Kraken Challenges SEC Claims, Warns of Potential Upheaval in US Financial Regulation

May 13, 2024

Cryptocurrency exchange Kraken, in a bold legal maneuver, has formally contested the Securities and Exchange Commission’s (SEC) allegations, seeking dismissal to avert what it terms a looming “upheaval” in the framework of U.S. financial regulation. This strategic challenge not only underscores Kraken’s determination to defend its position but also raises significant questions about the future trajectory of cryptocurrency oversight in the United States, signaling a potential watershed moment in the evolving relationship between regulatory authorities and the growing crypto industry.

In the latest legal development on the case filed by the SEC against Kraken, the crypto exchange’s legal team mounted a robust defense against the financial watchdog, contending that its assertions lacked substance. With both parties poised for a crucial hearing scheduled for June, Kraken’s lawyers asserted in a court filing submitted last Thursday that the regulator had failed to provide evidence of any investment contracts traded, brokered, or settled on the exchange. 

Moreover, Kraken challenged the SEC’s application of the Howey Test, a cornerstone of securities law established by a 1946 U.S. Supreme Court case, arguing that the agency had not met the criteria to classify assets as investment contracts and, consequently, securities. “The SEC cannot satisfy Howey’s additional requirements that there be investments of money in a common enterprise with a reasonable expectation of profits based on the efforts of others,” the crypto exchange’s lawyers argued.

“This would gut Howey by significantly expanding the SEC’s jurisdiction to a host of investment activities that were never delegated to the agency. Such a significant reordering of the U.S.’s financial regulatory structure should be debated in Congress, not in the courts,” Kraken’s lawyers added.

Kraken’s chief legal officer, Marco Santori, responded to Kraken’s legal action against the SEC, noting that the regulator failed to specify the exact investment contract allegedly traded on Kraken. Instead, it relied on vague notions of “investment-like expectations” and “investment concepts,” asserting they suffice. Furthermore, rather than identifying a common enterprise, as mandated by law, it referenced an “ecosystem” as adequate. Kraken’s legal team criticized this approach as lacking concrete evidence.

“The SEC had its opportunity to tell the Court what, precisely, is the investment contract that supposedly trades on Kraken. But they couldn’t. Instead of identifying a contract, the SEC argued there are investment-like ‘expectations’ and ‘investment concepts’ in the air and those should be good enough. Instead of identifying a common enterprise (required by the law), it said there is an ‘ecosystem’ and that should be good enough,” Santori said.

In response to the SEC’s arguments, the Kraken CLO expressed disappointment with the agency’s use of a straw man fallacy. He emphasized the need for Congress to establish a regulatory framework that doesn’t rely on sophistry reasoning for enforcement. He noted, “Sad to see a federal agency deploy a straw man fallacy so brazenly. All the more reason for Congress to put in place a regulatory framework that doesn’t require sophistry to enforce.”

The SEC initiated a lawsuit against Kraken in November of last year, alleging failure to register as a broker, clearinghouse, or exchange. This legal action followed a settlement reached several months earlier concerning Kraken’s former staking service. In February 2024, Kraken took steps to dismiss the SEC’s lawsuit. The company contended that the cryptocurrencies cited in the SEC’s complaint, at least, should be classified as commodities rather than securities

In April, the SEC submitted a 39-page opposition to Kraken’s motion to dismiss, asserting that it is simply not the case that this enforcement action exceeds the authority Congress granted the SEC. A hearing to address Kraken’s motion to dismiss the SEC’s lawsuit is scheduled for June 12 at 2 p.m. 

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