I’ve read the 90 page complaint lodged against Kraken- here’s what I’ve found.
I’ve read the SEC’s 90 page official complaint lodged against Kraken seen here: https://www.sec.gov/news/press-release/2023-237.
As someone that purchases their crypto primarily through Kraken (one of the only decent exchanges in Aus now) I, like I’m sure many of you, thought Fuck… not again. As a result of that, I thought I’d take the time to read the actual complaint the SEC lodged against Kraken on 20 Nov 23.
The initial summary paints a grim picture through sweeping statements such as:
“For example, Kraken has at times held customer crypto assets valued at more than $33 billion, but it has 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. Similarly, Kraken has held at times more than $5 billion worth of its customers’ cash, and it also commingles some of its customers’ cash with some of its own. In fact, Kraken has at times paid operational expenses directly from bank accounts that hold customer cash. In addition, during 2023, the independent auditor determined that issues related to Kraken’s recordkeeping for customer custodial assets had resulted in material errors to Kraken’s financial statements for 2020 and 2021.”
Continuing on however, as the complaint goes into specifics, a vastly different picture is painted (in my opinion):
“In 2020 and 2021 together, Kraken earned more than $43 billion in revenue from trading-based transactions, including from fees charged to customers, sales of crypto assets to customers, and proprietary trading”
“In its 2020 and 2021 financial statements, Kraken describes how it may commingle custodial funds with its own. Kraken’s financial statements state that “[a]mounts shown as Customer custodial funds are restricted to use based on the terms of service with our customers. Such funds may be in separate accounts or commingled with cash that is unrestricted.” “Unrestricted” cash is Kraken’s proprietary or corporate cash for which it has “unrestricted rights of withdrawal and use….” Kraken’s independent auditor has observed that as of December 31, 2021, approximately $33.6 million of customer custodial fiat appeared to be in Kraken’s operational bank accounts. Kraken’s independent auditor similarly observed that as of December 31, 2020, approximately $30.8 million of customer custodial fiat appeared to be in Kraken’s operational accounts.”
In regards to crypto assets:
“Nonetheless, Kraken commingles customer crypto assets with its own. Commingling customer and proprietary assets creates a risk that, when customers request withdrawals of their assets, those assets might be encumbered (e.g., due to hypothecation, or liens or other interests being filed against such property to secure an obligation of Kraken) or gone completely. Concerning Kraken’s custody of crypto assets, in its audit plan for 2022, Kraken’s independent auditor stated: “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.
In 2023, Kraken found errors relating to customer custodial cash and crypto assets held for customers in 2020 and 2021. These errors were a result of Kraken’s poor recordkeeping practices and failure to properly record margin transactions, underscoring the deficient internal controls at the company. In materials provided to its auditor, Kraken stated: “In August 2023, the Company self-identified the possibility of an error.” This error was largely based on Kraken’s failure to establish a sub-ledger before offering its margin lending product. Kraken’s auditor determined that these errors were material to the 2020 and 2021 financial statements of Payward and Payward Ventures.”
Overall issues raised:
“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. That decision resulted in a business model rife with conflicts of interest that placed investors’ funds at risk,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “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.”
“The Commission seeks a final judgment: (i) permanently enjoining Defendants from violating Sections 5, 15(a), and 17A of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)]; (ii) ordering Defendants to disgorge their ill-gotten gains, on a joint and several basis, and to pay prejudgment interest thereon; (iii) permanently enjoining Defendants from acting as an unregistered exchange, broker, dealer, or clearing agency; and (iv) imposing civil money penalties on Defendants.”
- The major financial co-mingling appears to be around 33 million dollars in 2020-2021, a year that Kraken made $43 billion as outlined by the SEC. The “5 Billion” mentioned by the SEC had nothing to do with co-mingling.
- In regards to crypto assets, the co-mingling mentioned by the SEC appears to be the risks inherent with Ledgers in general, or that they are storing their own and customers in the same ledger/s. This does seem like an oversight by Kraken, but the SEC doesn’t state what percentage is co mingled, for how long, and also doesn’t mention that Kraken ever used customers assets (like it did with the minuscule proportion of fiat mentioned above.)
- Most of this sounds like it was disclosed by Kraken.
- The significant “risk” to customers seems to be Kraken operating an unlicensed securities exchange rather than anything else per the SECs language, and naturally they want a payout.
- The majority of the document harps on about Kraken’s history of operating an unlicensed securities exchange and goes into each token mentioned and why the SEC deems them securities.
Kraken’s response can be found here:
“The SEC alleges that Kraken “commingled” its own funds with its clients’. This is a similar allegation already made of other crypto trading platforms. 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 “commingling” is no more than Kraken spending fees it has already earned.”
It makes more sense once you read the SEC complaint.
Honestly seems like a nothing burger and the SEC just want to get paid. I am not advocating for using or not using Kraken, just laying out the arguments, as there have been links with some pretty hyperbolic word mincing shared today throughout the sub.
As always, NFA.