The real story of the SEC’s suit against Kraken, and why Kraken is moving to dismiss the case

On the morning of May 10, 2023, Kraken testified about the SEC’s overreach in crypto before both the House Financial Services Committee and the House Agriculture Committee.

Kraken testified that current laws do not adequately cover the digital asset industry, and that Congress could do more to put in place a set of rules to better protect consumers and investors.

Kraken testified that in any new set of crypto exchange rules, Congress should limit the SEC’s jurisdiction in favor of other agencies. The next day, the SEC called Kraken to say it was going to sue.

Crypto innovators in the United States should not have to fear retaliation for their political speech. They should be free to earnestly advocate for better law and more efficient markets. They should be free from intimidation by a politically compromised agency.

Similarly, U.S. crypto users should enjoy a full suite of consumer protections crafted by their elected representatives in Congress. They should be the focus of carefully tailored rules that take into account both the risks and risk mitigators unique to digital asset systems. They should not be pawns in agency power struggles.

Today, we filed a motion asking the Court to dismiss the SEC’s lawsuit against Kraken. The SEC’s Complaint did not claim any fraud or consumer harm whatsoever. It made only a registration-based argument that Kraken operates as an unlicensed securities exchange, broker, dealer and clearing agency because crypto tokens are so-called “investment contracts.”  Even taking all of the SEC’s allegations in the Complaint as true – and many are not – its argument is flawed as a matter of law.

The SEC never points to any “contract” between buyers on Kraken and token issuers, so there can’t be an “investment contract”

None of the assets in the SEC’s Complaint are investment contracts under the law.

For eight decades, the U.S. Supreme Court and Ninth Circuit (where this case was filed) have always required that the SEC identify a contract when finding the existence of an investment contract.

The SEC doesn’t do this in its case against Kraken. Instead, it asks the Court to endorse a new theory: Anything that may increase in value in an “ecosystem” can be an investment contract.  

With no precedent to defend this self-serving attempt at expanding its jurisdiction, the SEC instead relies on ambiguity and contradiction.

For example, in its Complaint, the SEC uses a new term of its own creation, the “digital asset security.” It argues that digital assets are themselves securities, but then concedes that digital assets are just computer code, not contracts.

Also, the SEC says Bitcoin and Ethereum are not securities, even though the SEC’s concocted “ecosystem” theories would apply to those assets just the same as those at issue in the Complaint. Finally, the SEC’s Chair told Congress the SEC did not have the authority to regulate crypto exchanges, but now in this litigation, it claims it does. We ask the Court to dismiss the SEC’s Complaint on these grounds.

Digital assets don’t meet the Howey requirements

We also ask the Court to dismiss the Complaint because, in addition to there being no contract, there was no investment contract. In the Supreme Court’s now famous Howey decision, an investment contract requires an 1) investment of money 2) in a common enterprise 3) from which the investor reasonably expects profits from the efforts of others.

The SEC fails to allege any of these occurred on Kraken’s exchange. The Complaint doesn’t contain any allegation, for example, that any purchaser’s money was pooled or otherwise committed to any enterprise. Nor does it allege any profits were reasonably expected from a common enterprise beyond those created by fluctuations in the market.

Allowing this case to continue sets a dangerous precedent for agency overreach

The SEC’s theory is that there can be an investment contract with no contract, no post-sale obligations and no interaction at all between the issuer and the purchaser. No pooling, no common enterprise, no profits from a business.

Howey has never been applied in this way, and for good reason: The theory has no limiting principle. It would grant to the SEC boundless authority over commerce and potentially open up the floodgates to private securities law claims. It would turn a broad range of ordinary assets or commodities, like sports memorabilia, trading cards, expensive watches, or even diamonds, into securities.

The SEC didn’t even claim this authority over the U.S. economy until the past year, to support its lawsuits against the crypto industry. Only now, 90 years after the Securities Exchange Act of 1934, did the SEC discover that it has near boundless discretion in finding “securities” even where contrary to decades of case law. 

The SEC should not be permitted to expand its own jurisdiction; that is Congress’ decision

The SEC’s attempted jurisdictional grab over the trillion-dollar digital asset industry – with potential application to all corners of the commercial marketplace and the broader commodities markets – is also grounds for dismissal under the Major Questions Doctrine.

It raises serious questions about abuse of power. This doctrine is designed to prevent agencies from “discovering” broad regulatory power without a clear delegation from Congress – which is exactly what the SEC is doing here. 

Kraken supports building coherent rules for this industry. Everyone – issuers, buyers and exchanges like Kraken – would benefit from having clear guidelines. Kraken advocates relentlessly for this.

But the SEC is moving in the wrong direction. Its theories in litigation are incoherent. We remain committed to doing what we believe is right for our community of clients and innovators. Our mission – accelerating the adoption of cryptocurrency so that everyone can achieve financial freedom and inclusion – remains central to everything we do. 

So today, we are asking the Court to dismiss this case and hand legislative power back to Congress, where it belongs.

These materials are for general information purposes only and are not investment advice or a recommendation or solicitation to buy, sell, stake or hold any crypto asset or to engage in any specific trading strategy. Kraken does not and will not work to increase or decrease the price of any particular crypto asset it makes available. Some crypto products and markets are unregulated, and you may not be protected by government compensation and/or regulatory protection schemes. The unpredictable nature of the crypto asset markets can lead to loss of funds. Tax may be payable on any return and/or on any increase in the value of your crypto assets and you should seek independent advice on your taxation position. Geographic restrictions may apply.

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