UPDATE 3-US SEC sues Kraken crypto exchange over failure to register

(Adds Kraken comments, paragraphs 3-4, 9)

By Jonathan Stempel

Nov 20 (Reuters) - Kraken, one of the world's largest cryptocurrency exchanges, was sued on Monday by the U.S. Securities and Exchange Commission, which accused it of illegally operating as a securities exchange without first registering with the regulator.

The lawsuit in San Francisco federal court is the latest step in SEC Chair Gary Gensler's push to bring cryptocurrency under his agency's purview, by contending that digital assets are investment contracts subject to federal securities laws.

Kraken intends to defend itself, saying Congress should decide how to regulate cryptocurrency exchanges and calling the SEC view of digital assets "incorrect as a matter of law, false as a matter of fact, and disastrous as a matter of policy."

The San Francisco-based exchange also said the lawsuit will not affect its more than 10 million clients.

In June, the SEC filed similar lawsuits against Binance, the world's largest cryptocurrency exchange, and Coinbase, the largest in the United States. Both are defending against the regulator's claims.

The SEC said Payward Inc and Payward Ventures Inc, which operate as Kraken, have since 2018 made hundreds of millions of dollars arranging crypto purchases and sales while turning a "blind eye" to securities laws designed to protect investors.

Kraken was also accused of having deficient internal controls and inadequate record keeping, reflected in part in its commingling customer money with its own and paying operating costs directly from customer accounts.

Failing to register has "resulted in a business model rife with conflicts of interest that placed investors' funds at risk," SEC enforcement chief Gurbir Grewal said in a statement. "Kraken's choice of unlawful profits over investor protection is one we see far too often in this space."

In its statement, Kraken said the SEC complaint conceded that any alleged "commingling" amounted to "no more than Kraken spending fees it has already earned."

The SEC also accused Binance of commingling customer funds, following a Reuters report describing such conduct. Binance has denied the commingling accusation.

Monday's lawsuit seeks a civil fine, disgorgement of ill-gotten gains, and a halt to acting as an exchange without registering.

Kraken was founded in 2011. It is backed by investors including Blockchain Capital, Digital Currency Group, Hummingbird Ventures, SkyBridge and Tribe Capital.

The case is SEC v Payward Inc et al, U.S. District Court, Northern District of California, No. 23-06003. (Reporting by Jonathan Stempel in New York; Additional reporting by Chris Prentice; Editing by David Gregorio, Stephen Coates and Chris Reese)