Legal Memorandum on the SEC’s Investigation on Binance

Author

Uçar Law & Consultancy Office

Uçar Law & Consultancy Office

Introduction

The purpose of this memorandum is to inform FTX of the SEC’s Binance investigation.

Binance and SEC will be introduced in this article.  Information about the investigation initiated by the SEC against Binance will be provided.

 

Binance

Binance is a cryptocurrency exchange that provides a platform for trading various cryptocurrencies.

Apart from FTX, Binance is one of the largest cryptocurrency trading platforms in the world, with almost 140 million users.[1]

Founded in September 2017 as a China-based exchange, Binance moved to Japan when the Chinese Government imposed a ban on cryptocurrency trading. Although Binance is a global stock exchange, it has various names in various countries, including Turkey. Binance opened an office in Turkey in 2020.

However, Binance’s opening of an office in Turkey was not only a result of its own will. Cryptocurrency assets around the world, in addition to the amenities they provide, also bring with them a number of negative situations. One of them is the convenience of anonymous money transfer in money laundering due to the way that Cryptocurrencies work. In order to prevent this and to ensure that cryptocurrencies are placed on a more legal footing, Turkey has made it mandatory for cryptocurrency exchanges to open an office in Turkey. Upon this, Binance Turkey started its activities in September 2020.

 

Functions and Authorities of the SEC

SEC is the organization that oversees securities and exchanges in the United States.

According to information on its official website, the SEC protects investors by enforcing federal securities laws to hold wrongdoers accountable and deter future misconduct.

The SEC monitors the activities of more than 28,000 entities in the securities industry, including investment advisers, broker-dealers, and securities exchanges, to facilitate capital formation and maintain fair, orderly and efficient markets.

 

Investigation Date

Monday June 5, 2023, the SEC filed a lawsuit against Binance and its founder Changpeng Zhao (also known as “CZ”)  and BAM Trading for violating federal securities laws.[2]

The SEC’s notice filed with the Federal Court alleged that Binance seriously put investor assets at risk by violating securities laws, thereby generating billions of dollars in revenue.

The SEC filed 13 separate charges against Binance in the lawsuit it filed. The SEC’s indictment also charges the listing and sale of securities-class crypto assets on the Binance platform, unregistered exchange, broker and clearing activities in the United States, and failure to restrict US citizens’ access to Binance.

 

Claims Against Binance.US

Plaintiff Securities and Exchange Commission’s (“SEC”) complaint against Defendants (Binance Holdings Limited (“Binance”), BAM Trading Services Inc. (“BAM Trading”), BAM Management US Holdings Inc. (“BAM Management”), and Changpeng Zhao) alleges as follows:

  1. This case results from Defendants disregard for federal securities laws and the investor and market protections they provide. Defendants have enriched themselves by billions of U.S. dollars while placing investors assets at significant risk.
  2. Defendants have unlawfully solicited U.S. investors to buy, sell, and trade crypto asset securities through unregistered trading platforms available online at Binance.com and Binance.US (collectively, “Binance Platforms”). Defendants have engaged in multiple unregistered offers and sales of crypto asset securities and other investment schemes. And Defendants BAM Trading and BAM Management defrauded equity, retail, and institutional investors about purported surveillance and controls over manipulative trading on the Binance.US Platform, which were in fact virtually non-existent.
  3. Binance and BAM Trading, under Zhao’s leadership and control, have unlawfully offered three essential securities market functions—exchange, broker-dealer, and clearing agency—on the Binance Platforms without registering with the SEC. Acutely aware that U.S. law requires registration for these functions, Defendants nevertheless chose not to register, so they could evade the critical regulatory oversight designed to protect investors and markets.
  4. Binance and BAM Trading have unlawfully engaged in unregistered offers and sales of crypto asset securities. In so doing, they have deprived investors of material information, including the risks and trends that affect the enterprise and an investment in these securities.
  5. BAM Trading and BAM Management have made misrepresentations to investors about controls they claimed to have implemented on the Binance.US Platform.
  6. Starting in or around 2018, determined to escape the registration requirements of the federal securities laws, Defendants designed and implemented a multi-step plan to surreptitiously evade U.S. laws.
  7. As one part of this plan to evade United States regulatory oversight over Zhao, Binance, and the Binance.com Platform, Zhao and Binance created BAM Management and BAM Trading in the United States and claimed publicly that these entities independently controlled the operation of the Binance.US Platform.
  8. 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.
  9. Defendants’ purposeful efforts to evade U.S. regulatory oversight while simultaneously providing securities-related services to U.S. customers put the safety of billions of dollars of U.S. investor capital at risk and at Binance’s and Zhao’s mercy. 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.
  10. Defendants understood the importance to crypto asset investors of implementing trading surveillance and controls over crypto trading platforms.
  11. Defendants BAM Trading and BAM Management touted the surveillance and controls supposedly in place to prevent manipulative trading on the Binance.US Platform.
  12. Defendants failed to implement on the Binance.US Platform the trade surveillance or manipulative trading controls BAM Trading and BAM Management touted to investors. Thus, Defendants failed to satisfy basic requirements of registered exchanges—to have rules designed to prevent fraudulent and manipulative acts and the capacity to carry out that purpose. The supposed controls were virtually non-existent, and those that did exist did not monitor for or protect against “wash trading” or self-dealing, which was occurring on the Binance.US Platform. Most notably, from at least September 2019 until June 2022, Sigma Chain AG (“Sigma Chain”), a trading firm owned and controlled by Zhao, engaged in wash trading that artificially inflated the trading volume of crypto asset securities on the Binance.US Platform.
  13. Congress enacted the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) in part to provide for the regulation of the offer and sale of securities and the national securities markets through registration and attendant disclosure, recordkeeping, inspection, and conflict-of-interest mitigation requirements. Binance and BAM Trading—both under Zhao’s control—have engaged and continue to engage in unregistered offers and sales of crypto asset securities, effecting unregistered crypto asset securities transactions on the Binance Platforms, combining core securities market functions while purposefully evading registration, and operating while impaired by obvious conflicts of interest. In doing so, they have dodged the disclosure and other requirements that Congress and the SEC have constructed over the course of decades to protect our capital markets and investors and thereby have violated—and continue to violate—the law.[3]

In summary, SEC filed a suit following investigation against Binance for“Charges include operating unregistered exchanges, Broker-dealers, and clearing agencies; misrepresenting trading controls and oversight on the Binance.US platform; and the unregistered offer and sale of securities.” allegations, on its announcement dated 5 June 2023.[4]

 

The Settlement Between Binance and the SEC

The SEC, concerned that Binance might transfer its funds to other countries, had requested that all Binance US assets to be frozen. Upon this request, the Federal Judge who handled the case suggested that it would be more appropriate to make an agreement between the parties rather than an order restricting access to the assets.

Binance stated that customer assets are safe against the SEC, arguing that there is no problem, and that stopping the actual flow of all funds will drag things to a completely problematic point and expose customers to inevitable losses.

On the recommendation of a Federal Judge, Binance and the SEC entered into an agreement on June 17 to create an environment to ensure not to freeze Binance US’s assets.

It was obvious that this signed agreement had a positive impact on the market in a way that could not be ignored. There are some important terms that parties agreed upon the agreement.

According to the agreement, CZ will provide detailed information about the company’s expenses, including company costs.

BAM Trading and BAM Management agreed not to provide any person or entity, including Binance and Changpeng Zhao, with the possession, retention or control over client assets.

Until the case is resolved, only Binance US employees will have access to customer funds. BAM Trading and BAM management are committed not to provide control over any accounts and customer assets.

BAM Trading and BAM Management will not be able to dismiss any managers and employees.

As it stated above, the reconciliation between the defendants and plaintiffs took place on June 17, 2023[5]. With this agreement, it was agreed on the matters briefly mentioned below:

  1. To release all assets held for the benefit of customers held within Binance to the supervision of the United States,
  2. The BAM is obliged to facilitate the withdrawal of funds by its investors located in the USA during the litigation process and is obliged to keep the assets belonging to the customers in the USA during the litigation process,
  3. The BAM expressly prohibits Binance from transferring any assets or funds or exercising control over such assets or funds to other Defendants Binance Holdings Limited, CZ or its affiliates.
  4. The settlement restricts any asset or fund expenditures, except for ordinary operating expenses, and the SEC has full oversight authority over such expenses,
  5. Defendants cannot destroy any records so far,
  6. Defendants are required to release all records into the custody of the SEC,
  7. Defendants should apply to the SEC as soon as possible for the security of funds and investments belonging to clients located within their structure.

 

Impact of the Investigation on the Crypto Assets Market

This situation will create a regulatory effect in many countries and lead to regulations by seizing crypto exchanges by countries. In this case, states will create rules and institutions aimed at regulating and controlling the market and the behavior of market players in order to eliminate disruptions and failures in the functioning of the market economy.[6]

Authorities such as the United States wants to control the Cryptocurrency investor and Cryptocurrency exchanges by launching such investigations in order to control cryptocurrency exchanges such as Binance, FTX, Coinbase, OKX.

The legal regulations established by the authorities to control such a large market remain insufficient. Due to the constant change of hands of money and assets, it is not possible to follow the changes in detail. Therefore, investors make their investments through informal(decentralized) exchanges in order to avoid paying high amounts of taxes to the states.

 The main reason of this investigation and the similar investigations is that the authorities desire to control informal money exchanges. Therefore, Regulations are on the agenda as new moves of the authorities who want to make such arrangements. States that want to make such arrangements with regulation want to maintain control over the system, which will clearly reveal the assets that investors and markets hide from the state.

If the SEC’s investigations against Binance deepen further and more investigations are opened against cryptocurrency exchanges active in their own economic markets in other countries; by negatively affecting exchanges such as major cryptocurrency exchanges (FTX, Binance, OKX, Coinbase, etc.), the trust in these exchanges will decrease.

Apart from FTX, OKEX etc., Binance is one of the cryptocurrencies with the largest trading volume among cryptocurrency exchanges. Subjecting Binance to any sanctions indicates that even one of the largest stock exchange can be punished and will reduce confidence in the market and it will also shake confidence in the stock markets.

These and similar investigations scare the cryptocurrency investor, but due to the lack of any legal regulation of state and international organizations, they cause the authorities to be prohibitive and interventionist on an incident basis.

You can contact us here for detailed information on the subject.

You can get detailed information about the work of our office in the field of Blockchain and Cryptocurrencies Law, Banking and Finance LawInformation Technology Law and Administrative and Tax Law on our website.

Begüm BAYLAR – Ebru CUMALI – Salih KARADENİZ

Uçar Law & Consultancy Office

References:

[1] https://www.binance.com/en

2 https://www.sec.gov/news/press-release/2023-101

[3] https://www.sec.gov/files/litigation/complaints/2023/comp-pr2023-101.pdf

[4] https://www.sec.gov/news/press-release/2023-101

[5] https://www.sec.gov/news/press-release/2023-110

[6] YAY Serdar, AKTAN Coşkun Can. (2016). REGÜLASYON İKTİSADINA GİRİŞ. EKONOMİ BİLİMLERİ DERGİSİ, Cilt 8, No 1, 117.

 

Diclaimer:

This article is prepared by Uçar Law & Consultancy Office for information purposes only, and the information and visual materials contained in it cannot be used, reproduced, published, transmitted to a third party or translated without prior written permission from us. This legal memorandum is not a comment or legal opinion and was prepared on the publication date and our attorney’s office is not responsible for its failure to
update continuously.”

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