Do Kwon lost to the SEC. The US is piling up other crypto wins, too

The Securities and Exchange Commission on Friday notched a court victory against brash crypto entrepreneur Do Kwon. His TerraUSD and Luna tokens collapsed in 2022, wiping out $40 billion in value and causing huge losses for investors around the world.

After a two-week civil trial, a New York jury agreed with the SEC’s claims that Kwon and his firm, Terraform Labs, defrauded investors by misleading them about the stability of TerraUSD, a so-called stablecoin designed to maintain a value of $1. Kwon had claimed that TerraUSD would “self-heal" if its value ever dropped below the peg.

The decision was the latest in a series of federal court wins bolstering regulators’ efforts to force the freewheeling industry to comply with the same laws that govern the stock and bond markets. Crypto firms have pushed back against the SEC’s campaign, saying it would hamper innovation if they were forced to comply with securities laws that date to the 1930s.

Jurors in the Kwon trial heard from investors who lost their savings in the TerraUSD-Luna crash, as well as whistleblowers who gave evidence that Kwon misled investors. Kwon didn’t attend the trial because he has been detained in Montenegro for more than a year as South Korea and the U.S. both vie to extradite him to face criminal charges.

The SEC accused Kwon and Terraform of misleading investors about a 2021 episode when TerraUSD temporarily dropped below its $1 peg, by failing to disclose a secret deal with high-speed trading giant Jump Trading to prop up the stablecoin. Jump “saved our ass," one Terraform employee told another in messages presented in court.

The SEC also accused Kwon of lying by saying that Terraform’s blockchain technology was used by a South Korean fintech company called Chai to process payments. Chai actually used more conventional payment systems, the SEC said.

Aaron Myung, a former Chai executive turned whistleblower, testified about his growing discomfort when he learned that Kwon was publicly touting Chai’s use of blockchain, and the jury heard conversations that Myung surreptitiously recorded as he investigated how Chai actually worked.

Jurors sided with the SEC after less than three hours of deliberation. Terraform said it was disappointed by the verdict and considering its next steps.

Many of the court brawls over crypto cases have taken place in Manhattan federal court, where Sam Bankman-Fried, the founder of crypto exchange FTX, last month was sentenced to 25 years in prison for stealing billions of dollars from customers and defrauding investors and lenders to his crypto hedge fund Alameda Research.

If Kwon is extradited to the U.S., he, too, would face criminal charges in New York.

In his civil case, U.S. District Judge Jed Rakoff will decide later how much Kwon and Terraform should have to pay in fines or forfeiture to investors. But Kwon’s case already has paid dividends for the SEC’s broader crackdown on crypto.

In December, Rakoff ruled that TerraUSD and Luna were sold as securities and that Terraform broke the law by failing to comply with SEC rules. His ruling buttressed the SEC’s other marquee enforcement actions: cases filed against Coinbase, Binance and Kraken.

Those fights ultimately turn on whether the three exchanges deal in assets that failed to comply with investor-protection laws. Most cryptocurrencies were sold without registering with the SEC. If the assets were issued illegally, then U.S. crypto exchanges would be forced to stop trading them.

Registration involves providing investors with standardized disclosures that reveal the company’s profits or losses, assets and liabilities as well as the financial stakes of management. Crypto startups don’t typically reveal that information and say their tokens are commodities, which are sold without having to deal with SEC rules.

In a pretrial decision last month, U.S. District Judge Katherine Polk Failla rejected many of Coinbase’s legal arguments against SEC supervision of crypto. Her opinion adopted Rakoff’s position that exchanges may have liability for trading digital coins that were initially issued in violation of SEC rules.

Failla’s decision allowed the SEC’s lawsuit to proceed to the next phase of evidence discovery. Still, her 84-page opinion was seen inside the SEC as an important win.

The Coinbase decision came after the SEC suffered a setback last year in one of its biggest cases. A different federal judge, Analisa Torres, partly rejected the agency’s claims that Ripple Labs illegally sold $1.4 billion of XRP, the sixth-biggest cryptocurrency by market capitalization.

Failla took a “broad swipe at some of their legal defenses and seemed a lot more welcoming of the SEC’s legal theories than the Ripple court was," said Marc Fagel, a former senior official at the SEC.

Coinbase, like the other exchanges, can beat the SEC’s suit if it can persuade the court that the specific cryptocurrencies cited in the regulator’s case aren’t securities.

“It looks harder for Coinbase because the judge knocked out some of their defenses, but they can still win on the merits," Fagel said.

Write to Dave Michaels at dave.michaels@wsj.com and Alexander Osipovich at alexo@wsj.com