SECURITIES AND EXCHANGE COMMISSION v. PAYWARD, INC., et al.
Case No. 23-cv-06003-WHO
UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA
January 24, 2025
ORDER GRANTING IN PART AND DENYING IN PART MOTION FOR JUDGMENT ON THE PLEADINGS
The United States Securities and Exchange Commission (the “SEC” or the “Commission“), is suing Payward, Inc. and Payward Ventures (d/b/a and hereafter, “Kraken“) under Sections 5, 15(a), and 17A(b) of the Exchange Act,
BACKGROUND
I presume a general familiarity with cryptocurrency. A background in cryptocurrencies and tokens,
Kraken is a United States cryptocurrency exchange. The “Kraken Trading Platform” allows customers to buy and sell crypto assets through an online market. Complaint (“Compl.“) [Dkt. No. 1] ¶¶ 1, 39. Kraken advertises that the Kraken Trading Platform is “one of the world‘s largest digital asset exchanges,” in that it has over nine million retail and institutional customers located across more than 190 countries. Id. ¶ 139. The Kraken Trading Platform enables Kraken to provide services for customers like opening accounts, depositing funds, entering orders, and trading crypto assets (the “Kraken Services“). Id. ¶ 40. Kraken is not and has never registered with the SEC as a securities intermediary. See Answer (Preliminary Statement) at 1.
Several hundred crypto assets are available on the Kraken Trading Platform for trade. In the Complaint, the SEC identifies eleven crypto assets that it argues were offered and sold as investment contracts on the Kraken Trading Platform and used the Kraken Services: ADA, ALGO, ATOM, FLOW, ICP, MANA, MATIC, NEAR, OMG, and SOL. See Compl. ¶¶ 234, 248, 275, 293, 321, 343, 358, 378, 396, 409, 433.1,2 This is not the first
The SEC filed the underlying complaint in this case on November 11, 2023. In it, it asks this court to: (i) permanently enjoin the defendants from violating Sections 5, 15(a), and 17A of the Exchange Act; (ii) order the defendants to disgorge their “ill-gotten gains,” on a joint and several basis, and pay prejudgment interest thereon; (iii) permanently enjoin the defendants from acting as an unregistered exchange, broker, dealer, or clearing agency, and (iv) impose civil monetary penalties. See generally Compl. Kraken moved to dismiss the action in its entirety for failure to state a claim. See Motion to Dismiss (“Motion“) [Dkt. No. 25]. I denied its motion, finding that the SEC has plausibly alleged that the secondary market transactions in the cryptocurrencies named in the Complaint constitute “investment contracts,” and as such, are subject to securities laws. See generally Prior Order.
Kraken filed a 74-page answer to the SEC‘s complaint. See generally Answer [Dkt. No. 91].3 It asserts eighteen affirmative defenses. See id. at 69-74. The SEC moves for judgment on Kraken‘s Eighth, Ninth, and Tenth defenses. See SEC Motion for Judgment on the Pleadings (“Motion“) [Dkt. No. 103]. Kraken‘s Eighth Defense concerns the major questions doctrine: it asserts that if there were an ambiguity with respect to the SEC‘s authority to enforce Sections 5, 15(a), or 17A of the Exchange Act, then I would be compelled to apply the major questions doctrine and resolve the ambiguity against the SEC‘s enforcement authority. See Answer 70-71. Its Ninth Defense asserts that it lacked “fair notice that Kraken‘s conduct was in violation of the law, in contravention of its due process rights.” Id. Its Tenth Defense claims that “[a]s applied to the transactions alleged by the [SEC], the securities laws and the test formulated by the [United States Supreme Court] in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) are impermissibly vague.” Answer 71.
LEGAL STANDARD
In reviewing the plausibility of a complaint, courts “accept factual allegations in the complaint as true and construe the pleadings in the light most favorable to the nonmoving party.” Manzarek v. St. Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1031 (9th Cir. 2008). Nonetheless, Courts do not “accept as true allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” In re Gilead Scis. Secs. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008). A
A court has discretion to permit leave to amend in conjunction with a
DISCUSSION
I. TIMELINESS
The SEC has moved for judgment under
Kraken argues that the SEC‘s motion is styled as a
Jones v. Nutiva, Inc., No. 16-CV-00711-HSG, 2016 WL 5210935 (N.D. Cal. Sept. 22, 2016) does not support Kraken‘s position either. There, the plaintiff, Jones, filed a
This case is more akin to Vasquez than San Diego or Jones. In Vasquez, the court considered the plaintiffs’
The SEC‘s motion is both in style and in substance a
II. THE MOTION
“Under
The major questions doctrine originates from the notion that Congress does not delegate5
extraordinary powers that transform an agency‘s authority without making its intent clear. See West Virginia v. EPA, 597 U.S. 697, 716, 142 S. Ct. 2587 (2022) (noting that under the major questions doctrine, courts “expect Congress to speak clearly if it wishes to assign to an agency decision of vast economic and political significance“). It requires that in the “extraordinary” case where an agency claims the “power to regulate a significant portion of the American economy” that has “vast economic and political significance,” that agency must show it has “clear congressional authorization.” Util. Air. Regul. Grp. v. EPA, 573 U.S. 302, 324, 134 S. Ct. 2427, 189 L. Ed. 2d 372 (2014) (citations omitted).
Kraken asserts that if there were ambiguity with respect to the SEC‘s authority to enforce Section 5, 15(a), or 17A of the Exchange Act, the major questions doctrine would apply and require resolving the ambiguity against the SEC‘s authority. See Answer 70-71 (Eighth Defense). I already held that the major questions doctrine did not apply to bar the SEC‘s claims. See Prior Order 29. Kraken concedes my ruling in its Answer but asserts the affirmative defense anyway.
The SEC is entitled to judgment on the major questions doctrine defense because this case does not concern the kind of major question that the United States Supreme Court contemplated. Those cases that do implicate the doctrine have the potential to impose massive influence over the American economy. See e.g., West Virginia, 597 U.S. at 724, 142 S. Ct. 2587 (Clean Power Plan was major because it would empower the Environmental Protection Agency to “substantially restructure the American energy market“); N.C. Coastal Fisheries Reform Grp. V. Capt. Gaston LLC, 76 F.4th 291 (4th Cir. 2003) (holding an EPA regulation that would impact every commercial or recreational fisherman raised a major question); Biden v. Nebraska, 600 U.S. 477, 143 S. Ct. 2355, 2373 (2023) (student loan forgiveness program proposed by President Biden was major insofar as it aimed to forgive approximately $430 billion in debt); FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120 (2000) (holding that a newfound regulation of the tobacco industry was a regulatory overreach).
Cryptocurrency is a growing financial instrument, but it has not risen to a level of economic import that is reasonably comparable to the American energy market, or billions of dollars of outstanding student loan debt. What is more, the SEC is not asserting a “transformative expansion in its regulatory authority” or a “highly consequential power beyond what Congress could reasonably be understood to have granted it.” See West Virginia, 597 U.S. at 724. While cryptocurrency itself is a relatively novel financial instrument, the principles driving the SEC‘s assertions of regulatory authority over cryptocurrency are not new. The SEC‘s driving theory behind this case, and similar enforcement actions in other courts, is that well-established securities laws apply with equal force to Kraken as a cryptocurrency platform because Kraken‘s activities bring it within the ambit of the SEC‘s authority as Congress envisioned it. Whether the SEC is correct is a question that will be resolved through litigation; for now, its theory of liability keeps this case outside the coverage of the major questions doctrine.
B. Fair Notice and Due Process Defenses6
In evaluating whether a defendant lacked fair notice that its conduct contravened the law, courts ask whether, at the time of the conduct, the law “fail[ed] to provide a person of ordinary intelligence fair notice of what is prohibited, or [was] so standardless that it authorize[d] or encourage[d] seriously discriminatory enforcement.” FCC v. Fox Television Stations, Inc., 567 U.S. 239, 253-54 (2012) (cleaned up). This doctrine is entwined with the Due Process Clause in that it protects two due process concerns: “first, that regulated parties should know what is required of them so they may act accordingly,” and “second, precision and guidance are necessary so that those enforcing the law do not act in an arbitrary or discriminatory way.” Fox, 567 U.S. at 253. When a defendant challenges a statute “as applied” to its own conduct, whether the statute is6
vague “turns on whether the statute provided adequate notice to him that his particular conduct was proscribed,” United States v. Harris, 705 F.3d 929, 932 (9th Cir. 2013), and whether a defendant had “adequate notice” turns on the facts of the case at hand, see id.; see also United States v. Lusby, 2022 WL 16570816, at *1 (9th Cir. Nov. 1, 2022) (“[v]agueness challenges may arise as either facial or as-applied objections [. . . ] the latter argues that the law is impermissibly vague under the ‘facts of the case at hand.‘“).
Kraken asserts that it “did not have, and [the SEC] failed to provide, fair notice that Kraken‘s conduct was in violation of the law, in contravention of [Kraken‘s] due process rights.” Answer 71 (Ninth Defense). It contends that the securities laws and the test formulated by the United States Supreme Court in Howey are “impermissibly vague” as applied to the transactions on its platform because an entity of ordinary intelligence in Kraken‘s position would not reasonably know if or when the SEC (or a court) would determine that a digital asset rises to the level of a “security” or “investment contract.” Answer 72 (Tenth Defense).7
When the Supreme Court defined the term “investment contract” in Howey, it “use[d] the7
terms ‘contract, transition, or scheme,’ ... leaving open the possibility that the security is not formed of one neat, tidy certificate, but a general ‘scheme’ of profit seeking activities.” Hocking v. Dubois, 885 F.2d 1449, 1457 (9th Cir. 1989); see also Prior Order 14 (discussing the Howey test for investment contracts). In its motion to dismiss, Kraken argued that when the at-issue assets were put to the Howey test, they failed it, meaning that the SEC‘s theory of liability was a non-starter. I found its argument to be unpersuasive. Taking the facts as the SEC pleaded them to be true, I determined that it was plausible that the at-issue assets formed the basis of investment contracts that are subject to securities laws. See generally Prior Order. But to obtain judgment on Kraken‘s fair notice and due process defenses, the SEC would have to show that any ordinary entity in Kraken‘s position would understand that the Howey test, as applied to the secondary market transactions on Kraken‘s platform, establishes that those transactions are investment contracts. It has not made such a showing.
The parties have conflicting perspectives on the impact of the SEC‘s publications about cryptocurrency regulation, and it is not yet clear whose will prevail. As the Southern District of New York observed in SEC v. Terraform Labs Pte. Ltd., 684 F. Supp. 3d 170, 192 (S.D.N.Y. 2023), the question of whether a cryptocurrency network had “fair notice” that its conduct breached securities laws depends on whether the SEC, “through its regulations, written guidance, litigation, or other actions [] provided a reasonable person operating within the defendant‘s industry fair notice that their conduct may prompt an enforcement action by the SEC.” Terraform Labs, 684 F. Supp. 3d at 192.
Kraken argues that the SEC‘s publications and actions were confusing and unclear. For example, the SEC says that Bitcoin and Ether (which the SEC has explicitly stated are not traded as securities) are unrelated to the digital assets traded on Kraken and named in the Complaint, but Kraken insists that it reasonably understood them to be related. See Oppo. 14, n.6. Kraken argues that the SEC‘s public commentary regarding cryptocurrency would suggest to an ordinarily intelligent entity in Kraken‘s position that its activities fell outside of the SEC‘s regulatory purview. See id. 14:1-15.8 In response,
Determining whether a defendant had fair notice of its purported offense requires examination of the facts of the case. The SEC‘s previous lawsuits, its public commentary, and its testimony in front of Congress all inform that examination. The SEC offers no authority that I should not consider its conduct over the last seven years. Indeed, other courts in similar lawsuits have held that it can be relevant. See Terraform Labs, 684 F. Supp. 3d at 192.
The Third Circuit‘s recent analysis in Coinbase, Inc. v. SEC, No. 23-3202, 2025 WL 78330 (3d Cir. Jan. 13, 2025), is consistent with this approach. In that case, the court required the SEC to provide a more thorough explanation for its denial of Coinbase‘s rulemaking petition to mandate that the SEC clarify how and when the federal securities laws apply to digital assets like cryptocurrencies and tokens. It discussed the fair notice and due process arguments made by Coinbase: it found that while those arguments did not apply in the rulemaking context, they would in enforcement actions, which “turn on case-dependent factors like what kind of digital asset is at issue” and “how far [the SEC‘s] interpretation of the statute or regulation deviates from its prior positions.” Coinbase, Inc., 2025 WL 78330, at *10. Judge Bibas‘s concurrence also takes aim at whether the SEC has provided fair notice and due process protections for cryptocurrency8
networks. See id., at *20-29 (Bibas, J., concurring). The opinion makes clear that fair notice and due process affirmative defenses are appropriately part of the litigation of enforcement actions. See generally id., at *9-11; id., at *9 (explaining that the appropriate way for Coinbase to raise a fair-notice argument would be as a defense in an enforcement action, rather than “on appeal from a petition to begin broad and open-ended rulemaking“).
The SEC cites Kashem v. Barr, 941 F.3d 358, 371 (9th Cir. 2019), for the rule that “[s]ubjective information about the defendant‘s mindset (or the enforcers of the statute) is irrelevant,” and as such, I do not need to consider Kraken‘s offered factual disputes about the SEC‘s regulatory behavior with respect to cryptocurrency leading up to this lawsuit. See Motion 9-10. But Kashem was a very different case. There, the Ninth Circuit held that the plaintiff had fair notice that his conduct would flag him for inclusion on the No-Fly List, where he had traveled to a foreign country to “fight jihad and to train for jihad” and received weapons at a terrorist training camp, both of which were activities clearly contemplated by the relevant national security statute that dictated who appeared on the No-Fly List. Kashem, at 374. Considering those facts, the court, in determining whether the relevant anti-terrorism statute was vague as-applied, chose not to factor in the government‘s failure to provide criteria about what kinds of associations designated someone for the No-Fly List. It explained that a person of ordinary intelligence in Kashem‘s position would recognize that his behavior (traveling for the purposes of engaging in jihad and receiving weapons from a terrorist training camp) qualified him for the list. Id.
The SEC insists that like the court in Kashem, I have all I need to resolve the as-applied challenge because I have the statutory language itself, the caselaw interpreting the Exchange Act, and a “factual sketch of Kraken‘s conduct” such that I
The SEC is over-simplifying the issues before me. Kraken has assured the court that it will not argue in its defense that it lacked fair notice that the Howey test provided the definition for “investment contract” and “security“; it will argue that as applied to the relatively novel facts of this case, which include but are not limited to the SEC‘s own published guidance and past behavior around cryptocurrency regulation, Howey and it is progeny are vague.10 Unlike the situation in Kashem, there is room in this case for Kraken to argue in its defense that an entity of ordinary intelligence in its position would not understand how the Howey test applies to the transactions on its platform.11
The SEC also argues that, by taking judicial notice of all of the documents presented by Kraken, see supra, n.8, I have all of the evidence necessary to make a decision on these affirmative defenses. I do not know whether that is correct. I agree that the SEC‘s public actions, whether through comments, publications, administrative proceedings or litigation, will form the bulk of the relevant record of what Kraken would have had fair notice of. And
ability to propound other discovery that it considers material to these defenses. If the parties disagree after meeting and conferring about relevance, proportionality, privacy, or other concerns regarding specific discovery requests, they may present their dispute in a five-page, joint letter.
CONCLUSION
The SEC‘s motion for judgment is GRANTED on Kraken‘s major questions doctrine defense (Eighth Defense). The motion is DENIED for its fair notice and due process defenses (Ninth and Tenth Defenses).
IT IS SO ORDERED.
Dated: January 24, 2025
William H. Orrick
United States District Judge