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SEC vs Kraken: Judge “Inclined to Deny” Motion to Dismiss Case

Last Updated June 21, 2024 12:46 PM
Teuta Franjkovic
Last Updated June 21, 2024 12:46 PM

Key Takeaways

  • In a hearing regarding the SEC’s lawsuit against Kraken, the judge indicated he is likely to deny Kraken’s motion to dismiss the lawsuit.
  • Kraken’s lawyer argued for equal regulatory treatment in crypto.
  • The judge rejected Kraken’s regulatory overreach argument in the SEC case.

A district judge expressed skepticism about crypto exchange Kraken’s attempt to dismiss the claims filed against it by the US Securities and Exchange Commission (SEC).

Judge William H. Orrick of the US District Court for the Northern District of California indicated  that he is likely to deny Kraken’s motion to dismiss the lawsuit. He suggested that the crypto assets in question may plausibly be considered investment contracts.

Judge Signals Kraken Could Lose SEC Lawsuit over Unregistered Trading

In November, the SEC sued Kraken’s parent companies, Payward and Payward Ventures, for allegedly operating an unregistered online trading platform. Kraken moved to dismiss the lawsuit in February. Prior to this, in February 2023, Kraken settled with the SEC by agreeing to pay $30 million and ceasing to offer staking services or programs to US clients. Since then, eight US state attorneys have filed an amicus brief, arguing that the SEC’s lawsuit exceeded the agency’s authority. Kraken has also filed multiple documents, contending that the SEC has failed to meet the criteria of the Howey Test.

Based on a 1946 U.S. Supreme Court case, the Howey Test is frequently cited by the SEC to determine if an asset qualifies as an investment contract and, therefore, a security. The SEC has countered Kraken’s arguments, asserting that the exchange is attempting to evade investor protections mandated by securities laws. The SEC also contends that a written agreement is not necessary for an investment contract to exist.

At a June 20 hearing  in the US District Court for the Northern District of California, Payward, the company operating as Kraken, had its lawyer Matthew Solomon meet with SEC counsel Peter Moores before Judge Orrick. They discussed a motion to dismiss filed by Kraken in February. The judge indicated he was inclined to deny the motion, suggesting it was plausible that digital assets on the exchange were offered and sold as investment contracts. He remarked that Kraken has its “work cut out” for them.

Kraken Lawyer Cites Ripple Ruling in SEC Lawsuit, Disputes SEC’s ‘Ecosystem’ Argument

During arguments before the judge, Solomon highlighted significant differences in litigated cases between the SEC and Terraform Labs and Telegram. He also referenced Judge Analisa Torres’ decision in the SEC’s case against Ripple Labs, where the XRP token was ruled a security when sold to institutional investors. However, Solomon suggested that the case most comparable to Kraken’s was Coinbase’s.

Solomon asserted :

“I think conjuring up the notion of an ecosystem just for crypto — that’s not the way rules oughta be applied. Crypto deserves no better than anybody else, but they oughta have the rules applied equally to them as they’ve applied to everyone else. The SEC doesn’t just have to show that there is a security under Howie, they’ve gotta show that that security was brokered, traded, or cleared on Kraken. That is impossible the way they’ve constructed their argument.”

The SEC argued that Kraken functioned as an “ecosystem” where tokens were sold as investment contracts, or “concepts,” making them securities under the Howey test. Kraken’s legal team countered these legal theories.

Although Ether was not explicitly mentioned in the SEC v. Kraken case, it has been a focal point for several crypto firms challenging the regulator in court. Reports from March indicated that the SEC was considering labeling ETH as a security and potentially bringing enforcement actions against firms dealing with the token.

Kraken Lawyer Criticizes Coinbase Decision, SEC Lawyer Defends It

Comparisons to Coinbase were frequently mentioned during Thursday’s proceedings. In the SEC’s case against Coinbase, Judge Katherine Polk Failla decided not to dismiss the agency’s case. In March, Judge Failla stated that the SEC had “plausibly” alleged that some crypto transactions on Coinbase’s platform constituted investment contracts.

Solomon mentioned :

“Naturally this court will look to that case and its reasoning in trying to determine whether you should follow the reasoning of Judge Failla in that case. We don’t think you should.”

Solomon furthermore argued that the Coinbase decision was not correctly decided. He noted that the court introduced the concept of an ecosystem, which Kraken interpreted to include issuers, the blockchain, promoters, and others, but not buyers and sellers. Solomon criticized the creation of this ecosystem notion specifically for crypto, asserting that rules should be applied equally to crypto as they are to other sectors. He believed that in the Coinbase decision, the rules were being stretched to the breaking point.

Meanwhile, SEC lawyer Peter Moores argued that the Coinbase decision was correctly decided. He explained that the Howey Test encompasses more than just an investment contract, countering Kraken’s argument that a written contract is necessary for an asset to be considered a security.

Moores emphasized that the Howey Test focuses on the substance of the matter, not just the form. He stated that looking only at the form is like examining the skeleton without considering the flesh that gives life to the investment opportunity.

Judge Rejects Kraken’s Major Questions Doctrine Argument in SEC Case

Kraken’s lawyers previously invoked the major questions doctrine in their filings, asking the judge to dismiss the case. This doctrine, frequently cited by crypto firms, argues that if an agency wants to make decisions on issues of major national significance, it must have clear congressional authorization. The SEC contended that it is not assuming new powers.

Judge Orrick disagreed, stating  that this is not a major question and does not represent a significant expansion of regulatory authority. He later reaffirmed his stance on the major questions doctrine, indicating he would not change his mind.

Toward the end of the hearing, Judge Orrick instructed Kraken  and the SEC to provide disclosures, and he estimated that discovery would take about a year.

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