On June 5, 2023, the Securities Exchange Commission filed a Complaint in the District of Columbia against Binance, one of the largest cryptocurrency exchanges in the world, and its founder. Specifically, the Complaint names Binance Holdings Limited (Binance), BAM Trading Services Inc. (Binance.US), BAM Management US Holdings Inc. and Binance’s founder, Changpeng Zhao (CZ). The filing comes just a few months after Binance was named as a counterparty in an order against the little-known cryptocurrency exchange Bitzlato, accused of laundering $700 million by U.S. authorities on Wednesday.
Binance is the world’s largest crypto exchanges by volume and the opacity of its corporate structure and principal place of business, which CZ has said is wherever he is located at any point and time, has seemingly caused consternation among regulators. The allegations against Binance provide an in-depth view of Binance’s international corporate and operational structure.
The Complaint alleges numerous violations of the Securities Act and the Securities Exchange Act, including the offer and sale of unregistered securities and the unlawful operation of an exchange, broker-dealer, and clearing agency, the same violations alleged in recent actions filed against Bittrex and Coinbase. While Bittrex exited the U.S. market in response to the SEC’s complaint against it, Binance and Coinbase vowed to defend the suits. The Complaint against Binance also contains allegations of fraud and control person liability, as well as a unique allegation that Binance’s stablecoin is an investment contract.
1. Operation of an Unregistered Exchange, Broker-Dealer, and Clearing Agency
The SEC alleges violations by Binance and Binance US on the basis that both platforms offered various services in violation of the Securities Act and Exchange Act. It alleges Binance, by offering its services to U.S. persons through the Binance.com platform, provided exchange, broker-dealer, and clearing agency services to U.S. persons. Generally, an exchange provides a marketplace for bringing together orders of securities of multiple buyers and sellers with set rules regarding order execution. Brokers and dealers are members of securities exchanges that aggregate orders and effect transactions for the accounts of others or for their own accounts, respectively. Clearing agencies are intermediaries that act as custodians of securities and funds and facilitate the settlement of securities transactions.
On a securities exchange that does not exchange crypto assets, customers do not interact directly with the exchange. Instead, brokers aggregate orders from customers and submit the orders on the customers’ behalf. Importantly, these functions cannot be performed by the same entity. The public policy reasons for prohibiting the same entity from performing such activities is to protect customer assets, prevent market manipulation, and promote fair and efficient operation of securities markets.
In the Complaint, the SEC alleges Binance and Binance US provided a marketplace and facilities for trading securities (e.g. providing an order Book, order Matching, trading Rules, and and OTC Desk), holds and controls customer funds, clears and settles trades, and receives compensation for such services. Importantly, the SEC has asserted violations against Binance, and not just Binance US, by alleging it actively solicited investors in the United States to trade crypto assets that are securities on Binance.com.
2. Liability as to Binance and CZ for Substantial Control Over Binance.US Operations
Regulatory agencies in the U.S. generally do not have jurisdiction over non-U.S. organizations that do not have a nexus to the U.S. Similarly, the SEC does not have jurisdiction over an individual serving solely as an executive to a non-U.S. organization simply by asserting claims against its U.S. subsidiary or affiliate. But where a non-U.S. entity or executive directly or indirectly controls the U.S. entity, it may be held liable for certain violations of law by the U.S. entity under a theory of control person liability.
Control person liability provides for liability against those who control, directly or indirectly, an entity or individual that violates the securities laws. The SEC and plaintiffs in private actions may assert control person claims against officers or directors who exercise control over a company that violates the securities laws based on the control person’s oversight and ultimate responsibility over such company.
In this case, the SEC asserted that CZ and Binance exerted substantial control over and were integral participants in the operations of Binance.US. The Complaint spends more than 60 pages on developing facts that, if proven, substantiate the assertion that CZ and Binance controlled Binance.US and directly offered Binance’s services to U.S. Persons. For example, the Complaint alleges Binance and CZ publicly touted restrictions banning U.S. persons and undermined its own compliance procedures by assisting and directing U.S. persons to use VPNs to circumvent geographic blocking of U.S. IP addresses. The Complaint also details the reported strategy of using a “Tai Chi” entity – Binance.US – as a magnet for U.S. regulatory action that could insulate Binance from liability.
Despite the existence of multiple service-level agreements between the various entities identified in the Complaint, the SEC asserted that Binance and CZ had de facto control of Binance.US, highlighting the absence of legitimate and transparent operational and financial controls among the various entities. According to the Complaint, CZ (1) beneficially owned between 81% and 100% of the U.S. entities; (2) directed the selection of crypto assets for listing on Binance.US; (3) with Binance, controlled bank accounts and finances of Binance.US.; (4) with Binance, controlled customer funds and crypto assets deposited, held, or traded with Binance.US; and (5) with Binance, directed Binance.US to engage market makers controlled by CZ. Lastly, the SEC claims Binance.US’s CEOs lacked meaningful independence from CZ and Binance, summed up by reference to the effort dubbed “Project 1776” by one of two former CEOs of Binance.US who provided testimony to the SEC.
The SEC alleges that under CZ’s control Binance and Binance.US provided exchange services, clearing agency functions, and brokerage services to U.S. customers. In support, the SEC asserted Binance commingled marketing efforts with Binance.US for the products and incentives of both platforms, allowed personnel to perform trade management functions and backend customer service operations for Binance.US, and held and controlled the crypto assets deposited and traded with Binance.US. It also alleged Binance.US used CZ-owned counterparties for order fulfillment and other trading functions.
3. Fraud as to Binance.US and Direct Parent
The Complaint also alleges that BAM Trading and BAM Management engaged in acts and practices that operated as a fraud and deceit upon, and made false and misleading statements to, customers using the Binance.US platform and investors in BAM Management. The fraud charges stem from claims that both entities touted non-existent controls to prevent manipulative trading on the platform when promoting the Binance.US platform and in presentations to investors. According to the SEC, despite launching in September 2019, Binance.US had implemented no trade surveillance or controls through at least February 2022. The SEC also claims these entities misleadingly touted the trading volume of the Binance.US platform and of various crypto assets, including through Binance’s affiliate, CoinMarketCap, despite having knowledge that substantial trading volume on the platform was attributed to wash trading. The SEC not only alleges that CZ knew wash trading occurred on the Binance.US platform, but that much of it occurred through numerous accounts affiliated with Sigma Chain, an entity he owned and operated using Binance employees.
Even so, a false or misleading statement must be material for the SEC to prevail on a claim for fraud. These statements are clearly material to equity investors as they go to the legality and profitability of the services offered in the U.S. Whether such statements were material to U.S. customers using the Binance.US platform is likely to be a hotly contested issue. Query whether users truly discern which exchange to use based on statements like the ones alleged in the Complaint.
4. Unregistered Offer and Sale of Securities
The Complaint alleges Binance and Binance.US illegally conducted offers and sales of securities to U.S. persons. It alleges Binance did so by offering BNB, BUSD, “BNB Vault,” and “Simple Earn.,” and that Binance.US did so by offering its staking program. Additionally, the SEC provided a non-exhaustive list of crypto assets sold on Binance.com and Binance.US and alleged to be securities: SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI
The SEC alleged the following with respect to BNB:
- In June 2017, Binance began issuing BNB—which was called “Binance Coin” until February 2022—in an ICO explicitly meant to fund the launch of the Binance.com Platform in July 2017.
- Binance marketed and sold BNB to investors globally.
- Binance offered 100 million of the 200 million BNB in the ICO at approximately $0.15 per coin.
- Purchasers had a reasonable expectation of profits because Binance promised to use its profits from the Binance.com Platform to repurchase and burn BNB.
- Binance also created an expectation of profits by creating additional financial incentives to buy BNB, thereby increasing demand for BNB, and its value. For example, Binance offered a 25 percent discount when investors used BNB to purchase a crypto asset. In other words, the trading discounts that Binance offered BNB purchasers further tie BNB’s success, and thus BNB purchasers’ profits, to Binance’s success.
Consistent with its approach in other cases, the SEC alleges that Binance created demand for BNB through financial incentives such as trading discounts to support its contention that Binance created an expectation of profits in purchasers of BNB. Typically, the SEC alleges the Howey prong – an expectation of profits based on the efforts – is satisfied by alleging demand for the token is stimulated in a number of ways. As seen in this Complaint against Binance, the Coinbase Complaint, and the Bittrex Complaint, the SEC typically alleges demand for a token is stoked when a contributing developer or entity discusses the superiority of the underlying protocol for the native token, a contributing developer or entity discusses the contributing team’s technical expertise, or, as is the case here, a deflationary mechanism is implemented and publicly discussed.
Certain language used by Binance to market BNB is particularly problematic. For example, the SEC cites to multiple instances in which Binance refers to purchasers of BNB as investors. Binance also described the repurchase and burning of BNB as functionally equivalent to a dividend. The SEC also alleges purchasers of BNB have an expectation of profits from Binance’s “venture capital arm,” Binance Labs, which apparently invested $500 million in grants to individuals and entities developing applications for the Binance blockchain. Binance also offered BNB as compensation to employees for salaries and pursuant to an employee incentive plan.
The SEC also alleges BUSD, a stablecoin redeemable on a 1:1 basis for U.S. dollars, is an investment contract from which investors expect profits. It asserts BUSD constitutes an investment contract because (1) investors contributed money for BUSD; (2) proceeds from said purchases were pooled in reserves; (3) Binance used a portion of the returns earned from such proceeds to “promote the Binance ecosystem that gave BUSD its profit potential,” and (4) Binance offered a reward program that promised payments to BUSD holders for holding BUSD on the Ethereum blockchain.
The SEC conflates two groups of BUSD holders – those who merely own BUSD and those who own BUSD and opt into Binance’s rewards program – to advance the theory that BUSD is an investment contract. Indeed, Binance has been unequivocal that BUSD is a fiat-backed stablecoin that maintains a U.S. dollar peg. The SEC’s approach illustrates its contempt for all things crypto and is consistent with its stance in other cases that the token itself embodies an investment contract.
- BNB Vault and Simple Earn
The SEC alleged the following with respect to BNB Vault and Simple Earn:
- Binance marketed Simple Earn as a program that pay interest to investors who lend their crypto assets to Binance for fixed or flexible lengths of time.
- Binance pooled assets loaned through Simple Earn and used its managerial expertise to deploy them “for a variety of purposes.
- BNB Vault is a similar program that is limited to holders of BNB and described on Binance.com as a “BNB yield aggregator” whereby investors can lend their BNB to Binance to earn investment returns.
- Binance exercises discretion and uses its entrepreneurial expertise in managing both programs, including identifying liquidity needs, negotiating with Launchpool issuers, choosing terms, holding and controlling the invested assets, and generating revenue, through its operation of the Binance.com Platform to pay the Simple Earn and BNB Vault investors.
- BNB “deposited” in BNB Vault will be “flexibly allocated in different products to help users maximize potential rewards.
- In both the Simple Earn and BNB Vault programs, Binance pools the crypto assets lent by investors and uses those assets to generate revenue that was used to pay returns to investors pro rata.
- Binance exercises discretion and expertise in managing both programs.
These characteristics are certainly indicative of an investment contract. For this reason, Binance did not offer such programs on the Binance.US platform. Instead, such programs were only available on Binance.com. Because Section 5 of the Securities Act is a strict liability statute, Binance can be held liable for failure to block U.S. persons from accessing such products. Here, SEC alleges “at least 3,200 and as many as 16,500 U.S. investors have participated in the Simple Earn investment programs, and at least 1,400 U.S. investors have participated in the BNB Vault program.”
- Staking Program
Since Kraken settled charges with the SEC stemming from its offer and sale of its crypto asset “staking services” to the general public, many have speculated that the SEC would bring similar actions against the other major U.S. crypto exchanges providing staking services. In that case, the SEC alleged Kraken pooled tokens and designated some for staking and some for reserve.
In the Kraken Complaint, the SEC alleged that Kraken’s staking program constituted an investment contract because customers received certain benefits based on the efforts of Kraken that would otherwise be unavailable when staking as an individual.
The benefits offered by Binance and Kraken’s staking programs are substantially similar according to the complaints, and such benefits include:
- instant reward accrual;
- shorter holding periods;
- low (or no) upfront deposits or staking minimums;
- compensation for slashing penalties;
- regularly scheduled payouts at certain rates;
- pro rata payouts; and
- an easy-to-use interface.
In both complaints, the SEC alleged Binance and Kraken exerted essential managerial efforts in determining how and when tokens are staked and rewards are distributed. The SEC also stressed that staking requires “considerable technical know-how,” and participants could benefit from Binance’s expertise, industry relationships, and infrastructure to generate passive income through staking. In light of these assertions, the Court will consider whether the efforts of Binance in fact constitute essential managerial efforts or are ministerial in nature.
- Crypto Asset Securities Offered on Binance.com and Binance.US
The SEC deemed 10 tokens securities in the Binance Complaint, including layer 1 tokens, layer 2 tokens, game platform tokens, and a data storage network token. Specifically, the SEC identified SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS and COTI as being investment contracts from the time each token was first offered and sold on each of the Binance platforms.
A common denominator with respect to each token is that the proceeds from the initial sales of the tokens were deployed, directly or indirectly, to develop or improve the protocol for each native token. The SEC also highlighted marketing efforts, development expertise, and deflationary mechanisms to assert individuals, teams, and entities stoked demand for the tokens.
The SEC is seeking relief permanently enjoining (i) Binance, BAM Trading, and CZ from further Exchange Act violations by continuing to act as an unregistered broker, unregistered exchange, and unregistered clearing agency; (ii) Binance and BAM Trading from further violations of the Securities Act by continuing to engage in unregistered securities offerings; and (iii) BAM Trading and BAM Management from further misleading and deceptive conduct in violation of the charged provisions of the Securities Act. In addition, the SEC is seeking disgorgement of all ill-gotten gains from the foregoing alleged Exchange Act and Securities Act violations, as well as civil monetary penalties against each defendant to the Binance Complaint. Importantly, the SEC did not allege scienter-based violations (i.e., those committed either knowingly or recklessly) but nonetheless, the SEC sought to permanently bar CZ from acting as an officer or director of any SEC-reporting company or issuer of SEC-registered securities.
Motion for Temporary Restraining Order
One day after filing the Complaint, the SEC filed an emergency action seeking, among other relief, a temporary restraining order freezing the assets of BAM Management and directing the repatriation of all assets held for the benefit of customers of the Binance.US trading platform. The SEC also seeks other emergency relief, including orders prohibiting the destruction of records, requiring sworn accountings of certain assets, and for expedited discovery and alternative service.
Binance is expected to vigorously defend the suit, especially given the allegations ensnare CZ personally and Binance global. While those claims are not present in the Coinbase action, both cases bring the same important regulatory issues front and center and represent the culmination of years of regulatory uncertainty.
Whether the crypto asset exchanges are in fact operating as unregistered brokers, exchanges, and clearing agencies centers on the key issue of whether the tokens named in the complaints are investment contracts. In each case, the SEC will need to convince the court that just one crypto asset named in its complaint satisfies the Howey test.
One legal theory supported among legal practitioners, legislators, and regulators is that tokens themselves are not investment contracts any more than orange groves in Howey are investment contracts. Instead, the analysis must focus on the agreements or promises made between the issuer and the purchaser to determine whether the specific facts and circumstances of each sale of tokens constitute an investment contract. With respect to this question, we expect the SEC to argue that all the tokens comprising the total supplies of each named asset are investment contracts, a position unsupported in any federal precedent until the LBRY case. The position will be contested, but the fact that the token issuers are not named as defendants presents a procedural quandry.
We continue to follow closely this case and the case against Coinbase as both suits make their way through the Courts and will post pertinent updates as they occur.
 SEC Press Release, SEC Files 13 Charges Against Binance Entities and Founder Changpeng Zhao (Jun. 5, 2023), https://www.sec.gov/news/press-release/2023-101.
 SEC Press Release, SEC Charges Crypto Asset Trading Platform Bittrex and Its Former CEO for Operating an Unregistered Exchange, Broker, and Clearing Agency (April 17, 2023) https://www.sec.gov/litigation/litreleases/2023/lr25694.htm
 An “exchange” is defined as “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.” Section 3(a)(1) of the Exchange Act. The term includes including “[a]n organization, association, or group of persons,” as one that: “(1) [b]rings together the orders for securities of multiple buyers and sellers; and (2) [u]ses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.” Exchange Act Rule 3b-16(a).
 A “broker” is defined generally as any person engaged in the business of effecting transactions in securities for the accounts of others, while a “dealer” is defined as any person engaged in the business of buying and selling securities for its own account. These terms are defined, respectively, under Section 3(a)(4) and 3(a)(5) of the Exchange Act.
 A “clearing agency” is defined by Section 3(a)(23)(A) of the Exchange Act and generally includes any person acting as an intermediary in making payments or deliveries in connection with securities transactions or provides facilities to compare data regarding the terms of settlement of securities transactions. A person acting as custodians of fungible securities or otherwise permitting the settlement, lending, or rehypothecation of securities without physical delivery is also generally considered a clearing agency.
 SEC Press Release, Kraken to Discontinue Unregistered Offer and Sale of Crypto Asset Staking-As-A-Service Program and Pay $30 Million to Settle SEC Charges (February 9, 2023) https://www.sec.gov/news/press-release/2023-25