DEF Files Amicus Brief in Support of Kraken’s Motion to Dismiss; HFSC Markup Includes Bill Focused on Innovation

DEF Files Amicus Brief in Support of Kraken’s Motion to Dismiss 

What happened? 

Last week, DEF, alongside the Blockchain Association, filed an amicus brief in federal court in the Northern District of California in support of Kraken’s motion to dismiss the Security and Exchange Commission’s (SEC’s) complaint. The brief had two primary focuses: the SEC’s categorization of digital assets as securities and the conflicting legal theories it presents in support of that categorization in ad hoc enforcement actions. 

First, we argue that the SEC’s various theories to classify all digital assets as per se securities are wrong. One argument that the SEC has relied on is that when a buyer of digital assets believes the value of the assets will rise due to the creators’ efforts, the assets become investment contracts. In recent actions, the SEC has even tried to argue that digital assets are securities because their value is tied to an “ecosystem,” a term the SEC has never defined. But the Howey test states that the mere expectation of profits is insufficient to establish an investment contract, which must involve a “common enterprise” or an ongoing obligation between the parties. Moreover, a digital asset can retain its value even if its creator has stopped promoting it — e.g., the DOGE token.

Second, we described the failings, both practical and legal, of the SEC’s “enforcement-only” approach. The SEC’s ever-changing theories are unsupported by the law and underscore its failure to engage with industry participants with clear regulation and guidance. Instead, the SEC continues to sue industry participants with an aggressive enforcement strategy.

Our brief follows Kraken’s earlier-filed motion to dismiss, which asks the court to dismiss the SEC’s complaint because the regulator failed to show that tokens on Kraken’s platform are investment contracts under the securities laws. In November 2023, the SEC sued Payward Ventures Inc. and Payward Inc., the business entities behind Kraken, alleging that Kraken operated as an unregistered broker, dealer, exchange, and clearing agency. 

What does this mean? 

The SEC’s case against Kraken raises many of the same issues found in the SEC’s cases against Coinbase and Binance, as well as LEJILEX and CFAT’s lawsuit against the SEC. As these cases progress in different district courts, the legal ambiguity around the classification of digital assets for regulatory purposes may result in conflicting legal findings. However, even conflicting legal findings can be a step forward as more judges wrestle with the nuances of this technology and cases make their way to appellate courts. 

HFSC Markup Includes Bill Focused on Innovation  

What happened?

Last Wednesday, Chairman of the House Financial Services Committee (HFSC) Patrick McHenry (R-NC) reintroduced the Financial Services Innovation Act. Previously introduced in 2019 and 2022, the bill focuses on establishing Financial Services Innovation Offices (FSIOs) within federal regulatory agencies.

Facilitating a new path to regulatory innovation, FSIOs would be tasked with administering “enforceable compliance agreements” that would allow companies to create, with regulatory sign off, alternative compliance programs for new products and services. In other words, FSIOs would administer sandboxes for builders. Representative McHenry argued the bill was needed to address the risk that fintech firms currently face from a lack of regulatory clarity when bringing innovative products to market. Enforceable compliance agreements would allow regulators and businesses to calibrate compliance obligations and avoid stifling innovation in financial services. 

What does this mean?

The flexibility that enforceable compliance agreements would provide could be very useful in the context of crypto and DeFi, as it could foster innovation while accomplishing public policy objectives in new ways.