SEC Accuses Kraken of Operating Unregistered Securities Exchange

The Securities and Exchange Commission identified 11 crypto tokens as securities in a complaint brought Monday against crypto trading platform Kraken.

The lawsuit brought by the SEC in U.S. District Court for the Northern District of California, San Francisco Division, alleges that Payward Inc. and Payward Ventures Inc., the registered companies behind Kraken, have been operating Kraken as an unregistered securities exchange since at least September 2018. The SEC refers to the tokens traded on Kraken as “crypto asset securities” in the corresponding press release relaying the charges.

The complaint alleges further that Kraken comingled its assets with that of its customers and also comingled the functions of exchange, broker, dealer and clearing agency in its client services. Kraken comingled a total of $33 billion in cryptocurrency and $5 billion in cash with its own assets, the SEC alleges.

The “comingling of functions” is a common criticism SEC Chairman Gary Gensler has made against actors in the crypto industry.

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Plan Fiduciaries, Take Note

401(k) plan fiduciaries should take note of the complaint when it comes to offering cryptocurrency to plan participants, Wagner Law Group partner Kimberly Shaw Elliott wrote in emailed commentary.

“The SEC’s new enforcement activity should be a clear warning to not only unregistered crypto providers and the advisers who recommend crypto investments, but also to retirement plan fiduciaries who approve those investments,” she wrote. “Is it prudent to place faith in the seller or holder of crypto who does not go through the rigors of registration? While some registered broker/dealers are now offering crypto to 401(k) plans through registered exchange-traded funds, a fiduciary must still weigh the risk of loss against the opportunity for gain from these highly volatile investments.”

Shaw Elliott noted a 2022 Department of Labor bulletin warning about the risks of allowing participants to invest in cryptocurrency. The regulator successfully received the dismissal of a lawsuit filed by recordkeeper ForUsAll Inc., which had sought damages for the bulletin’s chilling effect on providing cryptocurrency through the self-service brokerage window.

Philip Moustakis, a partner in Seward & Kissel and a former attorney with the SEC’s enforcement division, says the “threshold question is whether we are dealing with securities” in this case. If the tokens in question are not securities, then the SEC cannot bring the other allegations against them.

At various points in the complaint, the SEC asserts that different tokens were “sold as investment contracts,” a key component in determining that an asset is a security. The SEC also notes that the 11 tokens in question were all previously brought as examples of securities in enforcement actions taken against cryptocurrency exchanges Binance and Coinbase. The SEC stated that it needs “only [to] establish that Kraken has engaged in regulated activities relating to a single crypto asset security.”

The 11 tokens trade under the symbols ADA, ALGO, ATOM, FIL, FLOW, ICP, MANA, MATIC, NEAR, OMG and SOL.

The Howey Test

The SEC alleges in the complaint that: “Based on the public statements of their respective issuers and promoters—at least some of which were rebroadcast by Kraken itself on the Kraken Trading Platform—a reasonable investor would have understood the offer and sale of each of the Kraken-Traded Securities as offers and sales of investment contracts.”

Moustakis says that a fair attorney “could write both sides of the brief” about the tokens’ status, and this case “brings no further clarity” on which tokens are securities.

Though “the Howey Test is fairly clear,” Moustakis says, referring to the legal test for determining if an asset is a security, it can be difficult to apply to crypto because of the nature of blockchain technology. With crypto, “a security one day can be a non-security the next.”

Whether or not the tokens satisfy the Howey Test is the key question, because if they do not, then the other allegations fall outside the SEC’s jurisdiction, the attorney says. Comingling assets is “a no-no in the securities world,” Moustakis says, while also questioning whether cryptocurrency is the securities world.

On the comingling of functions, Moustakis says “federal securities laws break out the functions” of broker, dealer, exchange and clearing agency “to create a series of checks and balances” to protect investors. However, if the tokens are found to not be securities, then this “is an unregulated space.”

Gensler has repeatedly stated that the securities laws and Howey Test are clear enough and that further regulation or other clarification is not needed to bring enforcement actions against the crypto industry.

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Tags: Cryptocurrency, Gary Gensler, Howey Test, Kimberly Shaw Elliott, Kraken, Payward Inc., Payward Ventures Inc., Philip Moustakis, Securities and Exchange Commission, Seward & Kissel, The Wagner Law Group

Nvidia Corp.’s seemingly relentless march north stumbled despite strong third-quarter earnings and revenue reported Tuesday. The chipmaker, whose stock had more than tripled this year, fell almost 0.9% during Tuesday trading and around the same amount after the close.

Odds are, however, that Nvidia’s Tuesday decline is a hiccup stemming from market-wide forces and that the celebrated tech titan (market cap: $1.2 trillion) will resume its ascent, powered by the exuberance around artificial intelligence. Nvidia’s astonishing rally largely stems from its dominance in semiconductors used in AI, 2023’s hottest investment theme.

That is important because Nvidia has been the top stock among the Magnificent Seven, the group of companies that has led the market’s charge in 2023. This year through Tuesday, Nvidia has soared 248%, with Facebook parent Meta Platforms in second place at 170% and Apple the laggard at 52%. The S&P 500 is up 16.8% for the period.

The market’s catalyst has been tech firm OpenAI’s June announcement of its breakthrough of a machine-learning algorithm designed to generate human-like responses. Nvidia supplies the bulk of OpenAI’s chips.

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Note that Nvidia had a similar short-lived downward blip in August after it released robust earnings and revenue news. That small slide, which lasted only two days, came at the start of a three-month decline that interrupted this year’s bull market.

This latest Nvidia dip likely is due to qualms that the market as a whole, and tech in particular, may be overbought. On Monday, before the Nvidia report, LPL Financial declared in an analyst commentary that such worries are temporary and the S&P 500 will “keep working its way higher.”

To LPL, “the market appears to be taking a rest” leading up to “the Thanksgiving holiday, the historical pattern over the last five years.” November, the firm declared, has been the best month for equities since 1950.

The Q3 Nvidia performance, for the quarter ending in October, smashed Wall Street analysts’ projections (as published by FactSet). Quarterly revenue was $18.1 billion, and analysts expected $16.2 billion. Net income was $9.24 billion, and Wall Street anticipated $7.34 billion. GAAP earnings were $3.71 per share, compared with expectations of $3.03.

Of course, no stock stays popular forever. But there is a lot of sentiment that Nvidia can hurtle still higher in the near future, at least. As Christopher Robb, an analyst at Seeking Alpha wrote, “Similar to big wave surfing, the rules of investing in stocks with excessive valuation are different than normal investing.”

Tags: AI, Apple, Artificial Intelligence, Earnings, LPL Financial, Magnificent Seven, Meta, Nvidia, OpenAI, revenue, S&P 500