Why Terraform Labs’ $4.5B SEC Deal Isn’t a Bust for Victims

• Terraform Labs and Do Kwon have agreed to settle with the SEC over securities violations.
• The agreement will see Terraform Labs’ penalty added to the bankruptcy liabilities.
• The SEC is considering distributing a proportion of the penalty to fraud victims.

The collapse of Terra LUNA and TerraUSD in May 2022 sent shockwaves through the crypto industry, triggering a domino effect of bankruptcies due to the sector’s interconnected nature. This catastrophic event not only wiped out an estimated $40 billion in investor wealth but also tarnished the reputation of algorithmic stablecoins.

In the aftermath, the crypto world witnessed a series of dramatic events, including Terraform Labs co-founder Do Kwon’s flight from authorities and subsequent capture , as well as the company’s Chapter 11 bankruptcy filing. The latest development in this saga sees Terraform Labs’ agreement to a $4.5 billion settlement with the SEC over securities violations, which may benefit victims of the fraud.

Terraform Labs and Do Kwon Bow to SEC Pressure

Terraform Labs and its co-founder Do Kwon have reached an agreement with the SEC to pay a total of $4.5 billion and $204 million, respectively. This settlement, pending court approval, could benefit the victims of the Terra fraud, offering a potential pathway to restitution for those who suffered losses during the collapse.

According to the proposed final judgment filed on Wednesday, the charges against Terraform Labs and Do Kwon centered on the offer and sale of unregistered securities and violations of fraud provisions. The breakdown of Terraform Labs’ settlement deal is as follows:

• Disgorgement: $3,586,875,883
• Prejudgment Interest: $466,952,423
• Civil Penalty: $420,000,000
• Total Monetary Remedies: $4,473,828,306

While Do Kwon’s settlement is significantly smaller, but remains relatively substantial. It is as follows:

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• Disgorgement: $110,000,000
• Prejudgment Interest: $14,320,196
• Civil Penalty: $80,000,000
• Total Monetary Remedies Against Do Kwon: $204,320,196 

Under the terms of the agreement, Terraform Labs will treat the disgorgement and civil penalty amounts as an allowed general unsecured claim in its bankruptcy case. This claim will be satisfied through distributions to creditors and investors under the existing Chapter 11 bankruptcy plan.

Do Kwon is required to transfer various assets, including funds and crypto assets, to an escrow account and the Terraform bankruptcy estate, totaling no less than $204,320,196 to fulfill his obligations under the deal.

Coinbase’s chief legal officer Paul Grewal criticized the settlement for providing “zero meaningful relief to fraud victims.” However, the court filing stated that the SEC “may” distribute a proportion of the funds received to help fraud victims.

Fair Funds Provision

The court filing outlined a potential plan to distribute some of the funds to fraud victims under Fair Funds provisions. Specifically, the filing stated, “The Commission may propose a plan to distribute the Fund subject to the Court’s approval. Such a plan may provide that the Fund shall be distributed pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002.”

This mechanism could provide another pathway for affected investors to recoup their losses. However, it’s important to note that the SEC made clear that even if the Fair Funds provision is implemented, the $420 million and $80 million civil penalty elements are “paid to the government.”

Should a Fair Fund scheme be approved and established, Terraform Labs victims would have the opportunity to submit claims to the fund. This process typically involves a claims administrator who reviews and validates these claims according to the approved distribution plan. Once the claims are processed and validated, the funds are distributed to the eligible victims.

At this stage, there is uncertainty around how a Fair Funds scheme would operate in conjunction with claims on the bankruptcy estate.

On the Flipside

• Do Kwon remains in Montenegro awaiting extradition to the U.S. or South Korea to face separate criminal charges.
• Terraform Labs will be winding down its operations, meaning the Terra (LUNA) blockchain could be subject to a community takeover .
• Terra Luna Classic (LUNC) split from Terra (LUNA) following the implosion and distinguished itself as a community-run project. 

Why This Matters

As Terraform Labs settles with the SEC for $4.5 billion, the resolution not only holds the company accountable but also opens another potential way for victims to receive restitution.

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