On June 5, 2023, the SEC filed a comprehensive civil suit 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 Crypto
For years, the SEC has made it clear that cryptocurrency enforcement is one of its highest priorities. In 2022, the SEC conducted a total of 30 cryptocurrency-related enforcement actions, a 50% increase from 2021. And in the first half of 2023, the SEC is on track for a more than 25% increase from the figures of last year. SEC Chairman Gary Gensler bluntly expressed his concerns about the crypto industry in a recent interview with the Wall Street Journal:
“I’ve seen some non-compliance from time to time in traditional finance, but I’ve never seen an entire field so built on non-compliance with the law, and frankly that’s what a lot of the [cryptocurrency] business model.”
The Binance lawsuit illustrates how the SEC will litigate such alleged large-scale non-compliance with a utilitarian approach to the crypto industry, essentially overlapping the functions and participants in the traditional securities industry with their crypto counterparts.
inance Holdings Limited, the principal 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 web of subordinate or affiliated entities, in multiple jurisdictions, all connected to Zhao as their beneficial owner. As the complaint explains, Zhao has been “dismissive to ‘traditional mindsets’ about corporate formalities and the related legal requirements”, stating: “Wherever I sit is the Binance office. Everywhere I meet someone, it will be Binance be an office.
In the United States, professionals participating 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 dealers (those who buy or sell securities on their behalf) must register with the SEC. Any organization or group of individuals that provides a marketplace for the bringing together of buyers and sellers of securities constitutes an “exchange” under the Exchange Act and is required to register with the SEC.
Unless there is an applicable exemption, any company offering its securities for sale must file a registration statement with the SEC that discloses material information 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 house” that must also register with the SEC (again, subject to available exemptions). Finally, “broker-dealers” are “financial institutions” subject to the Bank Secrecy Act (“BSA”), which the SEC has the legal authority to enforce.
The complaint
As the complaint claims, Binance was aware of this. In a chat conversation with a Binance employee, the Chief Compliance Officer (“CCO”) stated: “As US users on .com [w]e are subject to the following US regulators, FinCEN OFAC and SEC. To evade regulation, Binance enacted a massive scheme to hide its customer base in the United States, breaking numerous laws. In the words of Binance’s CCO, “we operate like a fking unlicensed stock exchange in the US bro.”
At the heart of Binance’s alleged attempts to evade US regulations was its manipulation of its KYC processes. Binance made numerous public statements decrying any US-based activity and imposing restrictions against US-based activity “while privately encouraging US customers to circumvent these restrictions through the ‘strategic treatment’ of virtual private networks (“VPNs”) which would obscure their locations and thereby ‘minimize the economic impact’ of Binance’s public statements that it banned US investors from the platform.”
To allegedly disguise its presence in the US, Binance encouraged its customers to bypass Binance’s geographic blocking of US-based IP addresses by using a VPN service to hide their location. It also encouraged certain “VIP” US-based clients to circumvent Binance’s KYC restrictions by submitting updated KYC information omitting any US nexus. Furthermore, through August 2021, Binance did not require all of its customers to submit KYC documents.
The claims
Binance is facing eleven claims for various Exchange Act violations. Those counts include engaging in the unlawful sale of securities; act as an unregistered exchange, broker-dealer and clearing house; controlling person liability to Zhou; and securities fraud.
Interestingly, the SEC is bringing 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 below. Securities fraud is usually enforced civilly under Rule 10b-5, but in recent years the SEC has begun filing more claims under 17(a)(2). The elements of Rule 10b-5 and Rule 17(a)(2) are similar in that they each require a false statement or omission of material facts. In this case, the claim focuses on Binance’s statements about its KYC program and avoidance of the US markets.
The main difference between Section 17(a)(2) and Rule 10(b) is that Section 17(a)(2) does not require a scientist and can be established if the defendant acted negligently. In contrast, a civil violation of Rule 10b-5 requires a scientist, so the defendant must have acted recklessly. Section 17(a)(2) proceedings against Binance indicate that the SEC may be more inclined to pursue those cases under 17(a)(2) to take advantage of the lack of required scientist.
Many interested in SEC enforcement actions are concerned with the Supreme Court’s recent announcement that it will address the precedent set by the Court’s 1984 case Chevron USA, Inc. against NRDC, 467 U.S. 837 (1984) next term. The precedent that Chevron set, commonly referred to as Chevron deference, gives federal agencies the power to interpret and enforce vague statutes as they seem reasonable.
While this is unlikely to undermine the SEC’s classification of nearly all cryptocurrencies as securities, which is based on the SEC’s interpretation of the how so test – derived from Supreme Court precedent, not statute – elimination of the Chevron doctrine could certainly affect the SEC’s regulatory authority in the crypto space, setting the table for future litigation.