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Kraken has lost its bid to dismiss the U.S. Securities and Exchange Commission’s (SEC) civil complaint accusing the digital asset exchange of selling unregistered securities.
On August 23, Judge William Orrick of the U.S. District Court for the Northern District of California rejected the motion to dismiss the SEC’s charges filed by Kraken’s parent entities Payward Inc. and Payward Ventures Inc. The SEC accused Kraken last November of operating an unregistered securities exchange, broker, dealer, and clearing agency, earning “hundreds of millions of dollars unlawfully facilitating the buying and selling of crypto asset securities.”
Kraken filed its motion to dismiss in February, arguing that the SEC had failed to prove that the exchange’s token sales violated the Howey test used to identify securities under the SEC’s remit. Kraken also alleged that the so-called ‘major questions’ doctrine prevented the SEC from asserting authority over a new financial sector without express authorization from Congress.
In his ruling, Orrick said the SEC “has plausibly alleged that at least some of the cryptocurrency transactions that Kraken facilitates on its network constitute investment contracts, and therefore securities, and are accordingly subject to securities laws.”
Similarly, Orrick rejected Kraken’s ‘major questions’ argument, noting that the few cases in which the U.S. Supreme Court applied this ill-defined doctrine “involved a proposed regulation that would have far greater impact on the economy than what the SEC proposes here.”
Orrick also rejected Kraken’s argument that the SEC was asserting a “transformative expansion in its regulatory authority” or a “highly consequential power beyond what Congress could reasonably be understood to have granted it.” Orrick added that while digital assets are “a relatively novel financial instrument, the principles driving the SEC’s attempt to assert regulatory authority over it are not new.”
Kraken’s motion to dismiss was filed in February, months before the U.S. Supreme Court overturned the so-called Chevron doctrine, which allowed federal agencies to use their discretion when confronted by elements that appear to be within their remit but for which Congress never explicitly granted authority.
Other ‘crypto’ companies involved in similar SEC suits have publicly declared their enthusiasm for exploiting this new Chevron-free reality. Kraken will likely utilize this new line of defense in future efforts to avoid a trip to the regulatory woodshed.
It wasn’t a slam dunk for the SEC, with Orrick noting the agency’s “inconsistent manner” in discussing digital assets. The SEC sometimes alleged that the tokens themselves are securities, to the point of labeling them ‘crypto asset securities,’ leading Orrick to say the SEC “confuses its case.” But Orrick called this “a semantics error that does not obscure the SEC’s theory of liability.”
Nitty gritty
The SEC cited 11 tokens in its complaint, but Orrick chose to focus on two: ALGO (Algorand) and SOL (Solana). Kraken argued that, while these tokens may have been securities in the initial sales by their respective issuers, the secondary sales of these tokens on Kraken didn’t trigger the ‘investment contract’ plank of the Howey test.
Kraken claimed that the SEC failed to prove an ongoing link between Kraken and customers who bought, sold, or traded tokens on its exchange. Kraken also argued that an investment contract requires “post-sale obligations” from issuer to receiver, while the SEC insisted it does not.
But Orrick ruled that “the weight of authority, both recent and well-established, favors the SEC.”
Orrick said Kraken’s arguments ignored previous federal court rulings that “investment contracts are not limited to actual contracts… contractual formalities are not required for something to qualify as an investment contract, and therefore a security. What counts is the totality of the circumstances surrounding a sale, trade, or exchange, and the expectations of the investor. Kraken’s argument would improperly constrain Howey.”
As for Kraken’s belief in a secondary market loophole, Orrick ruled that Howey “applies wherever a court seeks to determine whether a transaction involves an investment contract, regardless of whether that transaction is on a primary or secondary market.”
Orrick called the SEC’s aforementioned labeling of tokens as securities “unclear at best and confusing at worst.” However, “the meat of the SEC’s pleadings” focused on Kraken’s offering of these tokens as investment contracts, which Orrick found to be “an acceptable framing, and one that the SEC has repeatedly advanced in other cases.”
Regarding Howey’s ‘investment of money’ plank, Kraken similarly argued that the initial offering of tokens by their issuers qualified but resales on Kraken didn’t. Orrick called this view “too narrow,” and it “defies common sense to suggest that when someone purchases crypto assets from a reseller or another investor, that person or entity does not understand themselves to be investing money in the asset.”
As for Howey’s investing in a ‘common enterprise’ element, Orrick found that the SEC had “plausibly alleged vertical commonality between the investors using Kraken to purchase crypto assets and the promoters whose job it is to promote those assets and grow their associated networks.” However, Orrick left things open about whether this allegation will hold up when things actually get to trial.
Orrick expressed similar sentiments regarding Howey’s ‘expectation of profits due to the efforts of others’ element. Kraken’s republishing/reassertion of token issuers’ representations on its exchange convinced Orrick that the SEC had plausibly alleged customers’ expectations, although the matter could go the other way at trial.
The next step in this long-running process is a case management conference on October 15, at which a proposed case schedule and trial date will be discussed.
Who ya gonna believe, me or your own eyes?
In a classic display of why no one takes ‘crypto’ seriously, Kraken’s Chief Legal Officer Marco Santori furiously spun this legal setback by tweeting that Orrick had “ruled, as matter of law, that none of the tokens trading on Kraken are securities.” Santori called the ruling “a significant win for Kraken” that confirmed the exchange’s long-held opinion that “it does not list securities.”
In truth, Orrick noted that “orange groves are no more securities than cryptocurrency tokens are. But the contracts and expectations surrounding the sale of both may form an investment contract, bringing them within the purview of” U.S. securities law.
Another view was offered by John Reed Stark, former SEC enforcement director, who tweeted that “the defense spent tens of millions in legal fees to litigate their failed position.” Stark twisted the knife, saying utility-free ‘crypto’ was “nothing more than mathematical computational blather custom designed for speculation and manufactured exclusively for crime, terrorism and predatory inclusion.”
The SEC issued a statement saying Orrick’s ruling confirmed that “the framework used to identify securities for nearly 80 years still applies, regardless of the labels used. Investors in crypto assets offered or sold as securities should get the same protections as investors in other securities, even when they are traded using intermediaries.”
In February 2023, Kraken settled with the SEC over a different matter, agreeing to pay a $30 million penalty and permanently give up its U.S. token-staking business. That may have hurt Kraken’s public image as tough-talking, authority-defying he-man woman-haters, convincing them to offer an actual defense the next time the SEC came calling.
Down under defeat
August 23 just wasn’t Kraken’s day, as an Australian federal court upheld charges filed against Kraken’s local subsidiary by the country’s securities regulator. The Australian Securities and Investments Commission (ASIC) sued Bit Trade in September 2023 for offering its margin trading product to retail customers who weren’t sufficiently savvy to understand the potential ramifications.
ASIC alleged that at least 1,160 Aussie customers used Bit Trade’s margin trading product between January 2020 and October 2021, leading to combined losses of nearly AU$13 million. The country’s Corporations Act requires financial product issuers to make a “target market determination” to ascertain whether retail customers fully understand the hot mess they may be involved in.
The ruling gave the two parties a week in which to negotiate appropriate declarations and injunctions. ASIC has indicated it will seek financial penalties against Bit Trade.
In a media release, ASIC Deputy Chair Sarah Court said the agency “initiated proceedings to send a message to the crypto industry that we will continue to scrutinise products to ensure they comply with regulatory obligations in order to protect consumers.”
Kraken expressed “disappointment” with the ruling, claiming that Australia’s crypto rules weren’t clear and that the exchange continues to advocate for “legal clarity.” You know, just not the kind of clarity that results in Kraken having to forego revenue.
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