SEC Files Lawsuit Against Binance and CEO Changpeng Zhao, Accusing Them of Numerous Securities Violations

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On Monday, the U.S. Securities and Exchange Commission initiated a lawsuit against Binance, the cryptocurrency exchange, as well as its founder and CEO, Changpeng "CZ" Zhao, alleging violations of federal securities laws. Binance operates both Binance.US and its main platform.

The lawsuit claims that Binance, Binance.US, and CZ offered securities to the general public without proper registration, using the BNB token and Binance-linked BUSD stablecoin. Furthermore, it alleges that Binance's staking service violated securities law. BAM Trading, the operating company for Binance.US, and Binance itself are also facing similar charges, including failure to register as a clearing agency, broker, and exchange. The SEC also accuses Binance of allowing customer funds to be commingled, asserts that CZ was secretly controlling Binance.US, and suggests that a CZ-owned entity artificially inflated Binance.US's trading volume.

The lawsuit further claimed numerous instances where Binance permitted individuals from the United States (including U.S. citizens and residents) to engage in trading activities on its platform, despite explicitly stating otherwise.

"As a second part of Zhao’s and Binance’s plan to shield themselves from U.S. regulation, they consistently claimed to the public that the Binance.com Platform did not serve U.S. persons, while simultaneously concealing their efforts to ensure that the most valuable U.S. customers continued trading on the platform," the suit said. "When the Binance.US Platform launched in 2019, Binance announced that it was implementing controls to block U.S. customers from the Binance.com Platform. In reality, Binance did the opposite. Zhao directed Binance to assist certain high-value U.S. customers in circumventing those controls and to do so surreptitiously because – as Zhao himself acknowledged – Binance did not want to 'be held accountable' for these actions."

Additionally, the SEC accused several other tokens, such as the native coins of the Solana (SOL), Cardano (ADA), Polygon (MATIC), Coti (COTI), and Algorand blockchains (ALGO), as well as the Filecoin network (FIL), Cosmos hub (ATOM), Sandbox platform (SAND), Axie Infinity (AXS), and Decentraland (MANA), of being classified as securities.

Binance's own Chief Compliance Officer told another employee in 2018 that "we are operating as a fking unlicensed securities exchange in the USA," the suit said.

Commingling and diverting funds

The lawsuit asserts that Binance's deficient financial controls led to the misappropriation of customer funds, potentially for personal gain. Shockingly, Merit Peak Limited, a market maker previously linked to Zhao, had unrestricted access to billions of dollars held by customers. Furthermore, the SEC alleges that Sigma Chain, another entity controlled by CZ, received an astonishing sum of nearly $200 million from BAM Trading and a BAM Trading custody account. Adding to the controversy, CZ himself purportedly received a staggering $62.5 million directly from one of Binance's bank accounts during the period spanning October 2022 to January 2023.

"Lacking regulatory oversight, Defendants were free to and did transfer investors’ crypto and fiat assets as Defendants pleased, at times commingling and diverting them in ways that properly registered brokers, dealers, exchanges and clearing agencies would not have been able to do," the suit said.

The SEC reported that Sigma Chain indulged in an extravagant purchase, acquiring a luxurious yacht valued at $11 million, funded through an account with access to customer funds.

The lawsuit alleges that CZ held complete ownership of a company named "CPZ Holdings Limited," which in turn held full ownership of "BAM Management Company Limited." The latter, in its entirety, owned 81% of "BAM Management US Holdings Inc.," with the remaining shares being held by seed investors and former employees. BAM Management US served as the parent company for BAM Trading Services, which operates Binance.US.

The SEC exposed internal conflicts where U.S. CEOs faced challenges with CZ and top officials from Binance exerting control over the U.S. operations, despite assurances of independence. The U.S. operations raised concerns about restrictive measures that required their managers to seek approval from the global company even for routine functions, referring to them as "shackles."

"I realized, huh, I'm not actually the one running this company, and the mission that I believe I signed up for isn't the mission. And as soon as I realized that, I left," former U.S. CEO Brian Brooks – who took over after running the U.S. Office of the Comptroller of the Currency – is quoted as saying, though he's identified only as "CEO B" in the suit. Brooks resigned after just three months at the helm of Binance's U.S. arm.

Brooks expressed specific concerns regarding the activities of Merit Peak and Sigma Chain on the Binance.US platform.

"Our customers couldn't, you know, clear orders without the presence of those makers on our platform, I thought that was a real problem," Brooks is quoted as saying. "It suggested that the company was, in fact, heavily dependent on CZ, not just as a control person but also as an economic counterparty."

In an internal complaint referenced in the lawsuit, Catherine Coley, the inaugural CEO of the U.S. operations, voiced her concerns about her team reaching a breaking point. She described the situation by stating that her entire team was on the verge of burning out. The lawsuit referred to her as "CEO A."

In an interesting turn of events, Coley made an attempt referred to as "Project 1776" at one stage, drawing inspiration from the American Revolution. According to the lawsuit, she confided in a colleague that the project was intended to secure "our independence."

Evading regulation

A portion of the SEC lawsuit refers to the "Tai Chi" documents, which were initially covered by Forbes in 2020. These documents seemed to outline a strategy for Binance to officially withdraw from the United States market, while simultaneously retaining a presence through an affiliate.

The lawsuit includes excerpts from Binance employees discussing potential methods to enable trading for U.S. customers on binance.com.

Furthermore, the Securities and Exchange Commission (SEC) alleged that Binance had unrestricted access to Binance.US's wallets, assets, custody tools, and private keys, raising additional concerns.

Additionally, according to the SEC, Binance enlisted the services of market makers, namely Merit Peak and Sigma Chain, with the aim of inflating trading volume on Binance.US. This arrangement led to conflicts of interest between CZ (Changpeng Zhao) and the customers of Binance.US, as alleged by the SEC.

"To create and maintain liquidity on the Binance.US Platform, BAM Trading recruited market making firms and other institutions, often offering low fees as incentives. Zhao and Binance were intimately involved in these efforts, which placed Zhao’s financial interests at odds with those of the customers trading on the platform he controlled," the SEC said.

The lawsuit further highlighted that Binance.US has its own OTC desk, and during a span of two years, it exclusively engaged with Alameda Research as its counterparty. Alameda Research was established by Sam Bankman-Fried, the founder of FTX. Unfortunately, in November last year, Alameda, along with the entirety of the FTX empire, faced a significant downfall.

'Vigorously defend'

In a long tweet, Binance.US called the suit "the latest example of regulation by enforcement," and said it believed the suit was "baseless."

Binance shared a statement on its blog, saying the company had "actively cooperated with the SEC's investigations and have worked hard to answer their questions and address their concerns," as well as work toward a settlement.

"To be clear: any allegations that user assets on the Binance.US platform have ever been at risk are simply wrong, and there is zero justification for the Staff’s action in light of the ample time the Staff has had to conduct their investigation. All user assets on Binance and Binance affiliate platforms, including Binance.US, are safe and secure, and we will vigorously defend against any allegations to the contrary," the statement said.

In a press release, SEC Chair Gary Gensler said, "Through thirteen charges, we allege that Zhao and Binance entities engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law."

The SEC spokesperson directed CoinDesk to a press release issued by the agency, while a Binance representative provided CoinDesk with a comparable statement in line with their blog post, asserting that the tokens mentioned by the SEC do not qualify as securities.

The SEC lawsuit further compounds the accusations made earlier this year by the U.S. regulatory body, the Commodity Futures Trading Commission (CFTC), which asserted that Binance and its founder Changpeng Zhao deliberately provided unregistered cryptocurrency derivative products in violation of federal regulations in the United States. Numerous allegations in the SEC's lawsuit bear similarities to those outlined in the CFTC's complaint.

CZ expressed his dismissal of the news as "fud" (fear, uncertainty, and doubt) by tweeting a single number, "4."

 

Penalties

The SEC aims to put a stop to Binance, Binance.US, and their respective agents from further breaching federal laws, requiring them to surrender any unlawfully acquired profits along with prejudgment interest, and imposing civil penalties.

Additionally, the Securities and Exchange Commission (SEC) aims to prohibit CZ from holding any positions as an officer or director in any company that issues securities. Moreover, they intend to restrict Binance, Binance.US, and CZ from engaging in the trading or participation of any securities, which encompasses "crypto asset securities" as well.

The lawsuit further specifies that the defendants would be prevented from functioning as unregistered brokers, clearing agencies, or exchanges in relation to any crypto asset securities.

UPDATE (June 5, 16:20 UTC): Adds Binance, Binance.US responses.

UPDATE (June 5, 18:15 UTC): Adds SEC tweet.