The Securities and Exchange Commission (SEC) has consistently emphasized its commitment to enforcing regulations in the crypto industry. In 2022, the SEC initiated 30 enforcement actions related to cryptocurrencies, marking a 50% increase from the previous year. As we approach the midpoint of 2023, the SEC is on track to surpass last year’s figures by more than 25%. In a recent interview with the Wall Street Journal, Gary Gensler, the Chair of the SEC, expressed his concerns about the crypto industry, stating, “I’ve witnessed occasional non-compliance in traditional finance, but I’ve never seen an entire field so reliant on non-compliance with the law. Frankly speaking, that’s what a significant portion of the cryptocurrency business model entails.” The ongoing lawsuit against Binance exemplifies the SEC’s approach to litigating cases involving alleged widespread non-compliance. The SEC adopts a utilitarian approach, comparing the functions and participants of the traditional securities industry with their counterparts in the crypto space. Binance Holdings Limited, the primary defendant, is a limited liability company based in the Cayman Islands that operates finance.com—an international crypto asset-trading platform serving customers in over 100 countries.
Binance operates through a network of subsidiary or affiliated entities across multiple jurisdictions, all linked to its beneficial owner, Zhao. As outlined in the complaint, Zhao has displayed a dismissive attitude towards corporate formalities and the accompanying regulatory requirements, asserting that “Wherever I sit is the Binance office. Wherever I meet somebody is going to be the Binance office.” In the United States, professionals involved in the securities market face substantial regulatory oversight by the SEC. Brokers (those facilitating securities transactions for others) and dealers (those conducting securities transactions on their own account) must register with the SEC. Any entity or group facilitating the buying and selling of securities, also known as an “exchange,” falls under the purview of the Exchange Act and must register with the SEC.
Unless an applicable exemption applies, companies offering securities for sale must file a registration statement with the SEC, providing significant disclosures about the company and its securities. Additionally, any individual acting as an intermediary in exchanging payment for security is considered a “clearing agency” and is required to register with the SEC, subject to available exemptions. Finally, “broker-dealers” are considered “financial institutions” under the Bank Secrecy Act (BSA), which the SEC is authorized to enforce.
According to the complaint, Binance was well aware of these regulatory requirements. In a chat exchange with a Binance employee, the Chief Compliance Officer (CCO) explicitly stated, “If US users get on .com, we become subjected to the following US regulators: FinCEN, OFAC, and SEC.” In an attempt to avoid regulation, Binance engaged in an elaborate scheme to conceal its customer base in the United States, thereby violating numerous laws. As stated by the Binance CCO, “We are operating as an [expletive] unlicensed securities exchange in the USA, bro.” The crux of Binance’s alleged efforts to evade US regulations centered around manipulating its Know Your Customer (KYC) processes. Publicly, Binance made numerous statements disavowing any US-based activity and emphasized restrictions against US customers. However, privately, the company encouraged US customers to bypass these restrictions using virtual private networks (VPNs) to disguise their locations and “minimize the economic impact” of Binance’s public claims that it prohibited US investors from accessing the platform.
To hide its presence in the US, Binance encouraged customers to use VPN services to circumvent Binance’s geographic blocking of US-based IP addresses. Additionally, certain “VIP” US-based customers were urged to submit updated KYC information that deliberately omitted any connection to the United States. Furthermore, until August 2021, Binance did not require all customers to submit KYC documents.
Binance is facing eleven claims for various violations of the Exchange Act. These include engaging in the unlawful sale of securities, acting as an unregistered exchange, broker-dealer, and clearing agency, imposing controlling person liability on Zhou, and securities fraud. Notably, the SEC has brought the securities fraud claim under Section 17 of the Securities Act instead of Section 10 of the Exchange Act and Rule 10. While securities fraud claims are typically enforced under Rule 10b-5, the SEC has recently employed Section 17 more frequently. Both Rule 10 and Section 17 require the presence of an untrue statement or omission of material fact. In this case, the claim focuses on Binance’s statements regarding its KYC program and its avoidance of the United States markets.
The key distinction between Section 17 and Rule 10 is that Section 17 does not require a showing of scienter and can be established if the defendant acted negligently. In contrast, proving a civil violation of Rule 10 necessitates demonstrating scienter, indicating that the defendant acted recklessly. By proceeding under Section 17 against Binance, the SEC suggests its inclination to pursue cases without requiring a scienter. Notably, legal observers await the Supreme Court’s review of Chevron U.S.A., Inc. v. NRDC, 467 U.S. 837 (1984), which grants federal agencies the authority to interpret vague statutes reasonably. The outcome of this review could potentially impact the SEC’s rulemaking authority in the crypto space, leading to future litigation.