Title: SEC Charges Kraken for Operating as an Unregistered Securities Exchange, Broker, Dealer, and Clearing Agency

Compiled by: Wu Says Editorial Team

The U.S. Securities and Exchange Commission (SEC) has charged Payward Inc. and Payward Ventures Inc. (collectively known as Kraken) for operating its cryptocurrency trading platform as an unregistered securities exchange, broker, dealer, and clearing agency.

According to the SEC's complaint, since September 2018, Kraken has earned hundreds of millions of dollars by illegally facilitating the buying and selling of crypto asset securities. The SEC alleges that Kraken intertwined the services of traditional exchanges, brokers, dealers, and clearing agencies without registering these functions with the Commission as required by law. Kraken's failure to register these functions deprived investors of important protections, including SEC oversight, record-keeping requirements, and conflict-of-interest prevention.

It is alleged that through its platform services, Kraken provided the following functions:

• Offered a market that aggregates multiple buyers' and sellers' securities orders through established non-discretionary methods, thereby operating as an exchange;
• Engaged in the business of executing securities transactions for Kraken customer accounts, thereby operating as a broker;
• Engaged in the business of buying and selling securities for its own account, without applicable exemptions, thereby operating as a dealer;
• Acted as an intermediary for processing crypto asset securities transactions for Kraken customers and as a securities storage institution, thereby operating as a clearing agency.

The SEC's complaint also alleges that Kraken's business practices, inadequate internal controls, and poor record-keeping practices posed a range of risks to its customers. According to the complaint, Kraken mixed customer funds with its own, including directly paying operating expenses from accounts holding customer cash. Kraken is also alleged to have mixed customers' crypto assets with its own, which its own auditors believed "posed a significant risk of loss to customers."

"We allege that Kraken chose to illegally earn hundreds of millions of dollars from investors rather than comply with securities laws. This decision led to a business model rife with conflicts of interest, putting investors' funds at risk," said Gurbir S. Grewal, Director of the SEC's Enforcement Division. "Kraken's choice of illegal profits over investor protection is something we often see in this space, and today we hold Kraken accountable for its misconduct while sending a message to others to comply with the rules."

The SEC's complaint, filed in the U.S. District Court for the Northern District of California, claims that Kraken violated registration provisions of the Securities Exchange Act of 1934 and seeks injunctive relief, a conduct-based injunction, the return of ill-gotten gains and interest, and civil penalties.

In February of this year, Kraken agreed to cease offering or selling securities through its crypto asset staking service or staking program and to pay a $30 million civil penalty.

The SEC's investigation was conducted by Elizabeth Good and Jenny B. Krasna of the Enforcement Division's Crypto Assets and Cyber Unit, with assistance from Peter M. Moore of the Boston Regional Office, and was supervised by Sachin Varma and Pasha Salimi. The litigation will be led by Alex Johnson, Daniel Blau, and Moore, under the supervision of Douglas Miller, Olivia Choi, and Tenreiro.

Kraken's Response

Response link:

https://blog.kraken.com/news/kraken-continues-to-fight-for-its-mission-and-crypto-innovation-in-the-united-states?utmsource=Social\&utmmedium=Twitter\&utm_campaign=Blog

The SEC has filed a lawsuit against Kraken, alleging it operates as an unregistered securities exchange, broker, and clearing agency. We dispute this and intend to vigorously defend our position in court. Today's news will not affect the products we offer, and we will continue to serve our customers without interruption. Our commitment to our customers and partners in the U.S. and globally remains steadfast.

The complaint against Kraken does not allege fraud, market manipulation, or losses to customers due to hacking or security vulnerabilities, nor does it allege a breach of fiduciary duty. While large sums are mentioned, there are no allegations that any of those funds were lost or misused - no Ponzi scheme, no failure to maintain adequate reserves, and no failure to keep customer funds on a 1:1 basis. In fact, none of these situations are true.

Instead, the complaint raises a technical argument: that Kraken's business requires special securities licenses to operate because the crypto assets we support are, in fact, "investment contracts." This is legally incorrect, factually wrong, and disastrous in policy terms.

We Disagree with the SEC, and the Law is on Our Side

The SEC has previously attempted this theory, but it was directly rejected by the courts. In that case, the SEC argued that the crypto assets traded on the platform were, in fact, securities transactions. However, the U.S. District Court for the Southern District of New York disagreed, ruling that the SEC had completely failed to meet the relevant legal tests. The court found that the SEC's unprecedented legal theory contradicted the "economic realities" of these transactions. For the same reasons, the SEC's case against Kraken will also fail.

The SEC alleges that Kraken "mixed" its own funds with customer funds. This is a similar allegation made against other cryptocurrency trading platforms. The SEC has not and cannot allege that any customer funds were lost or that any losses occurred, nor has it alleged that any losses will occur. The complaint itself acknowledges that the so-called "mixing" is merely Kraken spending fees that have already been earned.

The SEC has a well-known view that cryptocurrency trading platforms like Kraken simply need to "come register." As most securities law experts know, there is currently no law supporting this position. The SEC has not established any rules describing how crypto asset orders should be matched, has provided no guidance on how trades should be cleared, and has not proposed standards for how crypto asset trading should be conducted. This allegation is hollow; there are no exchanges, broker-dealers, or clearing agencies for investment contracts. The SEC is demanding compliance with a non-existent regime.

Congress is Advancing Bipartisan Legislation

Meanwhile, bipartisan groups of lawmakers are questioning the SEC's so-called "regulation by enforcement" approach. They are asking why the agency's actions against crypto companies seem to focus less on "compliance and customer protection" and more on "maximized publicity and political impact." Others have noted that the SEC's strategy "does not protect the public." In fact, this lawsuit does nothing to protect the public. Like previous complaints, its allegations are factually incorrect, violate the law, and represent a misguided approach to policymaking in the U.S.

Congress is advancing bipartisan bills in both the House and Senate aimed at establishing a clear registration and regulatory framework for centralized trading platforms. Congressional action, passed by elected lawmakers rather than agency enforcement, is the right way to create new laws for U.S. centralized cryptocurrency trading platforms. As we continue to expand our global business and diversify our product offerings, Kraken's commitment to the U.S. market remains unwavering. We will continue to defend our spot market business in the U.S., our customers, and the community of cryptocurrency innovators.

While some critics may argue that cryptocurrency trading platforms do not want to be regulated at all, that is not our position. In fact, Kraken has been operating for over a decade, with registrations, licenses, authorizations, and approvals in multiple countries and regions around the world, including the U.S., U.K., EU, and Canada, both in developed and emerging markets. We have consistently advocated for practical and effective crypto asset regulations. Our testimony to Congress in May emphasized Kraken's commitment to strong, coordinated consumer protection and anti-money laundering practices in the U.S.

Since the company's founding in 2011, we have worked tirelessly to ensure that U.S. consumers can safely access crypto asset technologies aimed at creating a fairer and more inclusive financial system. Comprehensive congressional action is the right way forward to prevent the U.S. from falling behind as crypto and Web3 advance globally through litigation.