Digital asset exchange Kraken has found itself embroiled in a legal battle with the US Securities and Exchange Commission (SEC) over allegations of operating as an unregistered securities exchange, broker, dealer, and clearing agency. The Kraken SEC lawsuit, initiated in November 2023, has sparked a debate about regulatory authority in the rapidly evolving digital asset industry.
Kraken previously faced SEC legal action, settling in February 2023 by paying $30 million due to issues with its staking program. Consequently, Kraken ceased its staking services as part of the agreement.
Kraken’s Response
Kraken, in a bold move, has fired back at the SEC, challenging the lawsuit and alleging regulatory overreach. The exchange asserts that digital assets are not securities and, therefore, fall outside the SEC’s jurisdiction.
Related reading: SEC’s Battle on “Unregistered Securities”: What is the Regulator Up To?
Kraken said in the blog:
“Even taking all of the SEC’s allegations in the Complaint as true – and many are not – its argument is flawed as a matter of law.”
Kraken SEC Case: Testimony and Lawsuit
Kraken’s stance stems from its testimony before Congressional committees on May 10, 2023. The exchange highlighted concerns about inadequate regulation in the digital asset industry and advocated for clear rules to protect consumers and investors. The very next day, the SEC notified Kraken of its intention to sue, leading to a legal battle centered on fundamental questions of regulatory authority.
Notably, a similar legal battle exists between SEC and Coinbase, in which Coinbase also alleges that the existing regulations are not enough, and asked the regulatory body for clarification and an extension of policies. The SEC dismissed Coinbase’s petition, stating that the regulations already in place are enough.
The motion by Kraken suggested that the SEC’s lawsuit was retaliation for critical testimony by Kraken’s Marco Santori on May 10, 2023. They were notified the following day.
Kraken wrote in their blog post:
“Crypto innovators in the United States should not have to fear retaliation for their political speech.”
Allegations and Defense
The SEC’s lawsuit alleges that Kraken operated unlawfully by facilitating the buying and selling of digital assets, which it deems securities, without proper registration. Kraken vehemently disputes these allegations, arguing that the SEC’s interpretation of “crypto tokens as investment contracts” lacks substance. The exchange points out that the SEC fails to establish a contractual agreement between buyers and token issuers, a crucial requirement under existing legal precedent.
Kraken also challenges the SEC’s application of the Howey test, a legal standard used to determine if a transaction constitutes an investment contract. The exchange argues that the SEC’s expansive interpretation of the test sets a dangerous precedent for regulatory overreach, as it lacks essential elements such as pooled investments or expectations of profits from a common enterprise.
Kraken states:
“The SEC fails to allege any of these occurred on Kraken’s exchange. The Complaint doesn’t contain any allegation, for example, that any purchaser’s money was pooled or otherwise committed to any enterprise. Nor does it allege any profits were reasonably expected from a common enterprise beyond those created by fluctuations in the market.
Allowing this case to continue sets a dangerous precedent for agency overreach.”
Major Questions Doctrine and SEC’s Petition
Furthermore, Kraken invokes the Major Questions Doctrine, a legal principle aimed at curbing arbitrary agency expansion without clear congressional authorization. The exchange contends that the SEC’s attempts to extend its jurisdiction into the digital asset industry lack a mandate from Congress, raising concerns about regulatory abuse of power.
Kraken’s lawyers argue:
“Such major questions are for Congress to expressly delegate to an executive agency, not for the agency to seize for itself.”
In response to Kraken’s challenge, the SEC maintains that the exchange operated as an unregistered securities entity, depriving investors of essential protections. The SEC alleges that Kraken commingled customer funds with its own, creating significant risks for investors.
Conclusion: Legal Battle Ahead
With both parties digging in their heels, a protracted legal battle lies ahead. Kraken’s motion to dismiss the SEC’s lawsuit is set to be discussed in a federal district court in San Francisco, with the hearing scheduled for June 12, 2024.
It’s worth noting that other digital asset exchanges like Coinbase and Binance are having similar legal clash with the SEC. The outcome of this legal showdown will have far-reaching implications for the regulation of the digital asset industry in the United States. As Kraken and the SEC continue to spar over jurisdiction and compliance, the case underscores the challenges of applying traditional securities laws to the fast-paced world of digital assets.
