In a one-two punch earlier this month, the U.S. Securities and Exchange Commission (SEC) brought successive actions against two of the world's largest cryptocurrency exchanges – the first blows in what will likely be prolonged litigation against some of the biggest players in the digital asset industry. First, on June 5, 2023, the SEC filed a complaint against Binance and its owner Changpeng Zhao. The next day, on June 6, 2023, the SEC filed a complaint against another large exchange based in the United States.

Neither of these actions should come as a surprise to those monitoring the cryptocurrency industry. In March 2023, the Commodity Futures Trading Commission (CFTC) filed an enforcement action against Binance, and, around the same time, the other national exchange announced it had received a Wells notice from the SEC regarding a likely enforcement action. The only real surprise was the SEC's decision to file the two complaints within a day of one another.

A Closer Look

Both SEC complaints include some similar claims. Specifically:

• operating an unregistered exchange, in violation of Section 5 of the Securities Exchange Act of 1934 (Exchange Act)
• brokering the purchase or sale of securities without registration, in violation of Section 15(a) of the Exchange Act
• functioning as a clearing agency with respect to securities without registration, in violation of Section 17A(b) of the Exchange Act
• control person liability against parent companies of the entities for the above violations under Section 20(a) of the Exchange Act
• the offer and sale of unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933 (Securities Act)

The similarities continue. Each complaint alleges that:

• numerous digital assets traded on the respective exchanges are securities – 10 or 13 tokens, respectively, with some token overlap between the complaints
• the exchanges' staking services are securities offered and sold without registration¹

Finally, both complaints include similar prayers for relief, including civil monetary penalties, disgorgement and injunctions against future such violations of federal securities laws.

But the similarities between the two complaints end there.

In contrast to the other SEC complaint against a primarily U.S.-based exchange, the SEC's complaint against Binance alleges egregious conduct – significantly, that Zhao engaged in an active, deliberate effort to create an illusion of regulatory compliance by creating a U.S.-based shell entity, operating as binance.us, which would ostensibly serve U.S. customers and be separate from Binance's international arm – itself operating as binance.com. The SEC alleges these entities were never truly separate, assets of the different entities' customers were commingled, binance.us violated the negligence-based antifraud provisions of the Securities Act, and Zhao maintained control of all entities – failing to observe corporate formalities that would have made the entities distinct and independent from other Binance affiliates.

Moreover, the SEC alleges that Zhao operated two market making entities, Sigma Chain and Merit Peak, to manipulate trade volumes and token prices and engage in wash trading. Also, unlike the complaint against the U.S.-based exchange, the SEC alleges Binance issued and sold its own digital asset securities – BNB and BUSD tokens.

The SEC also seeks a permanent officer and director bar against Zhao, prohibiting him from ever acting as an officer or director of a public company.

Notably, the Binance complaint includes detailed allegations indicating the SEC's apparent access to cooperating witnesses and receipt of internal communications and text messages. For example: "Binance's CCO bluntly admitted to another Binance compliance officer in December 2018, 'we are operating as a fking [sic] unlicensed securities exchange in the USA bro.'"

Also unique to the Binance action: on June 6, 2023, the SEC filed an emergency motion requesting the court issue a temporary restraining order (TRO) freezing certain of Binance's assets. The motion requested entry of an order, requiring, inter alia, the repatriation of certain assets belonging to or owed to customers of binance.us, prohibiting destruction of records, requiring sworn accountings and ordering expedited discovery. According to the SEC, a TRO is necessary because there is evidence, as detailed in the SEC's memorandum of law and several declarations, showing that Zhao and Binance are not reliable asset custodians, refused to agree to satisfactory procedures to safeguard the status quo, and are capable of easily removing assets from the jurisdiction of the court.

Binance argued in response that a restraining order was unnecessary, stating it was willing to make numerous concessions to address the SEC's concerns. At a June 13, 2023, motion hearing, District Judge Amy Berman Jackson agreed with Binance and ordered the parties to agree to terms for a consent order. A few days later, the parties stipulated to a consent order in which binance.us agreed to 1) limit access to U.S. customers' assets to binance.us employees, 2) repatriate to the United States and place under the control of binance.us any U.S. customer assets, 3) not provide access to U.S. customer assets to binance.com or Zhao, 4) provide a written accounting of binance.us accounts, 5) provide the SEC monthly operational expense reports and 6) expedite discovery, among other things.

It is not clear whether such sweeping concessions by Binance will move the needle in terms of its reputation with the SEC. Chair Gary Gensler, at a conference on June 8, 2023, lumped Binance and Zhao in with the likes of FTX, Terra/Luna, Do Kwon, Tron and Justin Sun:

We've seen this story before. It's reminiscent of what we had in the 1920s before the federal securities laws were put in place. Hucksters. Fraudsters. Scam artists. Ponzi schemes. The public left in line at the bankruptcy court.

Binance, for its part, filed a motion on June 21, 2023, requesting the court order the SEC to not "make misleading extrajudicial statements that may materially impact court proceedings."² At publication time, the SEC has yet to respond.

The SEC's actions earlier this month against two of the largest cryptocurrency exchanges in the world are the latest moves in a developing agency trend: shifting focus from individual digital asset issuers – which is akin to regulatory whack-a-mole – to scrutinizing major industry intermediaries on which digital assets are traded.

Key Takeaways

In the U.S., digital asset intermediaries may wish to consider ways in which either to register their activities with the SEC or strictly adhere to appropriate exemptions.

Expect increased SEC scrutiny of:

• digital asset intermediaries that seek to avoid U.S. federal securities laws by avoiding serving U.S. customers
• internal token listing policies established to ostensibly prevent an intermediary from offering securities on their platform
• any intermediary which combines traditionally separate functions – e.g., issuing securities, custody, brokering, buyer/seller matching, settlement and clearing

The SECond Opinions Blog will continue to monitor these proceedings and provide further updates. If you need additional information on this topic – or anything related to securities enforcement or investigations – please contact the authors or other members of Holland & Knight's Securities Enforcement Defense Team, or Holland & Knight's Digital Assets and Blockchain Tech Team.

Notes:

¹ Staking is a means of generating a return on digital assets by committing the digital assets for a certain period of time – analogous to a certificate of deposit.

² Defs.' Mot. for an Order Directing Counsel for Pl. to Comply with Applicable Rules of Conduct, SEC v. Binance Holdings Ltd., No. 23-cv-01599 (D.D.C. June 21, 2023), ECF No. 74.