Kraken Asks California Court to Dismiss SEC Case over Legal Jurisdiction and Misinterpretation

Attorneys representing the Kraken exchange have replied to the United States Securities and Exchange Commission’s (SEC) April filing, and asked the court to dismiss allegations against the exchange. Filings submitted Thursday in the Northern District of California argue that the SEC’s case stating that Kraken is running an unregistered securities exchange is fundamentally flawed.

Kraken Questions SEC’s Legal Jurisdiction

The exchange’s recent reply accuses the SEC of stretching the case by extending the SEC’s jurisdiction past limits set by the Howey test, used to determine what assets qualify as securities. Essentially, the Howey test sets four criteria: investment of money, in a common enterprise, expectation of profit, and derived from the efforts of others. Kraken’s lawyers stated:

“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. 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 US’s financial regulatory structure should be debated in Congress, not in the courts.”

Kraken’s reply also notes that the SEC is misinterpreting legal concepts, and questions the use of “ecosystem” and “investment concept”, instead of “enterprise” and “investment contract”.

In April, the SEC submitted an opposition to the exchange’s motion to dismiss, arguing that its enforcement action is within its authority as granted by Congress. The Commission argued that Congress created the SEC to “enforce the Securities Act and Exchange Act, including the requirement that securities intermediaries register with the SEC”. Interestingly, the SEC specified that it is not assuming new powers, and does need new bespoke laws for each new technology.

Kraken Enforcement Actions Since Last Year

The agency announced a suit against Kraken in November, accusing Kraken of running an unregistered securities exchange. An SEC press release alleges that Kraken earned several hundred million dollars helping people buy and sell crypto asset securities since at least September 2018. In addition to calling the exchange an unlawful broker, dealer, and clearing agency, the Commission stated that several assets Kraken features are securities. Named cryptocurrencies include Polygon (MATIC), Solana (SOL), OMG Network (OMG), Decentraland (MANA), Algorand (ALGO), Filecoin (FIL), and Near (NEAR).

The SEC also accused Kraken of commingling user funds up to $33 billion. Allegedly, the exchange uses customer funds to pay operational expenses and engages in several other unlawful business activities, including poor internal controls. At the time, Kraken denied the allegations, tackling the SEC for abandoning efforts at regulatory clarity, for continued enforcement action.

The Commission had earlier brought a complaint against the exchange. Last February, Kraken agreed to settle with the Commission for offering unregistered Staking-as-a-Service products to users in the US. The terms include permanently suspending the service and also paying a $30 million fine. At the time, SEC Chair Gary Gensler said any company offering investment contracts in exchange for tokens must provide adequate disclosure and safeguards in accordance with securities laws. Kraken agreed to the settlement without accepting or denying the allegations.