Crypto Exchange Kraken Settles SEC Action and Agrees to Pay $30M Fine and Shutter US Crypto Staking Service | Baker Hostetler

Important takeaways

• The US Securities and Exchange Commission (SEC) charged Payward Ventures Inc. and Payward Trading Ltd., commonly known as Kraken, with illegally offering and selling their crypto-asset betting services.
• The SEC alleged that the betting services Kraken offered and sold were securities subject to the registration requirements of the Securities Act of 1933 (Securities Act).
• Under the settlement with the SEC, Kraken agreed to pay a $30 million fine and unpledged assets staked by US investors; however, non-US investors will be unaffected.

The SEC’s complaint

According to the SEC’s complaint, Kraken offered and sold its stake[1] services to the general public where participants could transfer crypto-assets to Kraken in exchange for “advertised annual investment returns of as much as 21%” (Kraken Staking Program). The SEC alleges that this Kraken Staking program enabled Kraken to gain a competitive advantage in the staking market because Kraken pooled various participants’ cryptoassets and staked them on behalf of the participants, thereby earning higher returns than if the participants were staking the same cryptoassets on their own. By merging and controlling the tokens, Kraken is claimed to have reduced transaction costs and risks, and in the case of tokens actually staked by Kraken, increased the likelihood that Kraken itself would be chosen to validate blockchain transactions, for which they would earn rewards. Consequently, the SEC’s complaint alleges that investors lost control of the staked tokens and were given “very little protection” in exchange for the outsized returns.

As of April 2022, US investors had over $2.7 billion in cryptoassets invested in the Kraken Staking Program, and Kraken had earned from the staking program approximately $147 million in net revenue. Kraken is alleged to have violated the Securities Act by failing to register its betting services with the SEC, which otherwise did not qualify for an exemption from such requirements.

Kraken’s alleged failure to register prevented investors from accessing material information about the Kraken Staking program, which included Kraken’s business and financial condition, the fees charged by Kraken, the extent of Kraken’s profits, and the specific and detailed risks of the investment. Investors were also unaware of Kraken’s financial condition and whether it had the means to pay the marketed returns.

In the press release announcing the settlement, Gurbir Grewal, director of the SEC’s Division of Enforcement, stated that “Kraken not only offered investors outsized returns untied to any financial reality, but also retained the right to pay them no return at all. All the while it gave them zero insight into, among other things, its financial condition and whether it even had the means to pay the marketed return in the first place.”[2]

Settlement terms

Kraken did not admit or deny the SEC’s allegations, but it agreed to pay a $30 million fine and unpledged assets staked only by US investors, who also will not be able to stake new assets. However, Kraken will not withdraw Ether until after the Ethereum Network Shanghai Upgrade (an Ethereum Network upgrade) takes effect. Kraken’s withdrawal of crypto assets will not affect non-US investors. The settlement also permanently enjoins Kraken from violating section 5 of the Securities Act and from directly or indirectly offering or selling securities through its aforementioned crypto-asset betting services.

Conclusion

The SEC continues to take the position that certain crypto-related arrangements are investment contracts. Indeed, SEC Chairman Gary Gensler specifically stated in the press release that “staking-as-a-service providers must register and provide full, fair and truthful disclosure and investor protection.”[3] If a company has or plans to develop a crypto staking-as-a-service program, it would be advisable to consult a securities and blockchain attorney to ensure compliance with US securities laws.

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