On June 5, 2023, the SEC filed an extensive civil complaint against Binance Holdings Limited, its assorted 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
Over the years, the SEC has made it clear that crypto enforcement is one of its highest priorities. In 2022, the SEC brought a total of 30 cryptocurrency-related enforcement actions, a 50% increase from 2021. Also, for the first half of 2023, the SEC is on pace for a 25% increase from last year’s numbers. SEC Chair Gary Gensler made his concerns for the crypto industry clear in a recent Wall Street Journal interview:
“I’ve seen some non-compliance from time to time in traditional finance, but I’ve never seen an entire field built on non-compliance, and frankly, that’s the (cryptocurrency) business model. is.”
The Binance lawsuit illustrates how the SEC will prosecute such wholesale infringement by overlaying operations and participants in the traditional securities industry against their competitors in crypto, taking a utilitarian approach to the crypto industry.
The main defendant, inance Holdings Limited, is a Cayman Islands-based limited liability company that operates the binance.com platform – an international crypto asset-trading platform – serving customers in more than 100 countries.
Binance operates through a web of subsidiaries or affiliated entities in multiple jurisdictions, all linked to Zhao as their beneficial owner. As the complaint puts it, Zhao rejected ‘traditional mindsets’ about corporate formalities and their attendant regulatory requirements, saying, “Wherever I sit is a Binance office. Wherever I meet, someone is a Binance 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 for their own account) must register with the SEC. Any organization or group of persons that provides a marketplace to bring together buyers and sellers of securities constitutes an “exchange” under the Exchange Act and is required to register with the SEC.
Absent an applicable exemption, any company offering its securities for sale must file a registration statement with the SEC that makes material disclosures about the company and its securities. In addition, any person acting as an intermediary in the transfer of payment for a security is required to register with the SEC as a “clearing agency” (subject to available exemptions). Finally, “broker-dealers” are “financial institutions” subject to the Bank Secrecy Act (“BSA”), which the SEC has statutory authority to enforce.
complaint
According to the complaint, Binance was aware of all this. In a chat exchange with a Binance employee, its Chief Compliance Officer (“CCO”) stated: “(w)e are subject to the following US regulators, FinCEN OFAC and SEC, if US users reach .com.” In order to avoid regulation, Binance engaged in an elaborate scheme to hide its United States customer base, thereby violating several laws. In the words of Binance CCO: “We operate as an unlicensed securities exchange in the USA bro.”
At the heart of Binance’s efforts to evade US regulation was manipulation of its KYC processes. Binance has made several public statements disavowing US-based operations and promoting restrictions against US-based activity, “privately encouraging US customers to circumvent these restrictions through the ‘strategic treatment’ of virtual private networks (“VPNs”) that hide their locations. thereby ‘minimizing the financial impact’ of Binance’s public announcements that US investors are banned from the platform.
To hide their US presence, Binance encouraged customers to bypass the geo-blocking of US-based IP addresses by using a VPN service to hide their location. Some “VIP” US-based customers were also encouraged to bypass Binance’s KYC controls by submitting updated KYC information that was omitted by the United States Nexus. Also, as of August 2021, Binance will not require all of its customers to submit KYC documents.
Claims
Binance faces eleven claims for various violations of the Exchange Act. Those counts include engaging in the illegal sale of securities; acting as an unregistered exchange, broker-dealer and clearing agency; Limiting the liability of the person against Sow; and securities fraud.
Interestingly, the SEC brings securities fraud claims under Section 17(a)(2) of the Securities Act, rather than Section 10(b) and Rule 10b-5 of the Exchange Act. Securities fraud is civilly enforced under Rule 10b-5, but in recent years more claims have begun to be brought under SEC 17(a)(2). The elements of Rule 10b-5 and Section 17(a)(2) are identical. In this case, the claim centers on Binance’s statements about its KYC program and exclusion from the United States markets.
The main difference between Section 17(a)(2) and Rule 10(b) is that Section 17(a)(2) does not require scienter, which can be established if the defendant acted negligently. In contrast, a civil violation of Rule 10b-5 requires scienter, so the defendant must have acted negligently. The Section 17(a)(2) action against Binance suggests that the SEC may be more eager to pursue cases under 17(a)(2) to exploit the lack of requisite scienter.
On the minds of many interested in SEC enforcement proceedings is the Supreme Court’s recent announcement that it will address the Court’s 1984 precedent. Chevron USA, Inc. V. NRDC, 467 US 837 (1984) Supp. Chevron set, commonly referred to as Chevron Deference gives federal agencies the power to interpret vague statutes and enforce them as they see fit.
Although unlikely to undermine the SEC’s classification of almost all cryptocurrencies as securities, it is based on the SEC’s interpretation. Howie Test – derived from Supreme Court precedent, not statute – exclusion Chevron The theory could certainly influence the SEC’s rulemaking authority in the crypto space, setting the table for future litigation.
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