used Terraform’s blockchain technology to process and settle transactions made with cryptocurrencies. Terraform and Kwon also deceived investors about the stability of TerraUSD, which was said to be algorithmically “pegged” to the US dollar, Staren said.

Terraform denies the allegations and has criticized the SEC’s “unbounded zeal to characterize every cryptocurrency company as lawless.”

“Do Kwon didn’t defraud anyone,” his lawyer, David Patton, said in his opening. “He believed in the company he founded and everything he said about it.”

Kwon and Terraform lost billions of dollars trying to prevent its cryptocurrencies from crashing, he said.

“Failure doesn’t equal fraud,” Patton told jurors.

Terraform filed for Chapter 11 bankruptcy protection in January, claiming it couldn’t pay the penalties sought by federal regulators. Do Kwon owns about 92% of the company’s equity.

Pivotal Ruling

US District Judge Jed Rakoff, who is overseeing the civil trial, ruled in December that Terraform is liable for selling unregistered securities, agreeing with the SEC on a key element of its case and removing it from the issues the jury will have to consider. Terraform has said its cryptocurrencies don’t constitute securities under the law and that the SEC lacks jurisdiction. The company said it will appeal the ruling.

Kwon was arrested in Montenegro a year ago while trying to board a private jet to Dubai. He was convicted of attempting to travel using a fake passport and sentenced to four months behind bars, and now awaits the decision on where to send him. His team is pushing for South Korea, where sentences for white collar crimes are generally less harsh than in the US.

In January Rakoff delayed the trial’s start date for two months, at Kwon’s request, in hopes his extradition might come in time for him to participate in the trial. That possibility appears to have been eliminated by Montenegro’s protracted legal proceedings.

Staren told jurors they will hear evidence about the role of Jump Trading, a Chicago-based trading firm that, the SEC claims, secretly entered into an arrangement with Terraform to prop up TerraUSD a year before it collapsed.

The SEC also plans to present text messages between two Terraform executives discussing a “depeg,” in which TerraUSD lost its peg to the dollar, in May 2021.

Striking Exchange

“Do [Kwon] said if Jump hadn’t stepped in we actually might’ve been f—ed lol,” Brian Curran, the company’s head of communications, texted Jeffrey Kuan, Terraform’s business development head, the SEC said in court papers. Kuan responded “yeah i know they saved our a—.”

The SEC is expected to present testimony from two alleged whistleblowers, a Jump executive and the chief product officer at the Chai payment app, to prove that Terraform and Kwon intentionally misled investors.

Jump co-founder Bill DiSomma and Kanav Kariya, president of Jump Crypto, are also expected to be called as witnesses.

Jump hasn’t been accused of wrongdoing in the case.

Other likely witnesses include include Wintermute Trading Ltd. Chief Executive Officer Evgeny Gaevoy and Chief Operating Officer Marina Gurevich. Terraform has claimed that Wintermute’s shorting of TerraUSD in May 2022 contributed to a second and fatal depeg.

The trial, which is expected to take at least two weeks, will be underway when FTX’s Bankman-Fried learns his criminal sentence in the hearing on Thursday. Prosecutors have asked the judge to give Bankman-Fried, 32, as many as 50 years in prison. His team is asking the judge for 6 1/2 years.

The Terraform case is US v. Terraform Labs, 23-cv-01346, US District Court, Southern District of New York (Manhattan).

(Updates with comments from openings statements at trial.)

--With assistance from Yueqi Yang.

To contact the reporter on this story:
Bob Van Voris in federal court in Manhattan at rvanvoris@bloomberg.net

To contact the editors responsible for this story:
Misyrlena Egkolfopoulou at megkolfopoul@bloomberg.net

Peter Jeffrey, Steve Stroth

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