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SEC sues Kraken crypto exchange alleging commingling, securities violations


The fact that the Securities and Exchange Commission (SEC) is bringing a lawsuit against a cryptocurrency exchange, this time Kraken, is barely newsworthy. The SEC’s position that most cryptocurrencies are securities is well known and hence it expects exchange to register as broker dealers. However, the Kraken lawsuit has more serious allegations of commingling of customer and corporate funds. Part of the SEC’s push against crypto exchanges is that registered brokers are required to separate client and corporate assets.

What is not entirely unclear from the SEC legal complaint is whether the alleged commingling is ongoing. It applied to both digital assets as well as cash. Kraken’s audit reports stated customer cash of $30.8 million (in 2020) and $33.6 million (2021) appeared in the exchange’s corporate accounts. At times Kraken has held up to $5 billion in customer cash. 

During 2023 the auditor concluded there were material misstatements in the 2020 and 2021 accounts because of the commingling. However, that was based on Kraken highlighting the issue to the auditor – a very positive thing.

It’s unclear whether or not the audit for 2022 is complete as the lawsuit states that 2022 audit “plans” state, “There is a significant risk of loss of custodial (and proprietary) digital assets through theft/loss of public keys or improper controls over accounting for custodial digital assets that are comingled between customers and with the Company’s proprietary digital assets.” There is no mention of 2022 audit findings.

Apart from cash, the lawsuit alleges digital assets are also commingled, and at one time Kraken held $33 billion in assets. Kraken allegedly told its auditor that it does not separate accounting of crypto assets that are margined versus not margined.

Why now?

Given the SEC sued Coinbase and Binance in June, one has to wonder why this Kraken lawsuit is coming now? One observation is that Kraken previously showed a willingness to settle. And the SEC hasn’t faired so well in the courtroom of late. In February Kraken pulled its staking offering and paid a $30 million fine.

Kraken co-founder and former CEO Jesse Powell wrote on X: “Message is clear: $30m buys you about 10 months before the SEC comes around to extort you again. Lawyers can do a lot with $30m but the SEC knows that a real fight will likely cost $100m+, and valuable time. If you can’t afford it, get your crypto company out of the US warzone.”

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