Kraken Challenges SEC Lawsuit: A Battle Over Regulatory Overreach

While Kraken fights for regulatory clarity, Interpath takes control of HectorDAO after its huge $2.7 million hack.

Some of the latest legal updates in the crypto space over the past few days include that Kraken has moved to dismiss a lawsuit from the SEC, challenging allegations that it operated without proper registration and co-mingled customer funds, and arguing that the SEC's broad interpretation of investment contracts could unjustly extend its regulatory reach.

Meanwhile, Interpath Limited has taken control of HectorDAO's assets and social media channels after a court appointment, aiming to stabilize and manage the DAO's assets professionally. Digital Currency Group has objected to a bankruptcy settlement agreement reached by its subsidiary, Genesis, with the New York Attorney General, arguing that the settlement contradicts the Bankruptcy Code by improperly valuing assets and unfairly prioritizing certain creditors over others.


Kraken Files Motion to Dismiss SEC Lawsuit

Kraken has filed to dismiss a November lawsuit from the Securities and Exchange Commission (SEC), labeling it as a potential overreach of the agency's regulatory powers. The lawsuit, which accuses Kraken of co-mingling customer funds and operating without proper registration as a securities exchange, broker, dealer, and clearing agency, has prompted Kraken to file a motion for dismissal to a federal court in San Francisco. Kraken's defense contains concerns that the SEC's allegations could set a dangerous precedent for expansive regulatory authority over a wide array of transactions and assets, extending far beyond the crypto industry.

In a blog post, Kraken criticized the SEC's approach, arguing that the commission's definition of an investment contract is overly broad and lacks a clear limiting principle. According to Kraken, this interpretation could potentially classify quite a number of ordinary assets and commodities, like sports memorabilia, trading cards, and luxury goods, as securities.

The exchange holds firm that the cryptocurrencies traded on its platform do not constitute "investment contracts" under U.S. securities laws, pointing out the absence of direct agreements between Kraken's customers and cryptocurrency issuers, as well as disputing the notion that customers invested money with the expectation of profits derived from the efforts of these issuers.

Kraken's motion also invokes the major questions doctrine, referencing a 2022 Supreme Court ruling emphasizing Congress's intent for legislative authority rather than regulatory overreach, a point agreed upon by many other crypto firms facing SEC legal action. Amid ongoing debates in Congress regarding the appropriate regulatory framework for cryptocurrencies, Kraken has vocally advocated for clear legislation that delineates the SEC's jurisdiction and expands the Commodity Futures Trading Commission's oversight of exchanges.

The case emerges as part of a broader scrutiny by the SEC under its chair, Gary Gensler, who has pushed hard for comprehensive regulation of the crypto industry, pointing towards investor protection concerns for his decisions.

Interpath Takes Control of HectorDAO

In other legal news, Interpath Limited, also known as Interpath Advisory, has assumed control of the Hector decentralized autonomous organization (Hector DAO) treasury, along with its social media channels, after a court appointment by the Virgin Islands High Court. This move came after HectorDAO suffered a $2.7 million hack in January, attributed to either a private key compromise or the actions of a suspected rogue developer. The incident led to calls from investors for the DAO's assets to be managed by a neutral third party, which now became a reality with Interpath's involvement.

Interpath, a firm listed by the British Virgin Islands Financial Services Commission as a regulated entity and insolvency practitioner, was officially appointed as interim receivers over Hector DAO's assets. This decision was made to ensure the professional handling and liquidation of the assets, distancing the management from the HectorDAO team, which faced a lot of criticism post-hack.

The takeover includes full custody of HectorDAO's treasury assets, which have been transferred to a new, secure wallet. Previous signers have been removed from the DAO's multisignature wallet, ensuring no involvement from the old team in future transactions. Interpath's role also extends to conducting an investigation into the January hack and attempting to recover investor funds, though they still have to receive authority to distribute these assets, pending final court approval.

The hack is not the only motivation for this move as, in July of last year, HectorDAO suffered huge losses after over $8 million was lost due to depegging incidents linked to the $1.5 billion Multichain exploit. Despite a vote to liquidate the treasury and return funds to investors, most of these funds remain undistributed.

Interpath's takeover is a pivotal moment for HectorDAO, and is aimed at stabilizing the situation and ensuring a structured approach to managing and potentially recovering the lost assets. The firm's authority to control communication channels also means it will be the primary source of updates for token holders and concerned investors as they try to navigate through the recovery process and the ongoing investigation into the hack.

DCG Challenges Genesis Bankruptcy Settlement

Digital Currency Group (DCG), a venture capital firm, voiced objections against a settlement agreement reached by its bankrupt subsidiary, Genesis, with the New York Attorney General’s (NYAG) Office. Filed on Feb. 21, DCG's objection criticizes the settlement's approach to compensating unsecured creditors based on asset valuations at the time of distribution rather than at the petition date, which DCG argues contradicts requirements set by the Bankruptcy Code. The U.S. Supreme Court has established that settlements cannot breach the Bankruptcy Code, reinforcing DCG's stance.

DCG contends that the settlement unfairly allocates the residual value of the debtor's estates to the NYAG and, subsequently, to unsecured creditors, bypassing DCG's rightful participation as a creditor and equity holder. This arrangement, according to DCG, deprives them of a fair opportunity to engage in the distribution process after unsecured creditors' claims are addressed. Notably, the settlement stipulates that the NYAG will only be compensated after the unsecured creditors have been paid, positioning DCG, as Genesis's sole equity holder, as a secured creditor.

These objections come in the backdrop of a lawsuit filed by the NYAG in October of last year against Genesis, DCG, and crypto exchange Gemini, accusing them of defrauding investors through the Gemini Earn program, a partnership between Genesis and Gemini. DCG is now requesting that the court delay approval of the settlement until its concerns are fully addressed, arguing that the current arrangement prioritizes certain creditors at the expense of others and fails to consider the potential for successfully contesting the NYAG's claims in court.