Lawsuit Against Binance: SEC Accuses World's Largest Crypto Exchange of Mishandling Funds

The Securities and Exchange Commission (S.E.C) has made serious allegations against Binance, the world's largest cryptocurrency exchange, accusing it of mishandling customer funds, deceiving American regulators, and providing false information to investors regarding its operations. This far-reaching case has the potential to reshape the power dynamics and wealth distribution within the cryptocurrency landscape.

This is not the first time this year that federal regulators have accused Binance of circumventing laws aimed at safeguarding investors in the United States. Regulators have long viewed Binance, with its reported daily trading volume of $65 billion, as a prime target in their efforts to regulate a crypto industry that has been built upon an overtly anti-government philosophy.

Commingling of Customer Funds: Allegations of Mishandling and Transfers to Merit Peak

In a comprehensive 136-page complaint, the S.E.C. alleges that Binance commingled billions of dollars in customer funds and covertly transferred them to an entity named Merit Peak Limited, which is under the control of Binance's founder, Changpeng Zhao.

The complaint further contends that Binance misled investors about the efficacy of its systems in detecting and preventing manipulative trading, as well as its measures to restrict U.S. users from trading on its international platform. According to the complaint, customers based in the United States were supposedly granted access only to a seemingly separate company called Binance.US, established specifically for operating within the country.

Deceptive Practices: Misleading Investors and Regulators

Regulators assert that Binance and Mr. Zhao have "enriched themselves by billions of U.S. dollars while placing investors' assets at significant risk." The civil lawsuit, filed in the Federal District Court in Washington, seeks to hold them accountable. In response, Binance expressed disappointment and disheartenment over the S.E.C.'s decision, emphasizing that the case is a misguided attempt to evade providing much-needed clarity and guidance to the digital asset industry. The company vows to vigorously fight back.

Binance also accuses the S.E.C. of rushing into legal action, highlighting that the regulators recently served the company with a new set of 26 document requests. These charges are part of a broader trend of U.S. regulators and prosecutors cracking down on the unruly aspects of crypto trading and demanding compliance with U.S. laws. For instance, Sam Bankman-Fried, the founder of FTX, once a major competitor of Binance until it filed for bankruptcy in November, is facing an October trial for fraud and other charges. In recent months, the S.E.C. has also imposed fines and penalties on crypto lending firms.

Regulatory Crackdown: U.S. Authorities Targeting Binance and Cryptocurrency Industry

The S.E.C. takes the position that most crypto tokens issued by exchanges like Binance and FTX should be classified as securities under federal law. Reena Aggarwal, a finance professor at Georgetown University, observes that U.S. regulators are significantly impeding Binance and sending a clear message to the crypto world at large.

Binance was already under mounting pressure prior to this lawsuit. In March, the Commodity Futures Trading Commission initiated its own civil enforcement action against Binance and Mr. Zhao. Additionally, the Justice Department is investigating the exchange for potential money-laundering violations. Binance also lost its external auditing firm towards the end of last year, and its market dominance has dwindled.

Consequences for Binance: Lawsuits, Investigations, and Diminished Market Dominance

To restore its tarnished reputation, Binance has hired new compliance officials, including a former federal prosecutor who now leads its compliance operation.

Legal actions such as the S.E.C.'s complaint against Binance expose the darker side of the crypto industry, revealing how major global exchanges like Binance have misled the general public for years, according to lawyer David Silver, who has previously sued Binance on multiple occasions.

The S.E.C. has filed a total of 13 charges against Binance and Mr. Zhao (also known as C.Z.), seeking restitution from the exchange and aiming to prevent Mr. Zhao from holding any officer or director position in any registered U.S. entity that issues securities.

Gurbir S. Grewal, director of the S.E.C.'s enforcement division, asserts that Zhao and the Binance entities were well aware of the regulatory requirements but consciously chose to evade them, thereby putting their customers and investors at risk. The C.F.T.C. is also seeking a lifetime ban on Mr. Zhao from engaging in any business activities within its jurisdiction, as well as a permanent expulsion of Binance from the United States.

Challenging U.S. Jurisdiction: SEC and CFTC Engaged in Regulatory Tug-of-War over Binance

Although the S.E.C. and C.F.T.C. often coordinate enforcement actions, they have engaged in a jurisdictional tug-of-war to determine the primary regulator for crypto trading. Binance, with its headquarters situated outside the United States, has been offering high-risk trading options that are not permissible for American customers. In 2019, the exchange established a separate entity in the U.S. named Binance.US, which offered a narrower range of trading features. However, the S.E.C. claims that this separate entity was merely a facade to conceal the fact that Mr. Zhao and his associates were actively enabling U.S. customers to trade on Binance's much larger, unregulated offshore exchange.

The S.E.C.'s complaint alleges that Binance actively recruited American customers to the international exchange, despite not being authorized to operate within the United States. Internal messages cited in the complaint reveal that Binance executives intended to circumvent restrictions on U.S. customers through alternative means while maintaining a public appearance of non-engagement with U.S. users.

When Binance took steps to comply with U.S. regulatory requirements, it did so in a disingenuous manner, according to the filing. Binance.US was meant to be an independent entity separate from its offshore parent company, but behind the scenes, Mr. Zhao and other senior Binance leaders were intimately involved, leading one executive to feel deceived into becoming a mere puppet, as per the complaint. The S.E.C. further alleges that Mr. Zhao instructed V.I.P. customers to bypass systems designed to restrict U.S. customers' access to the platform, and their plan to retain lucrative U.S. investors while pretending to restrict them was allegedly successful.

Some of the accusations against Binance bear resemblance to the actions that led to the downfall of FTX, which resulted in criminal charges against Mr. Bankman-Fried for utilizing customer deposits for other business operations, political contributions, and charitable donations. The complaint against Binance claims that more than $20 billion, including customer funds, has been deposited into the bank account of Merit Peak, the trading firm controlled by Mr. Zhao.

Sending customer funds to Merit Peak without customer notice placed those funds at risk of loss or theft, according to the complaint.