The Breakdown - Ban By Enforcement: The SEC Sues Binance and Coinbase

Episode Date: June 6, 2023

Yesterday the SEC sued Binance and CZ. Today, the SEC sued Coinbase. As Blockchain Association's Jake Chervinsky put it, it's pretty clear that SEC Chair Gensler is going for a strategy of "banning by enforcement."  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? Well, ask and ye shall receive, I guess. It is Tuesday, June 6th, and we are talking about the SEC going after Binance and now Coinbase as well. A quick note before we dive in. If you are enjoying the breakdown, please go subscribe to it. Give it a rating. Give it a review. Or if you want to dive deeper, into the conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit. ly slash breakdown pod. Well, friends, yesterday I told you how just as I was pressing record on

the show all about the new McHenry Thompson bill, the SEC threw my plans into turmoil by suing Binance and CZ. So of course, this morning I came all prepared with a full workup of the details of that sued and what it means and the crypto industry's interpretation thereof, only to have Gary Gensler fire his second shot in his many days, suing Coinbase as well. Now, the simple fact of the matter is that I have not had a chance yet to dig fully into the Coinbase suit, although the first interpretations from many of the crypto legal minds that I trust seem to think that there are some pretty significant differences between the two suits. That said, they're still alleging a lot of the same things in terms of what assets they say

are securities. And of course, it still amounts to the SEC going after the biggest global exchange and the most well-known U.S. exchange inside of one week. The blockchain associations Jake Chervinsky summed it up this way. I often think of a line Matt Levine wrote last September about SEC Chair Gary Gensler. His message is basically, I should be the main regulator of crypto. And as the main regulator, my plan is mostly to ban it. Forget regulation by enforcement. This SEC wants a ban by enforcement.

So today we are going to dig into the details of the Binance suit as planned. And then tomorrow we will do a larger workup of the Coinbase suit and what it all means. put together. So let's start with Binance. The SEC's lawsuit announced yesterday, alleges that Binance International, Binance U.S., and Binance CEO, CZ, have violated securities laws by failing to register with the regulator and for offering unregistered securities for sale. Each company is alleged to have failed to register as an exchange, a broker-dealer, and a clearing agency. The sale of unregistered securities relates to a range of Binance products, including B&B, Binance's exchange token, BUSD, Binance's stablecoin, simple earn as well as B&B vault, the exchanges to yield generating accounts,

and finally, Binance's hosted staking program, which supports a wide range of proof-of-stake assets. The lawsuit also alleges that 10 independent cryptos are securities, including large market cap tokens, Salana, Cardano, Polygons Maddick, and Cosmoses Adam. Now, CZ was named personally in the lawsuit under the legal theory that he is a, quote, control person relative to both Binance International and Binance U.S. The SEC alleges that CZ had functional control over both platforms and is therefore liable for their breaches of securities law. Now, the lawsuit weighs in at a hefty 136 pages, with 38 pages dedicated to analysis of why

the various independent tokens ought to be categorized as securities. Ryan Selkis, the co-founder at Masari, wrote, advocating for crypto is very hard sometimes, zero days since last incident. Gabe Shapiro wrote, today's been a really long week in crypto law. Now, the SEC did not mince words in their press release. with Chair Gary Gensler explaining the severity of the accusations clearly. Throughout 13 charges, he said, we allege that Zau and Binance entities engaged in an extensive web of deception,

conflicts of interest, lack of disclosure, and calculated evasion of the law. As alleged, Zau and Binance misled investors about their risk controls and corrupted trading volumes while actively concealing who was operating the platform, the manipulative trading of its affiliated market maker, and even where and with whom investor funds and crypto assets were custody. They attempted to evade U.S. securities laws by announcing, sham controls that they disregarded behind the scenes so that they could keep high-value U.S. customers on their platform.

Krabir Gurwal, the director of the SEC's enforcement division, added his own terse words. The entities not only knew the rules of the road, but they also consciously chose to evade them and put their customers and investors at risk, all in an effort to maximize their own profits. Now, substantively, what's similar or different as compared to the recent CFTC lawsuit? While many of the allegations of operating deficiencies in outright contemptive regulation were already used as the background for the CFTC lawsuit against Binance that was filed at the end of March. The details of those allegations were covered at length on the breakdown episode of March 28, but to quickly summarize, Binance is alleged to have maintained an internal market maker called Merit Peak,

which traded against customers on both the Binance International and U.S.-based platforms. Binance U.S. exchange was alleged to be merely a diversion for regulators, with separation between the domestic and international corporations nearly non-existent and CZ exerting significant control over the operations in the U.S. In addition, funds were allegedly freely exchanged between the two companies. When the U.S. exchange was established in 2019, Binance said they would begin blocking access to U.S. residents. Both lawsuits now allege that this regional blocking was little more than window dressing, with Binance staff alleged to have knowingly assisted major U.S. citizens in

circumventing regional controls and generally being indifferent to U.S. customers accessing their exchange via a VPN. This part is particularly important, as it's the legal argument which allows the regulators to assert jurisdiction over Binance International and not just the domestic exchange. Now, it's worth noting that these are still allegations leveled by the regulator, but the evidence presented includes excerpts from numerous internal chat logs, which paint a pretty grim picture of Binance's attitude towards compliance. Now, when it comes to what's new in this suit, a ton of words have been spilled around some of the evidence, including further chat logs and testimony from former Binance U.S. CEOs. One of the most seemingly damning quotes is attributed to

the Binance Chief Compliance Officer from 2018, who wrote, We are operating as a f***-un licensed securities exchange in the USA, bro. This quote is being literally plastered all over the SEC's social media accounts, which really drives home the idea that the SEC is not only conducting an enforcement campaign, but also a PR campaign to be seen as a tough regulator for the industry. Now, of course, as there always is, there is important context. While no matter what, it was incredibly stupid to write this down, the CCO in this particular instance wasn't representing his own thing.

thoughts, he was parodying the SEC view. Crypto developer Lawrence Day wrote, Very funny to see a federal agency devolving into TikTok-level screen grabs for their regulation by enforcement. This quote is paraphrasing the SEC's view at the time, and they all know this. I hate jumping to Binance's defense for this. I'm one of their biggest haters. David Morris from CoinDesk wrote something similar, saying, this quote is going around and I just want to point out what's going on here. A Binance employee adopted the SEC's worldview, repeated it, then that became evidence against Binance. That same CCO is also quoted as saying, we do not want Binance.com to be regulated ever. On the surface, we cannot be seen

to have U.S. users, but in reality, we should get them through other creative means. In the lawsuit, CZ is also quoted, saying that the goal was, quote, to reduce the losses to ourselves, and at the same time to make the U.S. regulatory authorities not trouble us. Now, one big difference is that unlike the CFTC lawsuit, this time around, we have quotes attributed to the two previous CEOs of Binance U.S., which was incorporated as BAM trading. Both Catherine Coley and Brian Brooks, appear to have provided extensive testimony to the SEC in support of this lawsuit and it revealed a lot about what went on at the domestic exchange. Investor Adam Cochran wrote, The SEC had the past two CEOs of Binance U.S., Cooley and Brooks, both testify. I believe the SEC

overreaches in bad cases in this space due to a political agenda, but this isn't one of those. This time, they brought receipts. Coley, who presided over the U.S. platform from its launch until May 2021, is paraphrased as saying that CZ's controls felt like quote-unquote shackles that often prevented employees from understanding and freely conducting the business of running and operating the U.S. exchange. The situation was so bad that by November 2020, she said that her, quote, entire team feels like it had been duped into being a puppet. When Brooks took over his CEO, he claims to have said the links between the U.S. and international platforms was a problem, and insisted that control over domestic data and technology needed to be transferred to the U.S.

company. Now, Brooks remained in that position for only three months, leaving after it became clear that he was being overruled on the transfer of operations by CZ. He testified at the law, that, quote, what became clear to me at a certain point was CZ was the CEO of BAM trading, not me. All of the things that we had previously agreed and had worked on for 80 days were suddenly repudiated with no further discussion. And on that day, I realized, huh, I'm not actually the one running this company, and the mission that I believed I signed up for isn't the mission. As soon as I realized that, I left. Although the lack of financial controls between Binance U.S. and the international entity had previously been discussed in news articles and in the CFTC lawsuit,

Koli's testimony gave even more details. She testified that in June 2020, she was alerted by a trust company that worked with Binance US, that their internal transfers had increased from around 10 million to 1.5 billion per day. Coley said that she had no means to verify the transactions as she lacked appropriate account access. In December 2020, 17 million was transferred from Binance US to Merritt Peak, the international market maker. Coley only discovered the nature of the transaction after asking employees at Binance International and was quoted as saying, Thanks, helpful, just had to get explanation anytime someone breaking our limits with massive withdrawals. I have to ask where you get that kind of money and where is it going. I'm on a wild goose chase to make sure we have knowledge of where 17 million is moving around.

Now, transfers of cash between Binance U.S. and the international exchange are one thing, but the SEC lawsuit extends the allegation to actual controls over customer assets. The lawsuit alleges that, quote, Binance had sufficient control to manage and authorize the transfer of crypto assets, including between various omnibus wallets without the need for any authorization from Binance, US. The SEC claimed that that arrangement put U.S. customers at risk because it gave, CZ and Binance effectively free reign. The SEC alleged that customer assets were commingled and diverted, quote, in ways that properly registered brokers, dealers, exchanges, and clearing agencies would not have been able to do. Now, holding aside questions of Binance's behavior, there's also the question of this accusation that a bunch of different assets are in fact securities. Indeed,

to win this lawsuit, the SEC needs to prove that the tokens and products offered by Binance are in fact securities. As I said, at the top, 10 major independent cryptos have been alleged to be securities in the lawsuit. The full list includes Solana, Polygonsmatic, Cosmosis Adam, Cardano, Algorand, Filecoin, Decentralands Mana, Sandboxes Sand, Axi Infinity, and Cote. Now, the analysis in the lawsuit is extensive, but not all that novel from legal theories already put forward by the SEC. Each piece of analysis hinges on the idea that the token is an embodiment of the initial investment contract between early investors and the team, so continues to be a security in secondary sales. As for the initial investment contract, the SEC really

relies on various statements about teams working to accrue value to the token, similar to other token cases. Now, the really noteworthy thing here is that the lawsuit extends the SEC's strategy of suing exchanges for their token listing standard, rather than suing the token issuers and allowing them the ability to make a case that their tokens should be considered commodities. Now, Binance responded, as you might expect, defiantly. Binance's chief strategy officer, Patrick Hillman wrote, For every journalist calling and asking, bizarrely, we have not even been given a copy of the complaint ourselves. Smart PR move to rob us of our right to defend ourselves publicly. Indeed, he went on with even deeper accusations of the SEC's

intentions here. Hillman wrote, prior to the complaint being made public, several media were pitched that there would be evidence of user funds being misused in an obvious attempt by someone to undermine community trust in the markets. There is zero evidence of this because it is patently false. CZ responded with his characteristic number four, suggesting that he believed this was all just another example of FUD. He wrote, our team is all standing by ensuring systems are stable, including withdrawals and deposits. We will issue a response once we see the complaint. Haven't seen it yet, media gets the info before we do. Now in a blog post, Binance also claimed that they had been cooperating with investigations for some time in an attempt to reach a negotiated settlement and were

thus disappointed by the lawsuit. Binance wrote, while we take the SEC's allegations seriously, they should not be the subject of an SEC enforcement action, let alone on an emergency basis. Unfortunately, the SEC's refusal to productively engage with us is just another example of the Commission's misguided and conscious refusal to provide much-needed clarity and guidance to the digital asset industry. Binance said that they were prepared to fight the lawsuit to the full extent of the law. Binance rejected the notion that the SEC's actions have anything to do with protecting investors, arguing instead that, quote, the SEC's real intent here appears to be to make headlines. And whether you like Binance or not, there is no denying that Gensler has been on an absolute media

tour for the last two days. Bankless co-host Ryan Schott Adams summed up a lot of people's feelings when he just pointed out how little trust the SEC has. He wrote, I have no idea if Binance is 100% clean here, time will tell. But I do know that the SEC declaring that Seoul, ADA, Maddic, Adam, and NaxS are securities is a direct attack on crypto. I trust Binance more than I trust the SEC. I trust CZ more than Gensler. What a sad state. Jeff Dorman from Arka gave the meh take. He said it's mostly irrelevant since no one operates in the U.S. anymore and a bunch of non-criminal charges for past wrong doings doesn't really matter. I see two actual negatives from this. One, the SEC explicitly defining certain tokens randomly as securities

could lead to delistings on Cracken and Coinbase or any other U.S. exchange. Two, negative sentiment effect if CZ is out and people loved him. That's about all I see, pretty benign otherwise. From a market standpoint, how many times can you rally on the same news over and over again, i.e. 2020, corporate spying Bitcoin, or sell off on the same news, i.e. 2023, SEC hates crypto. It just doesn't have much impact anymore. In a global industry with perfect substitutes and low barriers to entry, targeting any single product, Bitcoin mining stablecoins, or any single player, finance, Coinbase, crack, and blockfi, etc., just doesn't matter. Business will always continue somewhere else. So that brought us up to this morning and the SEC's targeting of Coinbase in another

lawsuit. And there's some parts of the complaint are similar. The SEC is saying that Coinbase has operated as an unregistered broker exchange and clearing agency simultaneously, right, the Coinbase platform merges three functions that are typically separated in traditional securities markets, those of brokers, exchanges, and clearing agencies. Yet Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets. Now, one big difference with this suit is that neither Brian Armstrong nor any other executive of Coinbase were named as defendants. Paul Grewell, Coinbase's chief legal officer who's in fact testifying today in front of Congress, wrote,

the SEC's reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America's economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance. The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation. In the meantime, we'll continue to operate our business as usual. Indeed, one of the things we'll explore tomorrow is the extent to which the timing of these things was coordinated with the McHenry-Thompson Act. there are many who feel like there was a relationship one way or another. Either these actions being rushed up to match those potential new rules from Congress, or those in Congress who wanted to push forward those new rules knowing that this was coming

and wanting to get out ahead of the conversation as well. Jake Chravinsky again did a good job summing up the vibe after a couple hours of people ingesting the news. He wrote, I sends two reactions to the SEC's cases against finance and Coinbase. One, outrage at the SEC's underhanded tactics and open hostility and flagrant disregard for its own mission. Two, relief that the SEC finally took its shot and it's really not that bad? Life and business go on. The outrage is justified. For years, the SEC has failed to give useful guidance or engage in productive rulemaking, all while falsely claiming the law is clear and telling exchanges to come in

and register despite refusing to explain how they can do so. This is ridiculous. But the relief is justified too. Anticipation is often worse than reality, and that feels true here. It's good to get past though, will they or won't they phase and finally get into the fight. The SEC doesn't make the law. It only makes allegations and can and will lose in court. So friends, we will leave it there for today. Lots more to dig into tomorrow and throughout the week, I'm sure. And by the way, if you want to get a little bit more involved in this fight in a practical way, check out join dFA.org. The Digital Freedom Alliance is a new coordinated grassroots movement of crypto advocates to be a political and economic force and was just announced by Ryan Selkis from Masari.

More on that later this week as well. Until tomorrow, be safe and take care of each other. Peace.