In a lawsuit filed on Monday, the Securities and Exchange Commission alleges that Kraken, currently the third-largest crypto exchange by spot-market trading volume, failed to register its services with the agency in violation of U.S. securities law.
The lawsuit comes less than a year after the SEC settled with Kraken over its crypto-staking business, with the exchange agreeing to pay a $30 million fine and end the service in the U.S. The initial complaint drew industry pushback, with Coinbase CEO and cofounder Brian Armstrong tweeting that “regulation by enforcement” doesn’t work.
“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,” Gurbir S. Grewal, director of the SEC’s Division of Enforcement, said in a statement. “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.”
“We disagree with the SEC’s complaint against Kraken, stand firm in our view that we do not list securities and plan to vigorously defend our position,” said a Kraken spokesperson in a statement shared with Fortune. “It is disappointing to see the SEC continue down its path of regulation by enforcement, which harms American consumers, stunts innovation and damages U.S. competitiveness globally.”
‘Rife with conflicts of interests’
Mirroring the lawsuits filed earlier this year against the crypto exchanges Coinbase and Binance, the SEC alleges Kraken operated in the same manner as a traditional financial firm—as a securities exchange, broker, dealer, and clearing agency—but without registering with the agency.
Similar to the other complaints, the SEC claims a number of cryptocurrencies are securities and therefore under its jurisdiction, including Solana, the Polygon blockchain’s MATIC, and the Cardano blockchain’s ADA.
The SEC further alleges that Kraken commingled customers’ money with its own. In the complaint, the agency cites a report from an independent auditor hired by the exchange who found “a significant risk of loss” for Kraken’s customers. The SEC also cites Kraken’s own terms of service, which states that Payward—its parent company—makes “no warranty” that customers’ crypto assets “are held by [the customer] free and clear of any security interest or other lien or encumbrance by Payward or others.”
The commingling of customer assets is a serious allegation given the practices of former Kraken competitor FTX, which collapsed last November. As laid out in a criminal case against FTX founder Sam Bankman-Fried by the Department of Justice, FTX commingled customer assets with its trading firm, Alameda Research, using the funds for its own purposes.
In its complaint against Kraken, the SEC does not allege that the firm misallocated customer assets, but not complying with securities law “resulted in a business model rife with conflicts of interest that placed investors’ funds at risk,” Grewal said.
