SEC’s Case Against Kraken Will Proceed to Trial, California Judge Rules

As a seasoned researcher with a keen interest in the intersection of finance, technology, and law, I have been closely following the ongoing legal battles between cryptocurrency exchanges and regulatory bodies like the SEC. The recent ruling by Judge William H. Orrick in favor of the SEC’s lawsuit against Kraken is yet another significant milestone in this evolving landscape.

A California judge decided on Friday that the court case filed by the U.S. Securities and Exchange Commission (SEC) against Kraken will move forward to a trial.

Back in November, the SEC filed a lawsuit against Kraken in the Northern District of California. They claimed that Kraken, being a cryptocurrency exchange, had broken federal securities laws by failing to register with them as a broker, clearinghouse, or trading platform. The lawsuit demanded that Kraken should be barred permanently from engaging in any more violations related to securities and also required the return of any unjust profits (il-gotten gains) along with other financial penalties.

Kraken is among several significant cryptocurrency trading platforms currently facing legal action from the SEC (Securities and Exchange Commission). Last year, similar lawsuits were initiated against Binance and Coinbase, accusing these platforms of breaching securities laws by not registering as brokers, clearinghouses, or exchanges with the SEC. Both Coinbase and Binance tried to dismiss these charges, but their efforts were unsuccessful. The judges presiding over each case decided that most of the accusations against them are valid, allowing the cases to proceed to trial.

Currently, the court has rejected Kraken’s request to dismiss the SEC’s case. In a ruling made on August 23rd, Judge William H. Orrick of the Northern District of California stated that the SEC has presented reasonable evidence suggesting that certain cryptocurrency transactions facilitated by Kraken may be considered investment contracts, making them securities and subject to securities laws.

Kraken’s unsuccessful motion, submitted in February, contended that the Securities and Exchange Commission (SEC) had not provided sufficient evidence to support their claim – in essence, stating that the case facts, if proven true, did not necessarily imply a breach of law – by suggesting that cryptocurrencies do not conform to the definition of a security as per the Howey Test.

In a partial accord with Kraken, Orrick determined that the specific cryptocurrencies mentioned in the SEC’s lawsuit are not inherently classified as investment contracts – a stance that SEC lawyers have attempted to distance themselves from during certain court proceedings.

“Numerous courts have distinguished between the digital assets and the offers to sell them before engaging in an analysis of whether cryptocurrency transactions constitute investment contracts. The distinction is valuable,” Orrick wrote. “Although the way the SEC labels the crypto assets at issue – as ‘crypto asset securities’ – is unclear at best and confusing at worst, I do not understand the SEC to be alleging that the individual cryptocurrency tokens in which Kraken enables transactions are themselves securities.”

“According to the accusations made by the SEC, these assets were marketed and traded both initially and subsequently on Kraken as investment opportunities. This interpretation is valid, as it’s a stance the SEC has consistently used in previous court cases,” the judge noted.

Kraken’s Chief Legal Officer, Marco Santori, expressed his delight over this particular part of the Orrick’s decision concerning X (previously Twitter), penning:

Today in the Northern District of California, the Federal Court decided that none of the digital tokens traded on Kraken are classified as securities. This decision is a major victory for Kraken, bringing clarity to the industry and crypto users nationwide. It also reinforces Kraken’s stance that it does not deal with securities by listing them.

A representative for Kraken declined to comment beyond Santori’s X post.

While Orrick determined that cryptocurrencies themselves are not investments, it doesn’t imply that transactions involving their purchase and sale can’t reasonably be classified as investment contracts.

“In a similar vein, orange groves and cryptocurrencies may not be considered traditional securities on their own, but the agreements associated with their purchase could potentially qualify as investment contracts. This would place both within the jurisdiction of the Securities Exchange Act.”

Kraken’s request to discard the case is backed by the argument that it should be dismissed based on the Major Questions Doctrine – a legal concept originated by the Supreme Court, which asserts that administrative agencies should not broaden their regulatory authority unless there is explicit approval from Congress for such expansion.

However, similar to other judges tasked with evaluating this doctrine, Judge Orrick found himself at odds with Kraken’s argument. He asserted that the $3 trillion cryptocurrency sector lacks the magnitude and significance within the U.S. economy or political arena to warrant application of the Major Questions Doctrine.

Previous courts have already decided whether claims like those made by the SEC potentially breach the major questions doctrine, and they found that they do not. In this case as well, the same conclusion applies…although cryptocurrency is a relatively recent form of financial instrument, the underlying principles guiding the SEC’s efforts to regulate it are not fresh concepts.

By October 8th, both sides must each provide a Combined Declaration. This document should outline a suggested timetable for the case and propose a trial date.