On June 5, 2023, the SEC filed a lengthy civil lawsuit against Binance Holdings Limited, its various affiliates, and its beneficial owner and CEO, Changpeng Zhao, alleging multiple violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.
The SEC and cryptocurrencies
For years, the SEC has made it clear that cryptocurrency enforcement is among its top priorities. In 2022, the SEC filed a total of 30 cryptocurrency-related enforcement actions, 50% more than in 2021. And, through the first half of 2023, the SEC is on track for a more than 25% increase over figures from last year. Gary Gensler, Chairman of the SEC, bluntly expressed his concern for the crypto industry in a recent interview with the Wall Street Journal:
“I’ve seen the occasional breach in traditional finance, but I’ve never seen an entire field so predicated on breaking the law, and frankly, that’s what a lot of those do.” [cryptocurrency] business model is.”
The Binance lawsuit illustrates how the SEC will litigate such an alleged wholesale breach by taking a utilitarian approach to the cryptocurrency industry, essentially overlapping the functions and participants in the traditional securities industry against their cryptocurrency counterparts.
inance Holdings Limited, the lead defendant, is a Cayman Islands-based limited liability company that operates the binance.com platform, an international crypto asset trading platform serving clients in more than 100 countries.
Binance operated through a network of subordinate or affiliated entities, in multiple jurisdictions, all tied to Zhao as their beneficial owner. As the Complaint states, Zhao “has disregarded ‘traditional mindsets’ about corporate formalities and their attendant regulatory requirements,” stating: “Wherever I sit, is the Binance office. Wherever I meet someone, it will be the Binance office.”
In the United States, professionals who participate in the securities market are subject to significant regulatory oversight by the SEC. For example, brokers (those who buy or sell securities on behalf of others) and intermediaries (those who buy or sell securities on their own behalf) must register with the SEC. Any organization or group of persons that provides a marketplace to bring together buyers and sellers of securities constitutes an “exchange” under the Exchange Act, it must register with the SEC.
Unless there is an applicable exemption, any company that offers its securities for sale must file a registration statement with the SEC making significant disclosures about the company and its securities. In addition, any person acting as an intermediary in the exchange of payment for a security constitutes a “clearing agency” which is also required to register with the SEC (again subject to available exemptions). Finally, “brokers” are “financial institutions” subject to the Bank Secrecy Act (“BSA”), which the SEC is legally empowered to enforce.
The complaint
As the Complaint alleges, Binance was aware of all of this. In a chat exchange with a Binance employee, its Chief Compliance Officer (“CCO”) stated: “If US users go to .com [w]We submit to the following US regulators, FinCEN OFAC and SEC.” To avoid regulation, Binance engaged in an extensive scheme to hide its customer base from the United States, thereby violating numerous laws. In the words of the CCO of Binance: “we are operating like a fucking unlicensed exchange in the US bro”.
The heart of Binance’s alleged efforts to evade US regulations was manipulating its KYC processes. Binance made numerous public statements disavowing any US-based activity and promoting restrictions against US-based activity “while privately encouraging US clients to circumvent these restrictions.” restrictions through the ‘strategic treatment’ of virtual private networks (“VPNs”) that would disguise their locations and thereby ‘minimize the economic impact’ of Binance’s public proclamations that it was banning US investors from the platform “.
In order to supposedly disguise its presence in the US, Binance encouraged its clients to bypass the geo-blocking of Binance’s US-based IP addresses by using a VPN service to hide their location. It also encouraged certain US-based “VIP” clients to circumvent Binance’s KYC restrictions by submitting updated KYC information that omitted any ties to the United States. Also, until August 2021, Binance did not require all of its clients to submit KYC documents.
the claims
Binance is facing eleven claims for various violations of the Exchange Law. Those charges include participating in the illegal sale of securities; act as an unregistered exchange, broker-dealer and clearing agency; liability of the controlling person against Zhou; and securities fraud.
Interestingly, the SEC files the securities fraud claim under Section 17(a)(2) of the Securities Act instead of Section 10(b) of the Exchange Act and Rule 10b-5 thereof. Securities fraud is normally civilly enforced under Rule 10b-5, but in recent years the SEC has begun bringing more claims under 17(a)(2). The elements of Rule 10b-5 and Section 17(a)(2) are similar in that each requires a false statement or omission of a material fact. In this case, the claim centers on Binance’s statements about its KYC program and its avoidance of the United States markets.
The key distinction between Section 17(a)(2) and Rule 10(b) is that Section 17(a)(2) does not require scienter and can establish whether the defendant acted negligently. By contrast, a civil violation of Rule 10b-5 requires a scienter, so the defendant must have acted recklessly. Proceeding under Section 17(a)(2) against Binance indicates that the SEC may be more eager to pursue those cases under 17(a)(2) to take advantage of the lack of required knowledge.
On the minds of many interested in SEC enforcement actions is the recent announcement by the Supreme Court that it will address the precedent set by the 1984 Court case. Chevron USA, Inc. v. NRDC, 467 US 837 (1984) forthcoming. The preceding Chevron set, widely referred to as Chevron deference, gives federal agencies the authority to interpret vague statutes and carry them out as they seem reasonable.
While it is unlikely to undermine the SEC’s classification of nearly all cryptocurrencies as securities, which is based on the SEC’s interpretation of the howie test – derived from Supreme Court precedent, not statute – removal of Chevron The doctrine could certainly affect the SEC’s regulatory authority in the crypto space, setting the table for future litigation.
This post SEC Complaint Against Binance Demonstrates Extent of Its Crypto Enforcement Efforts
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