FTX knockoff? How serious are the 13 charges filed by the US SEC against Binance?

On June 5, 2023, the U.S. Securities and Exchange Commission ( SEC ) filed 13 charges against Binance entities and founder Changpeng Zhao (CZ), including operating an illegal trading platform in the United States; operating an unregistered exchange, broker-dealer and clearing agency; misusing customer funds; unregistered securities issuance and sales, etc.

In a 136-page lawsuit filed in the federal court for the District of Columbia, the SEC detailed the illegal details of Binance and Zhao Changpeng. SEC Chairman Gary Gensler said in a statement: "Through 13 charges, we accuse Zhao and Binance entities of extensive deception, conflicts of interest, lack of disclosure, and intentional evasion of the law. The public should be careful not to invest any of their hard-earned assets in these illegal platforms."

Mixing of client funds, hundreds of millions of dollars in wash trades

Similar to the charges against Binance’s former competitor FTX and its founder Sam Bankman-Fried , the SEC alleges that CZ and Binance exercised control over customer assets, allowing them to commingle or transfer customer assets at will, including to an entity called Sigma Chain that CZ owned and controlled.

The document further alleges that BAM Trading and BAM Management US Holdings, Inc. (BAM Management) misled investors about non-existent trading controls on the Binance.US platform, and that Sigma Chain engaged in manipulative trading to artificially inflate the platform’s trading volume, with Sigma Chain accounts wash trading 48 of the 51 newly listed crypto assets between January 1, 2022 and June 23, 2022 alone.

Additionally, the complaint alleges that the defendants commingled and sent billions of dollars of investor assets to another company, Merit Peak Limited, which is controlled by Binance founder Changpeng Zhao and appears to have been used to buy and sell cryptocurrencies.

CZ and his holding companies allegedly control 100% of the various entities of Binance and Binance US . Below is a diagram of the shareholding structure of Binance entities:

The SEC also claims that at least $145 million was transferred from Binance.US to the Sigma Chain account in 2021. Another $45 million was deposited into the account from a Nevada trust company associated with Binance.US, and Sigma Chain also used $11 million from the account to purchase a yacht.

It is also worth noting that, similar to the murky structure of FTX and FTX.US, the SEC alleges that Binance has access to Binance.US wallets and assets, as well as the U.S. entity’s custody tools and private keys. Binance was also the designated custodian for crypto assets deposited, held, traded, and/or accrued on the Binance.US platform until at least December 2022. Zhao Changpeng signed off on multiple decisions related to trading services on the Binance.US platform, including the customer account opening process, front-end access development, and the creation of reserves to cover ACH deposits.

The SEC is asking the court to order an immediate “verification” of Binance and Binance.US’s finances, asset freezes and returns, document preservation, and the appointment of a receiver for Binance’s assets.

Binance operates as an unregistered exchange

“With respect to the Binance.US platform, Binance acted together with BAM Trading as an exchange, BAM Trading acted as a broker, and Binance and BAM Trading each acted as a clearing agency without being registered,” the SEC said.

CZ is also accused of violating the Exchange Act "as a controller of Binance and BAM Trading." The filing states: "Under the leadership and control of CZ, Binance and BAM Trading illegally provided three essential securities market functions on the Binance platform—an exchange, a broker-dealer, and a clearing agency—without registering with the SEC. The defendants were keenly aware that U.S. law required registration for these functions, but they chose not to register so they could evade key regulatory oversight designed to protect investors and markets."

“We’re an unlicensed securities exchange in the United States, man,” Binance’s chief compliance officer told a colleague in 2018, according to the filing.

Evading regulation and attracting American customers

Part of the SEC lawsuit references the so-called “Tai Chi” documents, which Forbes first reported in 2020 and appear to be Binance’s plan to formally exit the U.S. market while still maintaining a presence through affiliates. Binance initially sued Forbes over the report in November 2020 before dropping the suit in February 2021.

The lawsuit cites Binance employees who said they discussed ways to allow U.S. customers to trade on binance.com. The document quotes Binance CCO as saying: "On the surface, we don't have U.S. users, but in fact, we should attract them through other creative ways."

“In reality, Binance implemented much of Scheme Tai Chi, Zhao and Binance maintained substantial involvement and control over the U.S. entity, and behind the scenes, Zhao directed Binance to allow and conceal the continued access of many high-value U.S. customers to Binance.com,” the SEC alleged.

The complaint alleges that from June 2018 to July 2021, Binance had revenue of $11.6 billion, most of which came from trading fees, and that Binance.US operated its own over-the-counter trading desk, and for two years its only counterparty was Alameda Research , founded by FTX founder Sam Bankman-Fried.

Selling unregistered securities, at least 12 tokens are securities

The SEC considers BNB, BUSD, and the staking investment products available on Binance.US to be unregistered securities. It also said that BAM Trading’s staking program is an investment contract that falls within its definition of a security.

The filing alleges that Binance and BAM Trading illegally engaged in unregistered offerings and sales of crypto asset securities, including Binance’s own BNB and BUSD, as well as Binance’s profit programs BNB Vault and Simple Earn, and the so-called “staking” investment program available on the Binance.US platform.

The SEC called 12 tokens securities in the lawsuit, namely BNB, BUSD , Solana (SOL), Cardano (ADA), Polygon (MATIC), Filecoin (FIL), Cosmos Hub ( ATOM ), The Sandbox (SAND), Decentraland (MANA), Algorand (ALGO), Axie Infinity (AXS) and Coti ( COTI ).

The SEC said the list was not exhaustive: “Since the launch of the Binance platforms, the defendants have been able to trade crypto assets on those platforms that were offered and sold as investment contracts and, therefore, as securities.”

It is worth noting that the SEC did not list Ethereum as a security in the lawsuit. Bitpush previously reported that SEC Chairman Gary Gensler refused to specify whether ETH was a security during a nearly five-hour hearing in April.

What is the purpose of the SEC?

Binance was founded in 2017 and has quickly grown into a major player in the crypto space. As of last month, more than 40% of crypto transactions were conducted through the Binance platform, according to data provider CCData. The case is wide-ranging and has the potential to reshape the power and wealth landscape in the crypto space.

The SEC and CFTC have been engaged in a turf war to determine who becomes the primary regulator of crypto trading. The CFTC filed charges in March, accusing Binance and its founder Changpeng Zhao of violating federal law by offering unregistered crypto derivatives. Many of the allegations in the SEC lawsuit are similar to the CFTC's complaint. For the SEC, this lawsuit is another major bet that U.S. courts will agree that it has jurisdiction over the crypto industry.

In the lawsuit, the SEC seeks to prevent Binance, Binance.US and "their respective agents" from continuing to violate federal law and requires the defendants to pay "all ill-gotten gains" and pre-judgment interest. Some optimists believe that this accusation is a civil lawsuit and Binance may end up paying a considerable fine to settle.

But some people believe that Binance may be permanently banned from entering the US market. The SEC mentioned in the document that it hopes to prohibit CZ from serving as a senior officer or director of any securities issuer and prevent Binance, Binance.US and CZ from participating in or trading any securities, including crypto-asset securities. The lawsuit states that this also includes preventing the defendant from acting as an unregistered broker, clearing agency or trading with any crypto-asset securities.

Both the CFTC and the SEC have accused Binance of failing to comply with U.S. anti-money laundering laws. The U.S. Treasury Department, which oversees much of the U.S. anti-money laundering system, has not yet responded. If Binance is suspected of violating sanctions, much of the evidence contained in the civil lawsuit could be used to support separate enforcement actions by the Treasury and Justice Departments.

It is still unknown whether Binance can survive this crisis. It said that it hopes the U.S. Congress will intervene and pass bipartisan legislation to establish a viable regulatory system for digital assets to prevent the crypto industry from becoming a "victim of bureaucratic overreach."

Aaron Kaplan, co-founder of Prometheum , a digital asset securities trading platform registered with the SEC and FINRA, tweeted: "This meaningful action by the SEC marks the beginning of the U.S.'s move toward a regulated cryptocurrency market infrastructure, which should ultimately help the industry move forward. I expect this will be a net benefit for American investors and should allow innovation to flourish."