How do lawyers view the $4.3 billion settlement case of Binance?

What is the Legal Community's Perception of the $4.3 Billion Settlement Case Involving Binance?

Article by: Lawyer Liu Honglin, Man Kun Law Firm, Shanghai

On November 21, 2023, according to Bloomberg, the U.S. Department of Justice is seeking over $4 billion in fines from Binance to resolve a long-term investigation into the world’s largest cryptocurrency exchange. Subsequently, Binance reached a major settlement with the U.S. government. According to a plea agreement, CZ admitted to violating the Bank Secrecy Act and other related laws, agreed to pay a $50 million fine, resign as CEO of Binance, and refrain from participating in the operation of Binance for three years. Binance will pay approximately $1.805 billion in fines and $2.511 billion in judgments within 15 months after the verdict.

Emotions can hurt finances, and Binance has been emotionally entangled with U.S. regulatory agencies for a long time. On June 5, 2023, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against Binance and its CEO, Changpeng Zhao (CZ), accusing them of mishandling customer funds, misleading investors, and regulators. Binance illegally raised funds from U.S. investors through the sale of tokens such as BNB and BUSD and made billions of dollars in profit by selling other unregistered securities, with total revenue reaching $11.6 billion.

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The U.S. Securities and Exchange Commission (SEC) is one of the most important financial regulatory agencies in the United States. Its responsibilities include protecting investors, maintaining fair, orderly, and efficient markets, and promoting capital formation. How should we view the “lawsuit + fine” combo led by the U.S. SEC? Lawyer Honglin will discuss this with everyone in this article.

01. What does the SEC consider as securities?

The SEC’s criteria for determining whether a blockchain project is a security are based on the so-called “Howey Test” established by the U.S. Supreme Court in the 1946 Howey case. According to this test, if an investment contract meets the following four conditions, it qualifies as a security:

• The investor contributes money or something of value

• The investor expects to profit from the investment

• The investor relies on the efforts of a third party (such as a company or project team) to generate profits

• The investors have a common enterprise or mutual interest

The SEC believes that many blockchain projects raise funds through the issuance of tokens or cryptocurrencies, which qualify as securities and must comply with U.S. securities regulations. If these projects do not register or apply for an exemption with the SEC in advance, they may be sued by the SEC and required to cease their illegal activities, as well as pay fines and compensations.

02, SEC’s Past Revenue Record

Since 2017, quite a few blockchain projects have been lucky enough to attract the attention of the SEC. Here are some notable highlights:

• In December 2017, the SEC filed an administrative lawsuit against Munchee for allegedly conducting a public offering of MUN tokens without registration. Munchee is a blockchain-based food review platform that planned to reward users and businesses with MUN tokens. The SEC considered MUN tokens as securities due to Munchee’s promises of future token appreciation and listing on major exchanges in their whitepaper and social media. Munchee agreed to cease the token offering and returned $1.2 million to investors.

• In September 2018, the SEC filed a civil lawsuit against Block.one for allegedly conducting a public offering of EOS tokens without registration. Block.one is a blockchain-based smart contract platform that raised $4 billion through the sale of EOS tokens. The SEC classified EOS tokens as securities due to Block.one’s promotion of multiple future uses and listing on major exchanges on their website and social media. Block.one agreed to pay a $24 million fine to settle the case.

• In October 2019, the SEC filed an emergency lawsuit against Telegram Group Inc. and TON Issuer Inc. to halt the issuance of GRAM tokens. Telegram Group Inc. is a blockchain-based communication platform that raised $1.7 billion through the sale of GRAM tokens. The SEC considered GRAM tokens as securities due to Telegram Group Inc.’s promises of multiple future uses and listing on major exchanges in their whitepaper and private placement agreements. Telegram Group Inc. agreed to refund $1.22 billion to investors and pay a $18 million fine to settle the case.

• In December 2020, the SEC filed a civil lawsuit against Ripple Labs Inc. and its two executives for allegedly conducting a public offering of XRP tokens without registration. Ripple Labs Inc. is a blockchain-based cross-border payment platform that facilitates value transfer through XRP tokens. The SEC classified XRP tokens as securities due to Ripple Labs Inc. and its executives’ promotion of multiple future uses and listing on major exchanges on their website and social media. The SEC demanded Ripple to cease the token offering, return the illegal proceeds with interest, and pay civil fines. This lawsuit caused a significant drop in XRP token price and multiple exchanges delisted it. Ripple Labs Inc. and its executives denied the SEC’s allegations and claimed that XRP tokens are a form of currency, not securities.

• In June 2021, the SEC filed a lawsuit against Coinbase, the largest cryptocurrency exchange in the United States, accusing it of operating as an unregistered securities exchange, broker-dealer, and clearinghouse for its cryptocurrency trading platform. The SEC also claimed that Coinbase provided and sold securities related to its yield service plan without registration. The SEC demanded Coinbase to cease its illegal activities, surrender the illegal proceeds with interest, and pay civil fines.

These cases are just the tip of the iceberg when it comes to SEC’s regulatory enforcement actions against blockchain companies. It is believed that more talented entrepreneurs will be targeted in the future.

03, How to evaluate this phenomenon?

Don’t hit someone in the face, don’t argue without reason. Since the conversation has come to this point, let’s try to understand the initial intention behind his lawsuits against blockchain companies from the perspective of motivation:

Protect investors from fraud and deception. The SEC believes that blockchain is a potential innovative technology, but it also needs to develop within a legal, compliant, and reasonable framework. By suing these projects, the SEC can promote self-discipline, self-regulation, and self-strengthening in the blockchain industry. From the SEC’s perspective, many blockchain projects attract investors through false or exaggerated advertising, when in reality, these projects do not have genuine technology or business models, and there is suspicion of fraud or money laundering. By suing these projects, the SEC can force them to return funds to investors or pay fines, thus protecting the legitimate rights and interests of investors.

Maintain order and norms in the securities market. The SEC believes that many blockchain projects circumvent US securities regulations by issuing tokens or cryptocurrencies, and these regulations are in place to safeguard market openness, fairness, and transparency. By suing these projects, the SEC can compel them to comply with securities regulations, thereby maintaining order and norms in the market.

As ideal as it sounds, the reality is harsh. During the SEC’s lawsuits against blockchain projects, the following issues that have been criticized have indeed arisen:

First, the SEC’s criteria for determining whether a blockchain project is a security are too vague and subjective, without providing sufficient guidance and explanation. This uncertainty may make it difficult for blockchain entrepreneurs to determine whether their projects comply with regulations, thus exposing them to legal risks. Therefore, the SEC’s lawsuits against blockchain projects are prone to legal and ethical controversies. Some believe that the SEC’s actions are protecting the legitimate rights and interests of investors, while others believe that the SEC is abusing its power, which may harm investors’ interests. Cryptocurrencies are a new investment method that comes with high risks and high returns. The SEC’s lawsuits typically cause market panic, leading to significant price fluctuations in cryptocurrencies and causing huge losses for investors.

Second, regulatory authorities overlook the characteristics of the industry and overly rely on punishment and threats. Any emerging field requires time and space for exploration and experimentation. The blockchain industry needs an open, inclusive, and flexible legal and regulatory environment to encourage innovation and trial-and-error, rather than a rigid, conservative, and stringent environment that suppresses innovation and punishes mistakes. The frequent lawsuits by the SEC may make blockchain companies feel uneasy and confused, fearing that any innovative attempts may be targeted by regulations. This fear and uncertainty may hinder the development and application of blockchain technology.

04. How to evaluate this phenomenon?

The SEC’s prosecution of blockchain projects is a double-edged sword, with both positive effects in protecting investors and the market, as well as negative impacts in suppressing innovation and development. As advocates for compliant blockchain practices, we naturally hope that regulatory agencies, like the SEC, can change their attitude and approach towards blockchain technology and cryptocurrencies. They should shift from enforcement and litigation towards communication and negotiation, from repression and punishment towards support and encouragement, and from rigidity and conservatism towards openness and inclusivity. This will promote the healthy development of blockchain technology and truly protect the legitimate rights and interests of investors.

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