5 highlights of SEC’s lawsuit against Binance.

The U.S. Securities and Exchange Commission (SEC) has filed a lawsuit against Binance on June 5, accusing the exchange of selling unregistered securities. The SEC claims that Binance and its founder, Changpeng “CZ” Zhao, participated in a complex conspiracy that involved fraud, conflicts of interest, a lack of disclosure and willful disregard for the law. The SEC alleges that Binance deceived investors about risk controls, tampered with trade volumes, hid crucial operational data, and flouted U.S. securities laws. Binance allegedly created weak controls while secretly disobeying them to keep its highly valuable U.S. customers.

Binance.com and Binance.US have earned at least $11.6 billion through a variety of methods, including transaction fees collected from American clients. The SEC claims that Binance.com should have registered as a clearing agency, broker-dealer, and exchange, while Binance.US and BAM Trading should have registered as clearing agencies and exchanges, respectively. BAM Trading was also charged with the unregistered offer and sale of Binance.US’ staking-as-a-service program.

Despite publicly claiming that Binance prohibited U.S. customers from trading, the exchange allegedly permitted them to keep using the platform, demonstrating a deliberate disregard for U.S. securities laws. Binance created a sizable number of user accounts for people who provided Know Your Customer identity verification information that indicated their location within the United States from the initial launch of the Binance.com platform until at least September 2019.

The SEC alleges that Zhao continued to be in charge of Binance.US, even though Binance and BAM Trading announced cooperation to develop the platform serving American clients in accordance with U.S. laws. Zhao gave Binance.US the order to onboard Sigma Chain and Merit Peak as market makers, both of which were operated by Binance employees. Many of Binance.US’s bank accounts, including one that had money from American customers, had the head of the back office as the primary operator, raising questions regarding Binance’s operational openness and fund segregation.

Wash trading on Binance.US platform

The SEC has filed a lawsuit alleging that BAM Trading and BAM Management, affiliated with Binance.US, provided false information to both clients and equity investors regarding the platform’s market oversight and measures to detect and prevent manipulative trading. However, wash trading was a common practice on the Binance.US platform. This practice artificially inflated trading volumes, giving a false impression of market interest. The SEC’s charges raised doubts about the reliability of trading volume data and the transparency of Binance.US’s market activities.

Even before the platform’s launch, senior officials and staff at BAM Trading were well aware of the possibility of wash trading. A co-founder of Binance and the head of the trade matching engine team expressed concern about the matching engine’s ability to allow customers to trade with themselves in correspondence sent to BAM’s CEO (presumably Catherine Coley, though not identified by name) and senior Binance executives. However, they questioned whether it was necessary to comply with U.S./SEC regulations and prevent this manipulation.

When it was revealed at a meeting a year later that no measures had been taken to prevent market manipulation, an employee of Binance responsible for market surveillance was contacted by BAM Trading. The director of institutional sales at BAM Trading acknowledged the absence of safeguards against wash trading in January 2021. Despite Binance.US explicitly forbidding fraudulent trading, BAM Trading did not have transaction surveillance systems in place until February 2022.

It is worth noting that a significant portion of this wash trading activity took place through accounts associated with Sigma Chain, which acted as a market maker on Binance.US. BAM Trading and BAM Management were fully aware of Sigma Chain’s numerous accounts and active trading on the Binance.US platform.

Wash trading between Sigma Chain’s accounts continued after the platform’s launch in 2019 until at least June 2022. For instance, following the introduction of the crypto asset security COTI on the Binance.US platform on April 6, 2022, Sigma Chain quickly became involved in extensive wash trading, according to the SEC’s allegations. Strategically, the platform’s launch, the introduction of new securities, and the funding round all occurred during times when investors and equity investors were most vulnerable.

Diversion of customer assets and misuse of funds by Zhao and Binance entities

Zhao and Binance are accused in the SEC’s lawsuit of diverting customer assets at their discretion, including sending money to Sigma Chain in Switzerland, which is controlled by Zhao.

The SEC alleges that Merit Peak and Sigma Chain were used to transfer tens of billions of dollars between Binance, Binance.US, and other affiliated entities. Notably, the SEC revealed that Sigma Chain spent $11 million on a yacht, raising questions about how Binance and its affiliates handle customer assets and suggesting that money may have been used improperly.

The SEC also claimed that Merit Peak’s U.S. bank account has been used as a “pass-through” account since the launch of the Binance.US platform, receiving approximately $20 billion, including customer funds, from both Binance platforms. Merit Peak allegedly transferred most of this money to Trust Company A, possibly to purchase BUSD. This unnoticed transfer of consumer funds to an ostensibly independent company like Merit Peak posed a serious risk because it could have left the money vulnerable to loss or theft.

The extent of the alleged misappropriation of funds and diversion of customer assets will be further examined and scrutinized as the legal proceedings progress.