SEC: Binance Misused Customer Funds and Operated an Illegal Cryptocurrency Exchange in the U.S.

Monday, the Securities and Exchange Commission filed a lawsuit against Binance, the largest cryptocurrency exchange in the world, alleging that it operated an unlawful trading platform in the United States and misappropriated customer funds.

Changpeng Zhao, Binance’s founder and controlling shareholder, was also identified as a defendant in the SEC lawsuit. The SEC alleged that Binance and Zhao misappropriated customer funds and redirected them to a trading entity controlled by Zhao. Sigma Chain engaged in manipulative trading to make Binance’s volume appear greater than it actually was, according to the SEC.

The SEC alleged that Binance concealed that it commingled billions of dollars in customer assets and sent them to Merit Peak, which was owned by Zhao. The Wall Street Journal reported that the SEC was investigating the relationship between Binance.US, the newly formed U.S. subsidiary, Sigma Chain, and Merit Peak.

“This will be a landmark case,” said Kurt Gottschall, a partner at Haynes and Boone and former director of the Denver office of the Securities and Exchange Commission. “The SEC appears to be very concerned about the commingling of customer funds.”

The case was filed in federal court in the District of Columbia by the SEC. The agency wrote in its court complaint that Binance demonstrated “blatant disregard for the federal securities laws and the investor and market protections they provide.”

In 2018, Binance’s chief compliance officer was quoted by the SEC as saying, “We are operating as an unlicensed securities exchange in the United States, bro.”

According to documents witnessed by the Journal, the SEC and Justice Department issued subpoenas to Binance’s U.S. subsidiary in late 2020. Officials have increased enforcement efforts over the past year, following the failure of a number of cryptocurrency exchanges, including one of Binance’s chief competitors, FTX.

The lawsuit further complicates Binance’s relationship with U.S. regulators and law enforcement. In March, the Commodity Futures Trading Commission alleged that Binance and Zhao violated agency regulations governing platforms that offer derivatives to American traders. According to individuals with knowledge of the situation, the Justice Department is also investigating Binance’s anti-money laundering program.

In its court filing, the SEC requests that a federal magistrate freeze Binance’s assets and appoint a receiver, who is typically an outside attorney or other professional who assumes control of the company. The receiver is authorized to monitor and preserve the assets of users.

In cases involving fraud, such as Ponzi schemes, or when regulators do not trust management to operate a company in accordance with the law, the SEC typically seeks receivers.

According to Marc Fagel, a former director of the SEC’s San Francisco office, the threshold for a court to order an asset seizure and receivership is high. Regulators must demonstrate to a court that they are likely to prevail and require immediate action to prevent imminent damage to investors. Mr. Fagel remarked, “It would be extremely difficult for them to obtain this.”

Patrick Hillmann, Binance’s chief of strategy, told the Journal that there have been no significant outflows of user funds.

“Our entire team is on standby to ensure systems stability, including withdrawals and deposits,” Zhao said, referring to the potential for customers to withdraw funds.

Binance has stated that it intends to defend its platform and has refuted claims that user assets are stored on Binance.US platform were ever at danger. It had recently been in settlement talks with the SEC, but the regulator chose to sue instead, it said.

“All user assets on Binance and Binance affiliate platforms, including Binance.US, are safe and secure, and we will vigorously defend ourselves against any allegations to the contrary,” stated the company.

Binance.US also stated that it will defend itself against the lawsuit. This is the first federal regulatory action against Binance’s U.S. subsidiary. The CFTC focussed on the global entities of the exchange.

Additionally, the SEC alleged that Binance sold cryptocurrencies, including BNB and BUSD, that should have adhered to investor-protection regulations. According to data from CoinDesk, the value of BNB has decreased by more than 7% over the past 24 hours. Prior to the announcement, the price was down 2.5%.

Bitcoin, the most popular cryptocurrency, fell 4.5% from its 24 hour prior price to trade near $26,000 per unit. It is regarded as a leading indicator for digital assets.

After the lawsuit, executives from two major market makers, which facilitate buying and selling between crypto firms, stated that they were looking for methods to reduce their exposure to Binance. Due to Binance’s dominance in the cryptocurrency trading market, both parties deemed this endeavor to be challenging.

Binance was founded in 2017 and expanded rapidly to become a behemoth in the cryptocurrency industry. According to data provider CCData, more than 40% of all crypto trading occurred on the exchange as of last month. Historically, it has controlled more than two-thirds of crypto trading at periods.

Zhao, the proprietor of Binance, is one of the most prominent figures in crypto. He owns a majority stake in Binance and Binance.US. The Journal has reported that while Zhao and executives portrayed Binance.US as fully independent, both exchanges were profoundly intertwined, sharing staff, finances, and an affiliated entity that bought and sold cryptocurrencies.

“Until at least the end of 2022, Binance, at Zhao’s direction, maintained custody and control of the crypto assets deposited, held, traded, and/or accrued by customers on the Binance.US platform,” according to the SEC.

Nearly all of Binance’s employees focus on clearing and trade settlement. The SEC added that US exchanges were located outside the United States, predominantly in Shanghai. Previously, the Journal reported former Binance.US executives voiced concerns regarding the arrangement.

This month, Binance.com.US personnel did not have sole authority over Binance.US assets, according to the SEC.

The SEC also alleged that as early as 2018, Zhao and his company attempted to circumvent the agency’s regulations while allowing major American traders to use an overseas platform.

The SEC stated that Binance assisted large merchants in circumventing technology designed to prevent American users from accessing Binance.com. Zhao also established Binance.US, which was intended to be a separate entity created for American consumers. The SEC stated that Zhao and Binance controlled the U.S. platform.

In its lawsuit, the SEC also alleged that Binance lacked controls to prevent one of the most fundamental forms of manipulative trading for years. In the month of January 2021, Binance. According to the SEC, US users could still engage in wash trading by submitting both buy and sell orders to trade with themselves. Wash trading is prohibited by U.S. law because it can be used to fraudulently increase volume and manipulate prices.

According to the SEC’s lawsuit, a Binance co-founder wrote in an internal message in 2019 that wash trading “is primarily a compliance or regulation issue.” “We will prevent this if a US compliance or regulation states we must. If not, we will not.”

According to the SEC, Sigma Chain conducted a significant amount of cleanse trading on Binance.US.

The lawsuit provides new insight into how Binance has operated and its profitability — aspects of the exchange’s business that it has been reluctant to discuss, citing its private status. The complaint states that between June 2018 and July 2021, Binance generated at least $11.6 billion in revenue, primarily from transaction fees.

The lawsuit represents a significant wager by the SEC that U.S. courts will recognize its jurisdiction over the crypto industry, which frequently contests that digital assets are securities. The SEC has also filed a lawsuit against Bittrex and informed Coinbase, the largest cryptocurrency exchange in the United States, that it intends to take enforcement action against it.

The lawsuit against Binance alleges that its platforms unlawfully sold and traded ten tokens that are securities in the United States. On the SEC’s list are the cryptocurrencies Solana, Cardano, and Polygon. According to CoinMarketCap, all three rank among the top 10 cryptocurrencies by market capitalization.