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

On 20 November 2023, the U.S. Securities and Exchange Commission (SEC) announced that it had formally charged Payward Inc. and Payward Ventures Inc., collectively known as Kraken, for operating their cryptocurrency trading platform without proper registration. The SEC’s complaint, filed in San Francisco’s federal district court, asserts that since at least September 2018, Kraken has been unlawfully facilitating the buying and selling of crypto asset securities, earning hundreds of millions of dollars in the process.

Allegations of Unregistered Operations

The SEC accuses Kraken of combining the traditional services of an exchange, broker, dealer, and clearing agency without registering these functions as mandated by law. This alleged failure has reportedly deprived investors of critical protections, such as SEC inspections, recordkeeping requirements, and safeguards against conflicts of interest.

Specific Charges Against Kraken

The SEC’s complaint details several ways in which Kraken purportedly operates unlawfully:

  1. As an Exchange: Kraken is said to provide a marketplace that matches orders for securities from multiple buyers and sellers, functioning as an exchange.
  2. As a Broker: The platform allegedly engages in effecting securities transactions for Kraken customers’ accounts.
  3. As a Dealer: Kraken is accused of buying and selling securities for its own account, operating as a dealer.
  4. As a Clearing Agency: The company reportedly acts as an intermediary in settling transactions in crypto asset securities and operates as a clearing agency.

Concerns Over Business Practices and Internal Controls

The SEC’s complaint also highlights concerns about Kraken’s business practices, internal controls, and recordkeeping. It alleges that Kraken commingles customer funds with its own, including using customer accounts to pay operational expenses. This practice, along with the commingling of customers’ crypto assets with Kraken’s own, is cited as posing a significant risk of loss to customers.

SEC’s Enforcement Director’s Statement

Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, criticized Kraken’s decision to prioritize profits over investor protection, leading to a business model fraught with conflicts of interest and risks to investors’ funds. He emphasized the SEC’s commitment to holding Kraken accountable and sending a message to other entities to comply with securities laws.

Previous Settlement and Ongoing Litigation

In February 2023, Kraken agreed to cease offering or selling securities through crypto asset staking services or staking programs and to pay a civil penalty of $30 million.

The SEC seeks injunctive relief, conduct-based injunctions, disgorgement of ill-gotten gains plus interest, and penalties in the current litigation.

The investigation was conducted by members of the SEC’s Division of Enforcement’s Crypto Assets and Cyber Unit and the Boston Regional Office, with the litigation led by a team of SEC attorneys.

Kraken’s Response to SEC Allegations: Upholding Compliance and Client Services

In response to the SEC’s charges of operating as an unregistered securities exchange, broker, and clearing house, Kraken has expressed strong disagreement and a commitment to vigorously defend its position in court. Kraken emphasizes that these allegations have no impact on its current operations or services to clients, ensuring continuity and reliability.

Kraken’s blog post clarifies that the SEC’s complaint does not allege any fraudulent activities, market manipulation, customer losses due to security breaches, or mismanagement of funds. The company stresses that there are no issues of missing or misused funds, Ponzi schemes, or failure in maintaining adequate reserves or client fund identities.

Challenging the SEC’s legal standpoint, Kraken argues that the digital assets it deals with are not “investment contracts” and thus do not require special securities licenses. The company references a previous court ruling that rejected the SEC’s similar legal theory, emphasizing the need for a realistic approach to such transactions.

Addressing the allegation of commingling funds, Kraken explains that this refers to the use of fees already earned, with no customer funds being reported as missing or at risk. The company criticizes the SEC’s regulatory approach as demanding compliance with a non-existent framework for digital asset transactions.

Kraken advocates for legislative action over agency enforcement for creating laws for crypto trading platforms. The company highlights its compliance with international regulations and its advocacy for effective digital asset rules. Kraken reaffirms its commitment to its mission of promoting cryptocurrency adoption, financial freedom, and inclusion, maintaining its dedication to clients and the cryptocurrency community.

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