SEC sues Kraken but momentum is on the side of crypto as Ripple’s XRP comes out clean

Rick Steves

“We allege that Kraken made a business decision to reap hundreds of millions of dollars from investors rather than coming into compliance with the securities laws. That decision resulted in a business model rife with conflicts of interest that placed investors’ funds at risk. Kraken’s choice of unlawful profits over investor protection is one we see far too often in this space, and today we’re both holding Kraken accountable for its misconduct and sending a message to others to come into compliance.”

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

This charge stems from activities dating back to at least September 2018. The SEC’s complaint alleges that Kraken has been unlawfully facilitating the buying and selling of crypto asset securities, generating hundreds of millions of dollars in the process​​​​.

Kraken’s response to the SEC’s complaint asserts their disagreement with the allegations and their intention to vigorously defend their position in court as did Ripple Labs since December 2020 with much success.

SEC claims Kraken commingles customer funds with its own

Kraken’s operations have reportedly combined the traditional services of an exchange, broker, dealer, and clearing agency without the requisite registration with the SEC. This alleged failure to register has deprived investors of critical protections, including SEC inspections, recordkeeping requirements, and safeguards against conflicts of interest. The SEC’s complaint highlights several specific functions of Kraken’s platform, including:

Operating as an Exchange: Kraken is said to provide a marketplace that unites orders for securities from multiple buyers and sellers, using established, non-discretionary methods under which these orders interact.
Operating as a Broker: It is alleged to engage in effecting securities transactions for Kraken customers’ accounts.
Operating as a Dealer: Kraken purportedly buys and sells securities for its own account, without an applicable exception.
Operating as a Clearing Agency: It reportedly serves as an intermediary in settling transactions in crypto asset securities by Kraken customers and acts as a securities depository​​​​.

The SEC also points out several risks associated with Kraken’s business practices, including deficient internal controls and poor recordkeeping. Kraken allegedly commingles its customers’ money and crypto assets with its own, which, as per the complaint, poses a significant risk of loss to its customers.

According to Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, Kraken prioritized unlawful profits over investor protection, leading to a business model with conflicts of interest that put investors’ funds at risk​​​​. “We allege that Kraken made a business decision to reap hundreds of millions of dollars from investors rather than coming into compliance with the securities laws. That decision resulted in a business model rife with conflicts of interest that placed investors’ funds at risk. Kraken’s choice of unlawful profits over investor protection is one we see far too often in this space, and today we’re both holding Kraken accountable for its misconduct and sending a message to others to come into compliance.”

The SEC’s complaint, filed in a federal district court in San Francisco, asserts that Kraken violated the registration provisions of the Securities Exchange Act of 1934. The Commission seeks injunctive relief, conduct-based injunctions, disgorgement of ill-gotten gains with interest, and penalties. Earlier in the year, Kraken agreed to stop offering or selling securities through crypto asset staking services or programs and paid a civil penalty of $30 million​​.

Kraken not afraid of the SEC. Business as usual

Kraken has addressed its clients and global audience with a defiant response: “Today’s news has no impact on the products we offer and we will continue to provide services to our clients without interruption. We remain fully committed to our U.S. and global clients and partners.

The crypto exchange points out that the SEC’s complaint does not allege fraud, market manipulation, customer losses due to hacking, compromised security, or breaches of fiduciary duty.

They argue that the SEC’s claim that Kraken’s digital assets are “investment contracts” requiring special securities licenses is incorrect legally, factually, and problematic in terms of policy. Kraken also refutes the SEC’s commingling allegation, stating that it only involves the use of fees already earned. Kraken criticizes the SEC’s approach towards digital asset trading platforms, highlighting the lack of clear regulatory guidelines or legal provisions for operating as a securities exchange, broker-dealer, or clearing agency in the context of digital assets.

“The SEC already tried this theory and a court rejected it outright. The SEC argued in that case that digital assets bought and sold on trading platforms were really securities transactions. The Federal Court for the Southern District of New York disagreed, ruling that the SEC failed entirely to satisfy the relevant legal test. The court held that the SEC’s unprecedented legal theory was contrary to the “economic reality” of such transactions. The SEC’s case against Kraken will fail, too, and for the same reasons.”

“The SEC alleges that Kraken “commingled” its own funds with its clients’. This is a similar allegation already made of other crypto trading platforms. The SEC cannot and does not allege that any customer funds are missing, or any loss has occurred. Nor does it allege that any loss will occur. The complaint itself concedes that this so-called “commingling” is no more than Kraken spending fees it has already earned.

“The SEC famously argues that digital asset trading platforms like Kraken can simply “come in and register” with the agency. As most securities law experts know, there is not a single law on the books supporting this position. The SEC has promulgated no rule describing how an order in a digital asset should be matched, no guidance on how a trade should be cleared, and articulated no standards for how to broker a digital asset transaction. The allegation is hollow; there is no such thing as an exchange, broker dealer, or clearing agency for investment contracts. The SEC is demanding compliance with a regime that doesn’t exist.”

SEC v. Ripple on the final leg

The SEC v. Ripple lawsuit is approaching the end. The United States District Court for the Southern District of New York has scheduled the completion of the remedies-related discovery by February 12, 2024.

By March 13, the SEC is expected to file its brief with respect to remedies, and Ripple Labs will do the same by April 12, with a possible plaintiff reply by April 29, thus ending the final briefs.

According to Jeremy Hogan, an attorney close to the XRP community, such scheduling of the final briefs, by April, would suggest that the final judegment will take place in July. Hogan also praised the “TOP lawyers” hired by Ripple Labs for having whittled the case down to only 20% of what it used to be, including forcing the SEC to drop its claims against Ripple chief executive Brad Garlinghouse and co-founder Chris Larsen.

“How much of it will be left in July??”, he rhetorically asked, suggesting that Ripple’s defense may successfully reduce the SEC’s claims even further.

The general feeling among the XRP community and Ripple executives is that the blockchain company is winning big. Earlier this month, Ripple’s CLO Stuart Alderoty hailed another loss for the SEC. “The 2d Circuit in SEC v Govil held that the SEC can’t ask for a crippling disgorgement award w/o first proving that “investors” suffered actual financial harm. In other words, no harm, no foul.”

On that, attorney John Deaton, representing the XRP Holders in the SEC v. Ripple case, reiterated that instead of a draw, Ripple is the clear winner of the lawsuit. “If Ripple ends up paying $20M or less it’s a 99.9% legal victory.”

In the meantime, Ripple Labs continues to expand its footprint across the globe as the financial industry increasingly adopts blockchain solutions to replace legacy systems.

Dubai regulator approves of Ripple’s XRP utility

A notable milestone for Ripple and the broader crypto space was Dubai’s DFSA approval of the use of XRP within the Dubai International Financial Centre (DIFC). This approval positions XRP alongside other previously approved digital assets like BTC, ETH, and LTC under the DFSA’s virtual assets regime.

The endorsement of XRP marks it as the first virtual asset to gain such approval since the DFSA began accepting external applications. This move by the DFSA is set to enhance the legal and regulatory framework for XRP within the DIFC, allowing institutions to utilize XRP for more efficient global value exchanges.

The United Arab Emirates (UAE) has rapidly established itself as a jurisdiction focused on providing regulatory clarity for the burgeoning virtual asset services sector. The DFSA’s regime demonstrates a commitment to fostering a crypto, payments, and fintech ecosystem that is conducive to long-term development and innovation. This is further supported by Dubai’s Virtual Assets Regulatory Authority (VARA), which was established to ensure investor protection and promote high standards of risk assurance while facilitating technological advancement.

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