5 key highlights of the SEC’s lawsuit against Binance

On June 5, the United States Securities and Exchange Commission (SEC) brought a lawsuit against Binance, claiming that the platform had been involved in the sale of unregistered securities. In its 136-page complaint, the SEC alleged that Binance and its creator Changpeng “CZ” Zhao had been involved in a convoluted conspiracy that included fraud, conflicting interests, a lack of disclosure, and a conscious disregard for the law.

SEC Chair Gary Gensler has reportedly claimed that Binance deceived investors about risk controls, manipulated trade volumes, withheld essential operational information, and disregarded U.S. securities regulations. To prevent oversight from regulators, Binance purportedly developed inadequate safeguards while secretly disregarding them in order to retain its highly valued American clients.

The following are the main points from the SEC’s complaint:

Unregistered securities offering

According to the SEC, Changpeng Zhao has been running Binance.com and Binance.US as exchanges, brokers, dealers, and clearing agencies since July 2017 at least. The complaint alleges that these businesses have gained a minimum of $11.6 billion through multiple sources, such as transaction fees charged to American customers.

The SEC’s complaint alleged that Binance.com should have been registered as a clearing agency, broker-dealer, and exchange, while Binance.US and BAM Trading should have been registered as a clearing agency and exchange, respectively. Additionally, BAM Trading was required to register as a broker-dealer and was accused of offering and selling Binance.US’ staking-as-a-service program without proper authorization.

Controversial practice of allowing US customers to use Binance.com

In 2017, Zhao established Binance in Shanghai, yet the location of its main office has been kept secret ever since. The parent company of Binance is based in the Cayman Islands, thus making its organizational structure more intricate. The Security and Exchange Commission has asserted that, despite publicly affirming that Binance barred US customers from trading, the exchange allowed them to carry on using the platform clandestinely, thus showing a willful disregard for US securities laws.

Binance established a large number of user accounts for people who provided Know Your Customer identity verification information indicating their location in the United States since the launch of the Binance.com platform up until September 2019. Additionally, there were users who seemed to be physically located in the U.S. based on the internet protocol addresses used to access the platform.

CZ as a control person

In 2019, Binance and BAM Trading joined forces to create Binance.US, a platform tailored to American customers and compliant with U.S. regulations. However, the SEC has countered Binance.US’s claim of autonomy, maintaining that Zhao still had control over the company.

Notably, the SEC reported that Zhao instructed Binance.US to integrate Sigma Chain and Merit Peak as market makers, both of which were managed by Binance staff. Since the launch of the Binance.com platform, Merit Peak, owned by Zhao, has provided over-the-counter trading services for Binance. On the Binance.com platform, Merit Peak acted as the counterparty for customers, and on the Binance.US platform, it offered market-making services.

The SEC’s charges against Binance and Coinbase are detrimental to the DeFi sector.

Beginning in 2021, entities affiliated with Binance, under the control of Zhao, transferred customer assets worth billions of dollars to bank accounts held by Merit Peak in the United States. These funds were then transferred to Trust Company A (a New York-based limited purpose trust company), seemingly in connection with the release of Binance’s stablecoin, Binance USD (BUSD). By using Merit Peak as an intermediary to move client funds to purchase BUSD without disclosing the relationship, investors were unknowingly exposed to counterparty risk.

Furthermore, the head of the back office was the primary operator for many of Binance.US’s bank accounts, including one that held funds from American customers, which calls into question the transparency of Binance’s operations and the segregation of funds.

Wash trading on Binance.US platform

According to the SEC’s lawsuit, BAM Trading and BAM Management – which are linked to Binance.US – deceived both clients and shareholders regarding the efficiency of market oversight and the steps taken to detect and prevent manipulative trading on the platform. Nevertheless, wash trading was a regular occurrence on the Binance.US platform, which artificially boosts trading volumes and gives a false impression of market participation. The SEC’s allegations raise questions about the accuracy of trading volume data and the transparency of Binance.US’s market operations.

Prior to the platform’s debut, personnel at BAM Trading were conscious of the potential for wash trading. In a message sent to BAM’s CEO, who is likely Catherine Coley but not mentioned by name, and to senior Binance personnel, the co-founder of Binance and the head of the trade matching engine team expressed worry about the matching engine’s capacity to allow customers to trade with themselves. Nevertheless, they questioned if it was vital to abide by U.S./SEC rules and prevent this form of manipulation.

An employee of Binance in charge of market surveillance was contacted by BAM Trading when it was revealed at a meeting a year later that no measures had been taken to prevent market manipulation. The director of institutional sales at BAM Trading acknowledged the lack of safeguards against wash trading in January 2021. Despite Binance.US declaring that fraudulent trading was not allowed, BAM Trading did not have any transaction surveillance systems in place until February 2022.

It is noteworthy that a significant proportion of the wash trading occurred through accounts linked to Sigma Chain, which acted as a market maker on Binance.US. Both BAM Trading and BAM Management were aware of Sigma Chain’s numerous accounts and its active trading on the Binance.US platform.

Following the launch of Sigma Chain in 2019, wash trading between its accounts allegedly continued until at least June 2022. For example, after the crypto asset security COTI was added to the Binance.US platform on April 6, 2022, the SEC states that Sigma Chain quickly became involved in significant wash trading. Strategically, the platform’s debut, the addition of new securities, and the financing round all happened when investors and stockholders were most vulnerable.

Diversion of customer assets and misuse of funds by Zhao and Binance entities

In the SEC’s legal action, Zhao and Binance are accused of misusing customer funds, including transferring funds to the Switzerland-based Sigma Chain which is owned by Zhao.

The SEC alleged that Merit Peak and Sigma Chain were utilized to transfer tens of billions of dollars between Binance, Binance.US, and other linked entities. Notably, the SEC declared that Sigma Chain spent $11 million buying a yacht, which has raised questions about how Binance and its related organizations manage customer assets and implies that money could have been misused.

Furthermore, the SEC asserted that Merit Peak’s U.S. bank account has been utilized as a “pass-through” account since the establishment of the Binance.US platform, with approximately $20 billion — comprising customer funds — being received from both Binance platforms. Merit Peak then purportedly shifted the bulk of this money to Trust Company A, presumably for the purpose of buying BUSD. This unnoticed transfer of customer funds to an ostensibly separate company such as Merit Peak posed a grave danger as it might have left the money exposed to loss or theft.

The alleged misappropriation of funds and diversion of customer assets will be investigated and examined as the court proceedings continue.

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