SEC Says Binance Misused Customer Funds,

 SEC Says Binance Misused Customer Funds, Ran Illegal Crypto Exchange in U.S.

Regulator’s lawsuit asks federal judge to freeze company’s assets

Binance founder Changpeng Zhao was named as a defendant in the SEC suit. Photo: Benoit Tessier/Reuters

WASHINGTON—The Securities and Exchange Commission on Monday sued Binance, the world’s largest cryptocurrency exchange, alleging the overseas company operated an illegal trading platform in the U.S. and misused customers’ funds. 

The SEC lawsuit also named Changpeng Zhao, Binance’s founder and controlling shareholder, as a defendant. The SEC said that Binance and Zhao misused customers’ funds and diverted them to a trading entity that Zhao controlled. That trading firm, Sigma Chain, engaged in manipulative trading that made Binance’s volume appear larger than it actually was, the SEC said.

Binance also concealed that it commingled billions of dollars in customer assets and sent them to a third-party, Merit Peak, which was owned by Zhao, the SEC alleged. The Wall Street Journal reported last year that the SEC was examining the relationship between Binance.US—the U.S. arm created in 2019—and Sigma Chain and Merit Peak.  

“This will be a landmark case,” said Kurt Gottschall, a partner at Haynes and Boone LLP and former head of the SEC’s Denver office. “The SEC appears to be very concerned about the commingling of customer funds.” 

The SEC filed the case in federal court in the District of Columbia. Binance engaged in “blatant disregard of the federal securities laws and the investor and market protections these laws provide,” the agency wrote in its court complaint.

The SEC quoted Binance’s chief compliance officer as saying in 2018, “we are operating as a fking unlicensed securities exchange in the USA bro.”

Crypto imploded in 2022, as investors lost faith in digital assets and the industry was plagued with crisis. But unlike other collapses, it has largely avoided rippling into other markets. 

U.S. regulators have been circling Binance for years, with the SEC and the Justice Department sending subpoenas to its U.S. arm in late 2020, according to documents viewed by the Journal. Officials have ramped up enforcement efforts over the past year, after the collapse of numerous crypto companies, including one of Binance’s biggest rivals: FTX. 

The lawsuit adds to Binance’s challenges with U.S. regulators and law enforcement. The Commodity Futures Trading Commission alleged in March that Binance and Zhao evaded that agency’s rules, which cover platforms that offer derivatives to American traders. Binance also faces a Justice Department investigation over its program to detect money laundering, according to people familiar with the matter. 

The SEC’s court complaint asks a federal judge to freeze Binance’s assets and appoint a receiver, typically an outside lawyer or other professional who is given control of the company. The receiver is given the authority to track and preserve users’ assets. 

The SEC typically seeks receivers in cases that involve fraud, such as Ponzi schemes, or in which regulators don’t trust management to run a company in compliance with the law.

The bar for a court ordering an asset freeze and receiver is high, said Marc Fagel, a former director of the SEC’s San Francisco office. Regulators must show a court they are likely to succeed in the case and require emergency action to prevent imminent harm to investors. “It would definitely be a challenge for them to get this,” Mr. Fagel said. 

Binance hasn’t had any major outflows of user funds, Patrick Hillmann, Binance’s strategy chief, told the Journal.

“Our team is all standing by, ensuring systems are stable, including withdrawals and deposits,” Zhao said, referring to the possibility of customers pulling funds.

Binance said it intends to defend its platform and denied allegations that user assets on the Binance.US platform were ever at risk. It had recently been negotiating a settlement with the SEC but the regulator instead chose to sue, it said.

“All user assets on Binance and Binance affiliate platforms, including Binance.US, are safe and secure, and we will vigorously defend against any allegations to the contrary,” the company said.

Binance.US also said it would defend itself against the litigation. The SEC suit marks the first federal regulatory suit against Binance’s U.S. arm. The CFTC focused on the exchange’s global entities.

The SEC also alleged that Binance sold cryptocurrencies, including BNB and BUSD, that should have complied with investor-protection rules. The value of BNB fell more than 7% from the prior 24 hours, according to CoinDesk data. Before the announcement, it was down 2.5%. 

Bitcoin, the largest cryptocurrency, fell 4.5% from its level 24 hours earlier to trade near $26,000 apiece. It is seen as a bellwether for digital assets.

Executives for two major market makers, which facilitate buying and selling between crypto firms, said they were seeking ways to reduce exposure to Binance after the lawsuit. Both said such a task was difficult because of Binance’s hold over so much crypto trading.

Founded in 2017, Binance quickly grew to be a behemoth in the world of cryptocurrency. As of last month, more than 40% of all crypto trading took place through the exchange, according to data provider CCData. In the past, it has at times controlled more than two-thirds of crypto trading. 

Binance’s founder, Zhao, is one of the biggest figures in crypto. He is the majority owner of Binance and Binance.US. While Zhao and executives portrayed Binance.US as fully independent, both exchanges were deeply intertwined, mixing staff and finances and sharing an affiliated entity that bought and sold cryptocurrencies, the Journal has reported. 

Until at least the end of 2022, Binance, at Zhao’s direction, maintained custody and control of the crypto assets deposited, held, traded, and/or accrued by customers on the Binance.US platform,” the SEC said.

Almost all of the employees working on clearing and trade settlement on the Binance.US exchange were based outside the U.S., primarily in Shanghai, the SEC added. The Journal previously reported former Binance.US executives raised concerns about the setup.

As of this month, Binance.US staffers didn’t have exclusive control of all Binance.US assets, the SEC said.

The SEC also said that as early as 2018, Zhao and his company sought to evade the agency’s rules while still allowing important American traders to use the overseas platform. 

Binance assisted big traders with methods for circumventing technology designed to stop American users from accessing Binance.com, the SEC said. Zhao also set up Binance.US, which was supposed to be an independent entity created for U.S. users. Instead, Zhao and Binance controlled the U.S. platform, the SEC said. 

The SEC’s lawsuit also alleged that Binance for years lacked controls to prevent one of the most basic forms of manipulative trading. In January 2021, Binance.US users could still conduct wash trading—entering both buy and sell orders to trade with themselves, according to the SEC. U.S. law bans wash trading because it can be used to artificially boost volume and manipulate prices.

In 2019, a Binance co-founder wrote in an internal message that wash trading “is mainly a compliance or regulation issue,” according to the SEC’s lawsuit. “If some US compliance or regulation says we must prevent this, we will. Otherwise we will not.”

Sigma Chain conducted a lot of the wash trading on Binance.US, the SEC said. 

The lawsuit presents new insight into how Binance has operated and its profitability—parts of the exchange’s business that it has been reluctant to share, citing its status as a private company. Between June 2018 and July 2021, Binance earned at least $11.6 billion in revenue, mostly from transaction fees, the complaint said.

For the SEC, the lawsuit is another significant bet that U.S. courts will agree it has jurisdiction over the crypto industry, which often disputes that digital assets are securities. The SEC has also sued crypto exchange Bittrex and has told Coinbase, the largest U.S. crypto exchange, that it plans to take enforcement action against it.

The lawsuit against Binance alleges that its platforms traded 10 tokens that are securities, and thus were sold and traded illegally in the U.S. The SEC’s list includes digital assets known as Solana, Cardano and Polygon. All three rank in the top 10 cryptocurrencies by market value, according to CoinMarketCap.