Protecting Investors? A Detailed Explanation of the SEC’s Lawsuit Against Binance

SEC's Lawsuit Against Binance: A Detailed Explanation

Those following the overseas virtual asset circle must remember that Binance has been sued before. Starting earlier this year, major encrypted asset trading platforms that operate in the United States have begun to be intensively investigated and prosecuted, and as a cryptogiant, Binance is naturally at the forefront. On March 27, local time in the United States, the US Commodity Futures Trading Commission (CFTC) had already sued Binance and its CEO and founder Zhao Changpeng (hereinafter referred to as “CZ”) in the Federal Court of Chicago. The CFTC accused Binance and CZ of (1) providing regulated products or services to US citizens without legal registration; (2) implementing false compliance to achieve regulatory arbitrage. Interested partners can refer to Sa Jie’s team’s article “From the” Binance “lawsuit, see how difficult it is for encrypted assets to mix in the United States” for a detailed analysis.

Three months later, the SEC has just freed up its hands from an investigation of another top virtual asset trading platform and immediately filed a lawsuit against Binance. Whether this is to protect consumer rights in a race against time or a dispute over jurisdiction is still unclear. Today, Sa Jie’s team will provide a detailed explanation of this case, and as for where the regulatory focus lies, that is up to everyone’s “free interpretation”.

From the SEC’s perspective, what “crime” did Binance commit?

The main subjects of this SEC lawsuit are Binance Holdings Limited, the two entities BAM Trading Services Inc. and BAM Management US Holdings Inc., which are specifically used to operate Binance’s US business, and CZ, Binance’s actual controller.

Sa Jie’s team has compiled hundreds of pages of SEC complaint documents to analyze the following three points of this case:

(1) Operating regulated business without legal registration

SEC first believes that under CZ’s command and control, Binance intentionally provided the following illegal services to the US public on its own platform without registering with the Securities and Exchange Commission in accordance with the requirements of the US Securities Act of 1933 and the Securities Exchange Act of 1934: (1) exchanges; (2) securities brokers and dealers; (3) clearing agencies. This was done in order to evade key regulatory supervision measures to protect investors and the financial consumer market in the United States.

(2) Illegally providing and selling unregistered securities financial products

Entities affiliated with Binance and two BAM entities in the US illegally offered unregistered securities financial products (offering securities with high-risk encrypted assets) to the American public, such as Binance’s own BNB and BUSD, as well as many of its financial products marketed as “wealth management” products. SEC believes that this deprived investors of their right to receive accurate and substantive information, allowing them to invest in high-risk financial products without effective information disclosure.

(3) Implementing planned false compliance measures to arbitrage regulatory requirements

SEC spent a lot of effort analyzing the false compliance plans implemented by Binance and its subsidiary companies and controlling individuals such as CZ to arbitrage regulatory requirements. In several secondary charges, Binance and its affiliates and CZ intentionally made false statements (and raised approximately $200 million in investment and created billions of dollars in transactions), helped high net worth users “bypass compliance regulations,” commingled user funds, and manipulated securities markets (wash trading), among other charges.

Is there anything new under the sun compared to the SEC and CFTC lawsuits?

In the March CFTC lawsuit against Binance, the CFTC mainly accused Binance of two “charges”:

(1) Failure to register with the CFTC and directly provide regulated products or services to the US public.

CFTC believes that Binance’s provision of futures trading and “illegal off-exchange commodity options” directly to the US public without registering with the CFTC as a merchant that can collect futures commissions or as a designated contract market or swap execution facility violates the US Commodity Exchange Act. At the same time, CFTC believes that Binance also had inadequacies in its anti-money laundering obligations and frequent money laundering.

(2) Binance and CZ and other leaders actively provide high-net-worth customers with paths to evade compliance measures.

Binance actively “guided” some customers to use scientific Internet access tools such as VPNs to cover up their true location, and then allowed these customers with unclear identities and locations to trade normally on the Binance platform.

Comparing the charges in the two cases, we can see that there is nothing new under the sun, and the two cases are actually highly similar. The United States has always adopted a decentralized regulatory strategy in the field of financial regulation, dividing financial products into two main categories: securities and commodity futures. The SEC is responsible for regulating financial products classified as “securities,” while the CFTC is responsible for regulating “commodities” such as commodity futures used for investment purposes. In the traditional financial era a century ago, this was an effective and efficient way to improve regulatory effectiveness, but in today’s era of virtual assets with increasingly wide-ranging uses and multiple attributes, it has caused conflicts and contradictions among US financial regulatory agencies. Under the “impossible triangle” of conflicting regulatory interests, there has been a phenomenon of improper allocation of regulatory authority, ultimately resulting in conflicts and contradictions for businesses to bear.

In fact, the core of the conflict between US financial regulators and the two lawsuits is still: what is the legal nature of virtual currency?

From the perspective of the CFTC, according to Section 1a(9) of the US Commodity Exchange Act, “commodity” means wheat, cotton, rice, corn, oats, barley, rye, flaxseed, etc., all other goods and articles; and all services, rights, and interests (except onions and movie box office receipts (or any index, measure, value, or data related to such receipts) and any futures contracts currently or in the future dealing with delivery. This listing + generalization legislative approach gives the CFTC extremely broad “interpretive” space, and anything that meets its legislative generalization criteria can be regarded as a “commodity” and subject to CFTC regulation.

From the perspective of the SEC, the standard for determining whether an investment is a “security” is even clearer: any investment that meets the “Howey Test” standard can be considered a “security” subject to SEC regulation. The Howey Test comes from the famous SEC v. W.J. Howey Co. case, in which the court established four test criteria: (1) whether it is a money investment; (2) whether the investment expects to generate profits; (3) the investment is for a specific enterprise; and (4) the source of the profits comes from the issuer or a third party’s efforts rather than the purchaser himself. Anything that meets the above four criteria can be considered a “security.”

In recent years, due to the unclear nature of virtual currencies, the CFTC and SEC have been rapidly filing lawsuits against various virtual asset service providers, including virtual currency trading platforms and crypto-friendly banks, in order to establish regulatory precedents. The CFTC has established its jurisdictional basis by clarifying the “commodity” nature of virtual currencies through cases such as MyBigCoinBlockingy and Mcdonnell. The SEC has also been quick to act, with a report on an investigation of a DAO organization in July 2017 clarifying that the initial issuance of virtual currencies (ICOs) through distributed ledger or blockchain technology could constitute a securities issuance under U.S. securities laws. In December 2020, the SEC directly targeted Ripple Labs, one of that year’s virtual asset giants, and filed a lawsuit against it for issuing virtual assets, Ripple coins, without registration.

To date, the legal nature of virtual currencies and other virtual assets remains a controversial focus of legal theoretical research and judicial practice, and no authoritative views have emerged. A senior executive of a virtual currency company was quoted by Sajie as saying, “In the United States, the nature of virtual currencies depends on when, where, and to whom you ask.”

The direction and future of the case and whether the Web3 revolution will continue to occur in the United States

In this lawsuit, the SEC has made the following requests:

1. Permanently prohibit the illegal business activities of the defendant;

2. Shut down and ban the interstate trade channels of the defendant and its subsidiaries and controlling persons CZ engaged in related illegal businesses;

3. The defendant shall return the profits obtained from operating illegal businesses and pay the corresponding expected interest;

4. Impose fines on the defendant;

5. Take appropriate or necessary remedial measures to protect the interests of investors.

According to a report released by the defendant in 2019, it has about 1.47 million active users in the United States, including about 3,500 high net worth VIP users, who provide 60% of the virtual asset liquidity. Bloomberg News also reported that about 80% of the defendant’s actual business volume is in the United States in 2022, making the United States an important operating location that the defendant cannot leave.

In the lawsuit, the SEC also harshly criticized the overall business model of companies like Binance. The Sajie team believes that if the court makes a negative evaluation of the common business model of such virtual asset service providers represented by Binance, it will have a serious negative impact on the overall development of the Web3 industry in the United States. This has led Binance to be forced to “fight” the SEC and invest a lot of resources to deal with the lawsuit. In other words, Binance has reached a point where it cannot afford to lose, and the entire Web3 industry in the United States seems to have entered an uncertain situation.

Looking back to June 2022, although the virtual asset circle experienced the Black May incident, Democratic Senator Kirsten Gillibrand and Republican Senator Cynthia Lummis were still confident and jointly proposed a bipartisan and milestone “Responsible Financial Innovation Act” (Lummis-Gillibrand). In the draft of the bill, we can clearly see the proper arrangement of core issues such as the jurisdictional division of the SEC and CFTC, stablecoin regulation, digital asset banking business, and the tax treatment of digital assets. The two senators made it clear that they would use this bill as a continuous regulatory guideline to provide certainty for the virtual asset industry and ultimately ensure that the Web3 revolution occurs in the United States.

Unfortunately, the thunderous bill is still not clear, and the surge in regulatory investigations and lawsuits has increased doubts about the Web3 industry. Will the Web3 revolution still happen in the United States? Or do regulators still want the Web3 revolution to happen in the United States? These are the issues that the SEC and other regulators urgently need to clarify.

Conclusion

The Sajie team also noticed that the regulatory measures for virtual assets in the United States have not made no progress over the years. The legal nature of the regulatory targets is the prerequisite for formulating regulatory norms and achieving effective regulation. On May 19th of this year, when the “Responsible Financial Innovation Act” was “difficult to produce”, Republican House Majority Whip Tom Emmer and Congressman Darren Soto jointly proposed a “Securities Clarity Act”, which aims to clarify the regulatory classification of virtual assets, Provide certainty for innovators, and clarify the jurisdictional boundaries for regulators.

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