Binance refutes SEC lawsuit point by point, how does the US SEC respond?

Binance Counters Every SEC Allegation in Lawsuit - US SEC's Response to Follow

Source|Protos Authorized for Compilation by Wu Shuo

Compiled|GaryMa Wu Shuo Blockchain

On June 5, 2023, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against Binance and its CEO, Changpeng Zhao (CZ), with billions of dollars in fines. This week, the SEC responded to Binance’s formal motion to dismiss the lawsuit, reiterating and clarifying its claims.

The SEC’s lawsuit accuses Binance of illegally raising funds by selling two tokens, BNB and BUSD, to many U.S. investors. This fundraising, along with the millions of dollars earned by selling other unregistered securities, has generated at least $11.6 billion in revenue.

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In explaining its reasoning, the SEC focuses on the Howey Test, which U.S. courts typically use to determine whether someone is illegally selling cryptocurrency assets. The Howey Test refers to a 1946 Supreme Court decision in SEC v. W.J. Howey Co., where the Supreme Court defined an investment contract as a transaction that meets the following four conditions:

● The investment of money,

● In a common enterprise,

● With an expectation of profits,

● Derived from the efforts of others.

Some of the SEC’s arguments center around the court’s flexible interpretation of the Howey Test in prior cases involving alleged securities. For example, it cites three court rulings that “money” can take various forms, not just legal tender like the U.S. dollar. For instance, goods and services for which someone is willing to pay a monetary value can be exchanged for securities in tangible form.

Binance claims it does not list securities despite the lawsuit

The SEC counters Binance’s claim that it does not list securities using decades of legal precedents. It clarifies that an investment contract is a broad term that includes a wide range of tools used by fundraisers to propel their fundraising efforts.

In fact, the SEC summarizes decades of court rulings supporting its stance: “Congress broadly defined securities to embody a flexible rather than static principle, one that could accommodate the countless and variable schemes devised by those seeking the investment of money in the promises of others for profits. The courts have found various novel or unique investment vehicles to be investment contracts, including those involving orange groves, animal breeding programs, bovine embryos, mobile phones, internet-only businesses, and cryptocurrencies.”

The SEC claims that the price of the BNB token may fluctuate based on Binance’s efforts and luck, making it an enterprise with “vertical commonality.” It rejects Binance’s argument that the long-term performance of BNB is ultimately unrelated to Binance’s efforts.

Binance lawsuit involves vertical commonality

‘Vertical commonality’ exists when the fate of token holders aligns with that of token leaders. The ‘vertical enterprise’ of BNB includes token holders keeping the price high enough for Binance executives to fund the development of the digital asset ecosystem, attract new users through Binance.com, market BNB through Binance’s platform and marketing channels, and develop blockchain funding for BNB.

Through this approach, all efforts of Binance executives are completely aligned with the financial interests of retail BNB token holders. In fact, Binance executives themselves are the largest BNB token holders. Therefore, all BNB token holders share vertical commonality with Binance executives.

The SEC cited the BitConnect case, where the court ruled that “the platform itself is a common enterprise”. In BitConnect, members have vertical commonality; the value of BitConnect tokens (BCC) depends on the synergistic efforts of BCC token holders and promoters.

Pre-orders on Kickstarter are not securities

To clarify that investment contracts do not encompass all types of financial offerings, the SEC cited a case where profits “must come from the efforts of others” in a form of financial return rather than consumption. This excludes most Kickstarter activities, considering whether benefits received for contributing to crowdfunding campaigns count as securities. In other words, simply pre-ordering a product does not create a situation with a reasonable expectation of profits.

Of course, this may not exclude cases where a crowdfunding implies benefits that can be resold to others at a higher price. At that point, a simple pre-order could turn into an unregistered securities offering.

The element of “financial return rather than consumption” also became important in the LBRY case, where tokens could be used to obtain rights to access digitally published files on the LBRY platform, which seemed innocuous. Unfortunately, its supporters further promoted LBRY tokens as a way to profit, and these marketing claims turned LBRY tokens into unregistered securities.

Howey test does not require a written contract

Binance argues that the idea of BNB purchases not involving any investment contracts should be considered by the court. It states that a strict interpretation of the Howey test would require a “contractual arrangement” where the buyer “has a contractual right to share in the profits of the enterprise”.

The SEC rebuts this claim, stating that the Howey test does not require any written contract. It only requires the existence of “contracts, transactions, or schemes” that meet the conditions of the Howey test.

The SEC also rejects Binance’s argument that the transactions on the Binance.com platform did not occur within US territory and therefore are not subject to US securities laws. It claims that Binance sold numerous securities to many US investors.

It references Zhao Changpeng’s “Tai Chi Plan,” which was first exposed by Forbes’ Michael del Castillo and Jason Brett. This plan allowed Binance.com to secretly serve US customers by using BAM Trading as a deceptive agent. The reason why the second CEO of BAM Trading resigned is because, according to this CEO, “CZ is the CEO of BAM Trading, not me.”

In short, the SEC has now formally responded to Binance’s request to dismiss its billion-dollar lawsuit. The SEC points out the weaknesses in Binance’s arguments and highlights Binance’s attempts to distort the meaning of the Howey test.

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