A lawsuit filed on Monday by the U.S. Securities and Exchange Commission against crypto exchange Binance alleges major malfeasance and legal violations that the regulator argues should result in prohibiting the company, and its high-profile CEO Changpeng 'CZ' Zhao, from doing further business in the U.S.

The complaint sent shockwaves across the industry, with the price of bitcoin and shares of competing exchange Coinbase plummeting on the news, but it shouldn't have come as a surprise. The SEC told the federal court overseeing the bankruptcy of failed crypto lender Voyager in March that staff believed Binance was operating an unregistered securities exchange in the U.S. but had yet to bring charges.

The civil suit follows a similar one filed by the Commodity Futures Trading Commission in March. Both are notable in the amount of detail, including internal communications, that they use in building their cases. They also allege legal violations that could ultimately correspond to separate criminal charges.

The allegations against Binance parallel similar accusations made against failed crypto exchange FTX and its sister trading firm Alameda Research, including commingling of company and customer assets, misuse of customer funds and possible market manipulation of native tokens. As regulators have also alleged with FTX, Binance also allegedly courted U.S. customers despite operating offshore and not registering in the country, and had little separation between its U.S. and offshore operations, despite legal requirements to keep them distinct.

The SEC requested a court order for immediate “verified” accounting of Binance and Binance.US’s finances, the freezing and repatriation of assets, document preservation, and the appointment of a receiver for Binance assets.

“The SEC’s real intent here, instead, appears to be to make headlines,” Binance said in a statement about the enforcement action. “We intend to defend our platform vigorously.”

Binance and CZ allegedly transferred and then used customer funds for other purposes, including the purchase of BUSD

In allegations reminiscent of those made against FTX and its founder Sam Bankman-Fried, the SEC complaint also alleged that "billions of U.S. dollars of customer funds" from both Binance and Binance.US were "commingled in an account held by a Zhao-controlled entity" known as Merit Peak Limited.

The SEC complaint alleges that Binance used customer funds funneled to Merit Peak to purchase its own stablecoin, BUSD.

"The use of Merit Peak as an intermediary to transfer platform customer money to buy BUSD presented an undisclosed counterparty risk for
investors," the SEC said.

The regulator also said that Merit Peak's U.S. bank account — held at the now-defunct Silvergate Bank — "received, as a 'pass through' account, over $20 billion that included customer funds from both Binance Platforms. "Those funds were then sent out to an unnamed trust company "in transfers that appear to relate to the purchase of BUSD."

SEC lawyers also allege that Merit Peak and another firm, Sigma Chain, were involved in the "transfer of tens of billions of U.S. dollars involving BAM Trading, Binance, and related entities." Both Merit Peak and Sigma Chain, owned by Zhao, served as market makers on Binance.US. Included in those funds, the SEC said, were customer funds.

"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," the complaint reads.

At least $190 million was transferred from a bank account belonging to Binance.US to a Sigma Chain account in 2021, according to the SEC. Not all of the funds were used for BUSD or potential market manipulation purchases though, with Sigma Chain also purchasing an $11 million yacht.

Echoes of CFTC complaint of illegally operating in the U.S.

The SEC repeated similar accusations originally levied by the CFTC that Binance broke laws around operating in the U.S. without first receiving approval. It also maintains that evading U.S. laws was while courting U.S. customers was a major part of its business strategy.

According to the lawsuit, Binance’s CCO bluntly admitted to another compliance officer in December 2018 that “we are operating as a fking unlicensed securities exchange in the USA bro.” The complaint quotes Zhao in a 2019 internal meeting telling senior Binance executives that they should help mask the true geographic origin of U.S. customers, because if Binance did lose them, it would lose a significant amount of its trading volume.

“We don’t want to lose all the VIPs which actually contribute to quite a large number of volume,” Zhao allegedly said, according to the complaint. “So ideally we would help them facilitate registering companies or moving the trading volume offshore in some way—in a way that we can accept without them being labeled completely U.S. to us.”

Binance tracked its customer activity regularly, was aware of where customers logged in from, and knew that cordoning off U.S. customers would be a massive blow to business. According to the SEC, Binance estimated in August of 2019 that it had over 1.47 million U.S. customers.

“From the Binance.com Platform’s launch until at least September 2019, Binance overtly marketed its services to all customers and imposed no restrictions whatsoever on the ability of U.S. persons to buy, sell, and trade crypto assets on the Binance.com Platform,” the SEC said.

No real separation between Binance and Binance.US, other FTX echoes

Though the companies have made an effort to separate themselves in the public eye, the SEC said that Binance effectively controlled Binance.US, calling into question the legal compliance of both. The lack of separation also parallels similar charges levied that FTX effectively controlled FTX.US, despite the two needing to be separate for legal purposes.

“Zhao gave final signoff on various decisions relating to the Binance.US Platform’s trading services, including customer account opening processes, development of the front-end access, and creating a reserve to cover ACH deposits,” the complaint reads.

According to testimony from Binance.US’s former director of operations and former CEOs, Binance personnel ran much of the actual operations for the U.S. entity.

In another accusation reminiscent of the international web of corporate entities run by Bankman-Fried, the SEC said that Binance had an “opaque web of corporate entities” registered across different jurisdictions.

The SEC appears to have loads of receipts

In addition to a plethora of internal messages — again similar to the CFTC complaint which cites communications between employees — the SEC also has testimony from former Binance executives who are not named, but identifiable by the roles they previously held.

That includes testimony from former CEOs of the Binance.US holding company, identifying them by only by the dates of their tenures. Those details match up with former Binance.US CEOs Catherine Coley and Brian Brooks, the latter a former federal banking regulator and well-known figure within U.S. financial policy circles.

Brooks, in sworn testimony, said that Binance.US effectively could not operate without the liquidity provided by investment funds tied to Zhao. Brooks told the SEC that during his brief tenure as Binance.US CEO he grew concerned about the extent to which Merit Peak and Sigma Chain played on the trading platform, and the extent to which their presence as a counterparty to customers was necessary for the company to function.

“To the extent that these two liquidity providers were significant sources of liquidity, meaning that our customers couldn’t, you know, clear orders without the presence of those makers on our platform, I thought that was a real problem,” Brooks said. “It suggested that the company was, in fact, heavily dependent on CZ, not just as a control person but also as an economic counterparty and that is problematic, so I thought we needed to look into deplatforming them.”

Coley testified to “significant opacity” around Binance.US trading data and that she “did not get answers from CZ on why or how or what we would need to do to be able to bring the data over” to the U.S. from Binance’s main operations.

According to the SEC, Brooks also acknowledged in testimony that the level of connection between Binance and Binance.US’s holding company, BAM Trading, was a “problem” and that he wanted to transfer technology for Binance.US to the U.S. from Binance’s overseas operations. Brooks left three months after taking the job, and the transfer had not occurred by the time of his departure.

Money laundering, criminal liability still lingers

Both the CFTC and SEC have accused Binance of massive failure to comply with U.S. anti-money laundering laws, though neither agency is responsible for enforcing those laws. The U.S. Treasury Department, which oversees much of the U.S.’s anti-money laundering regime, has yet to weigh in on Binance.

If there is suspicion that sanctions have been violated, much of the evidence included in the civil suits might be used to support separate enforcement actions by the Treasury and Justice Departments.

March’s CFTC complaint cites internal communication by then-Chief Compliance Officer Lim about patterns of transactions by Hamas, which is sanctioned as a terrorist organization in the U.S., and acknowledgement that Binance customers were there for criminal activity.

“Like come on. They are here for crime,” Lim supposedly told another employee in a 2020 chat, quoted in the CFTC complaint. Binance’s money laundering reporting officer agreed that “we see the bad, but we close 2 eyes."

Disclaimer: The former CEO and majority shareholder of The Block has disclosed a series of loans from former FTX and Alameda founder Sam Bankman-Fried.

© 2023 The Block Crypto, Inc. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.

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