The Breakdown - The SEC Sues Kraken (Again?!)

Episode Date: November 21, 2023

10 months after settling with the regulator, the SEC is going after Kraken again. NLW explores the allegations and the crypto legal community's interpretation. Hint: more shots on goal to convince a judge tokens are securities. Today's Sponsor: Kraken Kraken: See what crypto can be - https://kraken.com/TheBreakdown Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Tuesday, November 21st, and today we are talking about overreach Gensler going after Cracken. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, well, there is some massive news brewing as I record this. It looks like CZ may actually be out at Binance, which would obviously just be a huge bit of news. And I will do a little bit of setup to that in the show later based on reporting from Bloomberg yesterday.

But obviously, should it happen as it appears to, it is going to be the centerpiece of tomorrow's show. However, today we are talking about the other thing, which is that the SEC has sued Cracken. Now, a disclosure, as I cover this, of course, Cracken is a breakdown sponsor. As I'm sure you understand, and as we've unfortunately been through before, it is breakdown policy that being a sponsor does not shield a company from being the subject of the show if they are in the news, nor will it color my take on that news, because at the end of the day, sponsors come and go, and the relationship I have with you guys to trust that I am giving you my unvarnished opinion is the most important thing. At the same time, and I will preview

what's coming, I don't think in any case that Cracken has anything to worry about on that front today. So, as I said, the SEC has filed a lawsuit against Cracken, with the core allegations being that they have operated as an unregistered securities exchange, broker, and clearinghouse. If this sounds familiar, it's because these are broadly in line with allegations leveled against Coinbase and Binance earlier this year. Now, in support of these claims, the SEC named 16 tokens they alleged to be unregistered securities, including Solana, Algarand, and Polygons Maddic. The list of tokens is a combination of the list from prior lawsuits and notably excludes Ethereum and Bitcoin. Now, in addition to the legal claims, the SEC lawsuit also includes allegations

regarding improper financial and corporate structure. The lawsuit alleges that Cracken at times held customer assets valued at more than $33 billion and, quote, commingled these crypto assets with its own, creating what its independent auditor had identified in its audit plan as a significant risk of loss to its customers. As you'll see, this is the part of the suit that people in the crypto industry are paying most attention to. The SEC also alleges that Cracken held more than $5 billion of customer cash, which was commingled with corporate funds. The allegation includes the claim that, Quacken has at times paid operational expenses directly from bank accounts that hold customer cash. The lawsuit claims that these issues had led to recordkeeping problems contributing to,

quote, material errors to Cracken's financial statements for 2020 and 2021. Now, notably, and very importantly, the SEC is not directly alleging the misuse of customer funds. The strongest allegation along those lines is that Cracken paid operational expenses from a shared account that held both corporate and customer funds. There is no allegation here that Cracken dipped into customer funds to service its own expenses. The lawsuit also flags corporate structure issues with employees working across multiple entities within Cracken's international operation. The SEC alleged that, quote, operating entities are cross-staffed according to product and service, not by region. None of these financial or corporate structure issues stand alone as individual

claims. Instead, they seem to be examples of operational decisions that would be prohibited if Cracken were operating as a registered securities exchange. The SEC is thus seeking to permanently ban Cracken from operating as an unregistered securities exchange and asks for monetary penalties. That is, of course, the same penalty requested in the Coinbase lawsuit. SEC Enforcement Division Director Gabir Ask Rwal said in a statement, We allege that Cracken 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.

Cracken's choice of unlawful profits over investor protection is one we see far too often in this space, and today we're both holding Cracken accountable for its misconduct and sending a message to others to come into compliance. Cracken's CEO Dave Ripley wrote, we strongly disagree with the SEC claims, stand firm in our view that we do not list securities, and plan to vigorously defend our position. As we've seen before, the SEC argues that Cracken should, quote, come in and register with the agency when there is no clear path to registration. It's allegations are factually incorrect, contrary to law, and the wrong way to create policy in the United States. As an industry leader, we will stand up to these allegations and defend the

crypto industry's right to exist in the U.S. We believe congressional action is the most appropriate path to resolving the lack of regulatory clarity in the U.S., and will continue to support these efforts to bring clarity and certainty to the chaotic environment that has been created in the U.S. Now, a couple more notes from the Cracken blog post response. First of all, it's set out to make clear what was not alleged. Cracken writes, the complaint against Cracken alleges no fraud, no market manipulation, no customer losses due to hacking or compromised security, and no breaches of fiduciary duty. On the co-mingling accusation, Cracken writes, the SEC alleges that Cracken commingled its own funds with its clients. This is a similar allegation already made

of other crypto trading platforms. And editors note, it linked to their case against Coinbase at that point. 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 co-mingling is no more than Cracken's spending fees it has already earned. Instead, they write, the complaint makes a technical argument that Cracken's business requires special securities licenses to operate because the digital assets we support are really, quote-unquote, investment contracts. This is incorrect as a matter of law, false as a matter of fact, and disastrous as a matter of policy. Now remember, this is the second part of Cracken's dispute with the SEC.

In February, Cracken agreed to shutter its staking service in the U.S. and paid a $30 million fine in settlement. Staking was later included as part of the SEC's lawsuit against Coinbase, claiming that staking services were unregistered securities offerings. Cracken co-founder Jesse Powell took to Twitter to write, USA's top decel is back with another assault on America. The massacists haven't been happy with the beatings they've been taking in New York and are shopping for a different flavor of RegDOM in CA. I thought we settled all their concerns for $30 million in February.

Now they're back for seconds. message is clear, 30 million buys you about 10 months before the SEC comes around to extort you again. Lawyers can do a lot with 30 million, but the SEC knows that a real fight will likely cost it 100 million in valuable time. If you can't afford it, get your crypto company out of the U.S. Warzone. Now, there has been much speculation around what the SEC's strategy here is. Mike Selig, a crypto lawyer at Wilkie Far and a former CFTC lawyer wrote, After Ripple, seems like the SEC is worried it will lose more crypto cases and is playing the numbers game. With its complaint against Cracken, we have three district courts that will evaluate

the security status of crypto-secondary sales. Southern District of New York, the Coinbase lawsuit, the District of D.C., the Binance lawsuit, and the Northern District of California, the Cracken lawsuit. Supreme Court may decide at all. Basically, the argument here is that the SEC has intentionally chosen three separate districts to give themselves three attempts at a favorable ruling on the question of whether crypto exchanges are facilitating unregistered security sales. Adding some evidence to this is Orlando Cosme, who points out that the Coinbase judge was the same one that throughout the Uniswap case, meaning the SEC might have problems in the SDNY. If the SEC loses Coinbase, it'll be much harder to then win on appeal, and Coinbase has shown a willingness to take

this case to Scotus. That would create good crypto law in the Second Circuit. This case allows the SEC to take another swing with relatively worse facts, at least as alleged in the complaints, potentially draw a more sympathetic judge, and create bad crypto law in the Ninth Circuit. This all just seems part of SEC Chair Gensler's War of Attrition against crypto. I hope Cracken decides to marshal its resources and fight this head on. Enough is enough. And indeed, that seemed to be a lot of the sentiment from across the crypto legal core. Marissa Tashman-Coppel, the senior council at the Blockchain Association said in a statement, we're disappointed to see the SEC engage in another example of clear overreach by filing an action against Cracken. The SEC's theories are incorrect as a

matter of law and expand beyond the jurisdiction granted to them by Congress. The SEC's action underscores the need for our elected representatives, not overzealous regulators, to establish regulatory clarity for the digital asset industry. Blockchain Association stands ready to support Cracken in its defense. Journalist David Morris pointed out the joke writing, I love when an SEC charging document opens with a description of a successful business that has been providing a desired service to the market steadily for more than a decade. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for

others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7-365 and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry. facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, BVI, DBA, Cracken.

Now, I think on the one hand that Mike and Orlando have the right of it when it comes to the legal strategy here, that this is trying to give them more bites at the Apple to get a favorable ruling as relates to security status. But they're also playing a narrative game here. With all of the emphasis on the commingling angle in their public statements, they're trying very clearly without saying the letters FTX to make people remember FTX. Of course, the issue with FTX wasn't just that it was mingling customer assets in omnibus wallets.

It's that Sam was explicitly authorizing them to be used for trading by Alameda research. That's why I think Cracken is focused so strongly in their statements around pointing out that even the SEC has not alleged that any single dollar or any single crypto asset has gone missing. It's also worth noting that those complaints are really all just part and parcel of an argument that Cracken should have come in and registered, to which they're pointing out there just wasn't a path to. Ultimately, to me, it all seems extremely in line with everything that we've seen from Gensler's SEC so far, and so whilst that is not surprising. It is a massive distraction, a massive waste of resources, but I, like so many others out there, hope Cracken decides to fight back

and avails themselves of the full extent of the law. Now, before we get out of here, a quick preview for what's coming later today. According to Bloomberg reporting yesterday, Binance was in talks with the Justice Department to settle criminal charges. The charges are, of course, in relation to a year's long investigation into alleged money laundering, bank fraud, and sanctions violations. Reporting suggests that talks were in advanced stages in the negotiation could be resolved as early as the end of the month. Again, remember, this was what we thought yesterday, and now it sounds like there's a press release at 3 p.m. Eastern. The big thing that everyone latched onto on crypto Twitter was the fact that the DOJ is seeking a payment of more than $4 billion from Binance.

Many now feel they understand why CZ kept saying four. The Bloomberg report stated that negotiations include the possibility that Binance CEO CZ would face criminal charges personally in the U.S. And Bloomberg sources also said that the agreement was trying to strike a balance that would allow Binance to continue operating, citing concerns that a Binance collapse would cause a negative fallout for markets and crypto holders. Now, I don't want to to get too much more into this because we're literally going to get that information before you even hear this. So apologies for the inherent latency of media. I will just say this. If this does go down in such a way that Binance is allowed to continue to operate, that the charges with the U.S.

government are settled in a meaningful and fully resolved kind of way, it is a massively, massively bullish thing for the crypto industry. The threat of this, the potential for institutional failure at Binance, has been one of the biggest overhangs of the crypto industry since even before FtX, but certainly since FtX collapsed a year ago. Having it resolved would remove a sort of Damekles that hangs over our heads and would allow the industry to move forward even faster than it recently has been. We should be cheering for the potential for a resolution here, and I can't wait to come back tomorrow and tell you what actually happened. Until then, one more big thank you to my sponsor for today's show, Cracken. Go to crackin.com and see what crypto can be. And until next time, be safe and take

care of each other. Peace.