On March 27, 2023, the CFTC filed 74-page civil complaint charging Binance’s co-founder, Changpeng Zhao (“CZ”), and its former chief compliance officer, Samuel Lim, with several counts of CEA and CFTC violations. According to the CFTC press release:
The complaint charges that Binance Holdings Limited, Binance Holdings (IE) Limited, and Binance (Services) Holdings Limited (together, Binance) operate the Binance centralized digital asset trading platform along with numerous other corporate vehicles through an intentionally opaque common enterprise, with Zhao at the helm as Binance’s owner and chief executive officer. The defendants allegedly chose to knowingly disregard applicable provisions of the CEA while engaging in a calculated strategy of regulatory arbitrage to their commercial benefit. “Defendants’ alleged willful evasion of U.S. law is at the core of the Commission’s complaint against Binance. The defendants’ own emails and chats reflect that Binance’s compliance efforts have been a sham and Binance deliberately chose – over and over – to place profits over following the law,” said Gretchen Lowe, CFTC’s Enforcement Division Principal Deputy Director and Chief Counsel. “Today’s enforcement action reflects that the CFTC and its Enforcement Division will pursue those digital asset platforms and individuals who flout and actively attempt to circumvent CFTC regulatory requirements. I thank the Enforcement team for their dedication and hard work in bringing this action.”CFTC Statement
Will Possible Criminal Charges Follow From the CFTC’s Complaint?
It is of course unclear at this time whether the allegations charged into CFTC’s complaint could ultimately result in criminal charges being filed by the United States Department of Justice. We have seen a definite pattern emerge of late where the SEC, the CFTC and the DOJ have been working in close partnership on crypto currency platform cases. CFTC Charges FTX Co-Owner with Fraud by Misappropriation and Aiding and Abetting Fraud Related to Digital Asset Commodities (noting that “the CFTC appreciates the assistance of the U.S. Attorney’s Office for the Southern District of New York, the Federal Bureau of Investigation, the SEC, and the Securities Commission of The Bahamas”).
It is therefore entirely possible that future criminal charges might follow the CFTC’s civil complaint. It was previously reported back in December of 2022 that the DOJ was “split” on whether to bring U.S. criminal charges against Binance. Exclusive: U.S. Justice Dept is split over charging Binance as crypto world falters
So what potential criminal charges could follow from the CFCT’s complaint. Let’s discuss some possibilities. It is important to stress that no criminal charges have been filed against Binance by the U.S. DOJ as of the writing of this blog post. Given recent reports that the DOJ is “split” on whether to bring charges against Binance, this begs the question—what could those possible charges be? Crypto Criminal Defense Lawyer
The allegations set forth in the CFTC’s complaint could potentially be charged in federal conspiracy counts alleging wire fraud and money laundering as associated with the CEA and CFTC violations set out in the CFTC’s complaint. A potential federal wire fraud count could potentially touch on the CFTC’s allegations of Binance’s alleged “willful evasion of U.S. law … including promoting the use of “creative means” to assist customers in circumventing Binance’s compliance controls and implementing a corporate policy that instructed Binance’s U.S. customers to access the trading facility through a virtual private network to avoid Binance’s IP address-based controls or create “new” accounts through off-shore shell companies to evade Binance’s KYC-based controls. CFTC Statement
The CFTC’s compliant charges:
For example, in February 2019, after receiving information “regarding HAMAS transactions” on Binance, Lim explained to a colleague that terrorists usually send “small sums” as “large sums constitute money laundering.” Lim’s colleague replied: “can barely buy an AK47 with 600 bucks.” And with regard to certain Binance customers, including customers from Russia, Lim acknowledged in a February 2020 chat: “Like come on. They are here for crime.” Binance’s MLRO agreed that “we see the bad, but we close 2 eyes.” ¶104.
Wire Fraud under Tile 18 United States Code Section 1343 is expansive and can encompass a wide range of allegedly fraudulent conduct.
Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, transmits or causes to be transmitted by means of wire, radio, or television communication in interstate or foreign commerce, any writings, signs, signals, pictures, or sounds for the purpose of executing such scheme or artifice, shall be fined under this title or imprisoned not more than 20 years, or both. If the violation ... affects a financial institution, such person shall be fined not more than $1,000,000 or imprisoned not more than 30 years or both.
Wire fraud affecting a financial institution has a 10-year statute of limitations. 18 U.S.C. § 3293(2) ("No person shall be prosecuted ... for a violation of ... [§] 1343, if the offense affects a financial institution ... unless the indictment is returned or the information is filed within 10 years after the commission of the offense."); 18 U.S.C. § 20 (defining financial institution). See United States v. Chanu, 40 F.4th 528, 535 (7th Cir. 2022).
Money laundering is prosecuted under Tile 18 United States Code Section 1957. “A person violates § 1957(a) when he "knowingly engages or attempts to engage in a monetary transaction in criminally derived property of a value greater than $10,000 and is derived from specified unlawful activity." See U.S. v. Huff, 641 F.3d 1228, 1230 (10th Cir. 2011) As noted in Huff, to prove money laundering, the government must prove five elements:
[T]hat the defendant (1) engaged or attempted to engage, (2) in a monetary transaction, (3) in criminally derived property, (4) knowing that the property is derived from unlawful activity, and (5) that the property is, in fact, derived from specified unlawful activity. See U.S. v. Huff, 641 F.3d 1228, 1230 (10th Cir. 2011).
Whether such charges can or may be brought by the DOJ is of course unclear at this time. It will be interesting to see whether the CFCT’s civil complaint against Binance is followed by any current enforcement action by the SEC or any potential concurrent criminal charges by the United States DOJ.
So What is Conduct is Charged in the CFTC’s Complaint?
Paragraph 7 of the CFTC’s complaint charges that:
Despite Binance’s solicitation of and reliance on customers located in the United States to generate revenue and provide liquidity for its various markets, Binance has never been registered with the CFTC in any capacity and has disregarded federal laws essential to the integrity and vitality of the U.S. financial markets, including laws that require the implementation of controls designed to prevent and detect money laundering and terrorism financing, in violation of the Commodity Exchange Act (“Act” or “CEA”), 7 U.S.C. §§ 1–26, and the CFTC Regulations (“Regulations”), 17 C.F.R. pts. 1–190 (2022). (emphasis added).
Binance’s VIP Program:
The CFTC’s complaint includes a lengthy summary and breakdown of Binance’s VIP customer programs and alleges that Binance's VIP program offers significant benefits to its top customers, including reduced transaction fees, white-glove customer service, preferential access to matching engines, and exceptions to trading rules. One notable benefit cited in the CFTC’s complaint is “prompt notification of any law enforcement inquiry” concerning a VIP's account. Complaint at ¶51
Binance’s Use of Encrypted Communications Apps:
The CFTC’s complaint further alleges that Binance uses various messaging applications for business communications, including Telegram, WeChat, and Signal. Complaint at ¶52 The CFTC charges that Signal's auto-delete functionality has been used by Binance's CEO and other personnel to engage in business communications, even after receiving document requests from the CFTC and after distributing document preservation notices. Complaint at ¶53 The CEO has used Signal for communications with various Binance personnel and has instructed others to use Signal for communications with U.S. customers. Binance does not have a corporate communications policy and continues to use Signal for business communications. Id.
The CFTC further alleges that Binance's CEO, Zhao, has been directly involved in the company's product offerings and has kept a close eye on competition. Complaint at ¶67 In an October 2020 chat, he discussed the potential risks of creating products that resemble gambling or could lead to addiction. Id.
The CFTC also charges that during the “Relevant Period”, Binance has traded on its platform through around 300 "house accounts" owned by its CEO Zhao, as well as Merit Peak and Sigma Chain accounts. Complaint at ¶69 According to the CFTC, Binance does not disclose its proprietary trading activity to customers. Complaint at ¶70.
Binance’s Ties to the United States:
The CFTC further alleges in its complaint that Binance has maintained significant ties to the U.S. financial system and economy, actively soliciting U.S. customers and employing at least 60 people in the country. Complaint at ¶70. Binance's senior management, including Zhao, has known that U.S. customers trade on their platform and have tracked their activities. Id. Binance officers, employees, and agents have interacted with U.S.-based institutional customers at various events. Binance has procured professional services from U.S.-based law firms, compliance consultants, and other vendors concerning its business operations. Id.
The CFTC charges that Binance has sought protection for its intellectual property in the U.S., filing trademark applications for various terms. Complaint at ¶80. In 2019, Binance.US was launched, catering to U.S. customers. ¶81. The corporate structure of Binance comprises over 120 entities worldwide, with its location and ownership deliberately obscured. The CFTC charges that Binance’s Founder and CEO, Zhao, has been responsible for all major strategic decisions, business development, and management of the Binance enterprise. ¶85.
The CFTC also alleges that despite purporting to restrict access to U.S. customers since mid-2019, Binance has left a “loophole” that allows customers to deposit, trade, and withdraw without submitting to KYC procedures. ¶91. Binance has been aware of its compliance issues, but is “prioritizing profits over legal compliance”, with only 30-40% of its customers verified through KYC documentation as of February 2022. ¶96.
The CFTC essentially charges that Binance has refused implement effective compliance The CFTC added that “Binance's platform facilitated potentially illegal activities”, and internal discussions revealed that Binance tolerated customers using the platform for illicit activities. ¶104.
For example, in February 2019, after receiving information “regarding HAMAS transactions” on Binance, Lim explained to a colleague that terrorists usually send “small sums” as “large sums constitute money laundering.” Lim’s colleague replied: “can barely buy an AK47 with 600 bucks.” And with regard to certain Binance customers, including customers from Russia, Lim acknowledged in a February 2020 chat: “Like come on. They are here for crime.” Binance’s MLRO agreed that “we see the bad, but we close 2 eyes.” ¶104.
The CFTC cited “internal discussions” between Binance colleagues:
Lim’s internal discussions with compliance colleagues illustrate that Binance has tolerated Binance customers’ use of the platform to facilitate “illicit activity.” For example, in July 2020, a Binance employee wrote to Lim and another colleague asking if a customer whose recent transactions “were very closely associated with illicit activity” and “over 5m USD worth of his transactions were indirectly sourced from questionable services” should be off-boarded or if it was in the class of cases “where we would want to advise the user that they can make a newaccount.” Lim chatted in response: “Can let him know to be careful with his flow of funds, especially from darknet like hydra He can come back with a new account But this current one has to go, it’s tainted” ¶105.
The CFTC further charges in its complaint that Binance's corporate communications attempted to portray that they did not target the United States, but internal communications showed otherwise. ¶107.
Defendants have been aware of the regulatory regime that applies to U.S. financial institutions such as FCMs, and exchanges such as DCMs and SEFs, throughout the Relevant Period, but have made deliberate, strategic decisions to evade federal law. ¶108.
The CFTC charges that Binance utilized “workarounds” to help its customers evade compliance controls, specifically IP address-based controls. ¶119. The CFTC maintains that senior management have allegedly instructed customers to use VPNs and provided guidance on how to bypass restrictions. Id. Binance has also is charged with creating special policies and procedures for VIP customers to evade both IP address-based and KYC documentation-based compliance controls. ¶122-23. The CFTC maintains these efforts were intended to retain U.S. customers and the associated revenue.
The CFCT charges that Binance allows U.S. customers to trade on its platform despite restrictions. The complaint cites one instances in October 2020, after a rival exchange faced legal action, Zhao directed Binance to replace U.S. data with "UNKWN" in their internal database, making it difficult to track U.S. customers. "UNKWN" was understood as a code word for the United States within Binance. ¶139.
Binances’ Broker Program:
The CFTC charges that Binance had a "broker program" that allowed third parties to introduce customers to the platform, without effective controls to prevent U.S. customers from accessing the platform. ¶141. Exchange and prime brokers facilitated access for institutional customers in the U.S. Binance allowed at least two prime brokers to open "sub-accounts" for U.S. customers to trade digital asset derivatives, without collecting identity-verifying documentation or attempting to learn the identity of these customers. ¶143.
The CFTS’s complaint next discusses three trading firms that they allege are examples “Market Participants Currently Trading on Binance and Binances’s Efforts to Help Them Evade It’s Compliance Controls.” Complaint at Page 48. Here’s a summary of these each trading firm cited in the CFTS’s complaint.
Trading Firm “A”:
Trading Firm A, a U.S.-based quantitative trading firm, has traded on Binance through various accounts and strategies.¶150-161. Binance provided VIP status, lower latency access, exceptions to order-messaging limits, and reduced trading fees to Trading Firm A. The firm used VPNs to access Binance.com and conducted trades using algorithms developed in the U.S. Id.
In June 2019, a Binance Key Account Manager instructed Trading Firm A to “switch the account KYC.” Following Binance’s instructions, Trading Firm A opened a “new” Binance account in August 2019 in the name of a wholly-owned subsidiary incorporated in the Cayman Islands. Substantially all personnel that perform work for this Cayman Islands nominee entity are employed by Trading Firm A or its subsidiaries and Trading Firm A controls all aspects of its Cayman Islands subsidiary. During the account opening process, Binance instructed Trading Firm A to access the Binance website through a VPN to avoid Binance’s IP address based compliance controls. Once this account was opened, Trading Firm A transferred all of its trading activity, and Binance transferred Trading Firm A’s VIP status and benefits, to the “new” account. Trading Firm A did not make any material changes in the way it traded on Binance in August 2019, other than the name on the account. ¶156.
Trading Firm “ B”:
Trading Firm B is a quantitative trading firm headquartered in New York, majority-owned by U.S. residents, with offices in various cities worldwide. ¶162-176. The firm uses proxy servers and automated trading algorithms developed in-house. Binance, a cryptocurrency exchange, has granted Trading Firm B VIP status, resulting in reduced trading fees and other benefits.
The CFTC charges that Trading Firm B began trading digital assets on Binance in July 2018 through a Hong Kong-incorporated subsidiary account. In February 2020, they encountered issues with opening a futures account and eventually opened a personal account under a UK-based employee, receiving VIP benefits. Trading Firm B conducted corporate trading activity through this personal account for years, with Binance fully aware of the arrangement. ¶169.
On February 13, 2020, Trading Firm B tried to “open a futures account” and received an “error message.” Senior Binance personnel then concluded this may have been due to “US ip” or that “the UBO would be a US person.” Binance employees chatted: “How annoying,” and surmised that Trading Firm B’s account was “[g]randfathered” from “back before [Binance] screened for” the location of its customers. After confirming that Trading Firm B was a “US entity in our system,” Binance employees conferred with Trading Firm B’s New York-based cryptocurrency business development personnel and “discussed with him (a) short term opening a personal account and (b) moving this personal account to their HK legal entity in medium term.” ¶167.
The CFTC charges that in March 2022, Trading Firm B created a new Binance account under a Jersey-based nominee shell company. ¶175. The nominee entity has no employees or significant capital but is linked to Trading Firm B through service agreements and confirmatory notes. Binance allowed Trading Firm B to continue trading through the personal account and eventually replaced the account's name with the Jersey nominee's name while maintaining the same VIP benefits, access, open positions, and account number. Id.
The CFTC charges that throughout these changes, Trading Firm B has always been the real economic party to its trading activity on Binance, and the net trading revenue derived from its trading activity on Binance has been consolidated into Trading Firm B's financial statements. ¶176.
Trading Firm “C”:
The CFTC charges that Trading Firm C is a New York-based quantitative trading firm, majority-owned by U.S. residents, with global offices and part of a corporate umbrella of affiliates and subsidiaries. ¶177-186. The firm trades digital asset derivatives on Binance using automated trading strategies developed in the U.S. and other locations. Binance's CEO, Zhao, has communicated directly with Trading Firm C's CEO and been part of a Signal group chat with the firm's New York-based Chief Investment Officer.
Trading Firm C conducts trading on Binance through at least 15 independent teams, including those based in and managed from New York. The firm's trading activity relies on functionalities developed under the supervision of three CTOs, two of whom are located in the U.S. ¶180.
Trading Firm C and its commonly-owned corporate affiliate have been the real economic party to its trading activity on Binance. The firm's net trading revenue from Binance is consolidated into the financial statements of its Delaware-incorporated affiliate and combined into Trading Firm C's financial statements. ¶182.
Initially, Trading Firm C traded on Binance through a Singapore-incorporated subsidiary account. In October 2021, the firm migrated its trading activity to an account under a Cayman Islands-incorporated nominee entity to comply with Binance's requirements concerning U.S. beneficial ownership. ¶183.
Consistent with its understanding that the trading activity in the “new” account held by the Cayman nominee is attributable to Trading Firm C, Binance has communicated about that account with Trading Firm C personnel that use @[trading-firmc].com email addresses and through Telegram chat groups with titles that include “Binance” and “Trading Firm C.” ¶185.
COUNT 1 of the CFTC Complaint: Violations of Section 4(a) of the Act, 7 U.S.C. § 6(a), or, alternatively, Section 4(b) of the Act,7 U.S.C. § 6(b) and Regulation 48.3, 17 C.F.R. 48.3 (2022) Execution of Futures Transactions on an Unregistered Board of Trade. ¶187-195.
Count 1 of the complaint alleges that Binance and its associated entities violated the Commodity Exchange Act and regulations by executing futures transactions on an unregistered board of trade. The complaint claims that during the relevant period, Binance offered, entered into, and confirmed retail commodity transactions involving digital assets without conducting these transactions on a board of trade designated or registered by the CFTC. Binance's retail commodity transactions were offered on a leveraged or margined basis, and were not limited to eligible contract participants or eligible commercial entities.
In the alternative, the complaint alleges that Binance violated regulations by permitting direct access to its electronic trading and order matching system without obtaining an Order of Registration for a foreign board of trade from the Commission.
The complaint further asserts that Zhao, as a control person, is liable for Binance's violations, while Lim, as Binance's Chief Compliance Officer, willfully aided and abetted these violations and is therefore liable to the same extent as Binance.
COUNT 2 of the CFTC Complaint: Violations of Section 4c(b) of the Act, 7 U.S.C. § 6c(b), and Regulation 32.2, 17 C.F.R. § 32.2 (2022) Illegal Off-Exchange Commodity Options. ¶196-202.
Count 2 of the complaint alleges that Binance and its associated entities violated Section 4c(b) of the Commodity Exchange Act and Regulation 32.2 by engaging in illegal off-exchange commodity options. During the relevant period, Binance is accused of offering, entering into, confirming the execution of, maintaining positions in, and conducting activities related to commodity option transactions in interstate commerce without executing these transactions on a registered board of trade or seeking registration as an exempt foreign board of trade.
The CFTC charges that Zhao, as a control person, is alleged to be liable for Binance's violations in this count due to his lack of good faith and for knowingly inducing the acts constituting these violations. Additionally, Binance is considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. The CFTC charges that Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶202.
COUNT 3 of the CFTC Complaint: Violation of Section 4d of the Act, 7 U.S.C. § 6d Failure to Register as a Futures Commission Merchant. ¶203-209.
Count 3 of the complaint alleges that Binance and its associated entities violated Section 4d of the Commodity Exchange Act by failing to register as a Futures Commission Merchant (FCM). The complaint claims that during the relevant period, Binance operated as an FCM by soliciting or accepting orders for the purchase or sale of commodities for future delivery, swaps, and retail commodity transactions, as well as acting as a counterparty in certain transactions. In connection with these activities, Binance allegedly accepted money, securities, or property to margin, guarantee, or secure resulting trades on its platform without registering as an FCM.
The CFCT charges that Zhao is liable as a control person for Binance's violations, as he directly or indirectly controlled Binance and did not act in good faith or knowingly induce the acts constituting these violations. ¶207. Binance is also considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶209.
COUNT 4 of the CFTC Complaint: Violations of Section 5h(a)(1) of the Act, 7 U.S.C. § 7b-3(1), and Regulation 37.3(a)(1), 17 C.F.R. § 37.3(a)(1) (2022) Failure to Register as a Designated Contract Market or Swap Execution Facility. ¶210-217.
Count 4 of the complaint alleges that Binance and its associated entities failed to register as a Designated Contract Market (DCM) or Swap Execution Facility (SEF) as required under Section 5h(a)(1) of the Commodity Exchange Act and Regulation 37.3(a)(1). During the relevant period, Binance operated a facility for trading swaps on digital assets like BTC, ETH, and LTC without registering with the CFTC as a DCM or SEF. Binance's trading system allowed multiple market participants to execute or trade swaps with one another, and certain products traded on Binance, such as perpetual futures or contracts on BTC, ETH, and LTC, are considered swaps under the Act.
Zhao is accused of being liable as a control person for Binance's violations, as he directly or indirectly controlled Binance and did not act in good faith or knowingly induce the acts constituting these violations. ¶215. Binance is also considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶217.
COUNT 5 of the CFTC Complaint: Violations of Regulation 166.3, 17 C.F.R. § 166.3 (2022) Failure to Diligently Supervise. ¶218 - 224.
Count 5 of the complaint alleges that Binance and its associated entities failed to diligently supervise their operations, violating Regulation 166.3. Specifically, Binance is accused of employing an inadequate supervisory system and failing to perform supervisory duties diligently. This includes failing to implement effective Customer Information Programs, Know-Your-Customer procedures, Anti-Money Laundering procedures, and ensuring the lawful handling of commodity interest accounts. Binance is also accused of instructing customers to evade compliance controls and intentionally destroying documents related to illegal conduct.
Zhao is alleged to be liable as a control person for Binance's violations, as he directly or indirectly controlled Binance and did not act in good faith or knowingly induce the acts constituting these violations. ¶222. Binance is considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶224.
COUNT 6 of the CFTC Complaint: Violations of Regulation 42.2, 17 C.F.R. § 42.2 (2022) Failure to Implement Customer Information Program, and Failure to Implement Know Your Customer and Anti-Money Laundering Procedures. ¶225-230.
Count 6 of the complaint alleges that Binance and its associated entities violated Regulation 42.2 by failing to implement a Customer Information Program, Know-Your-Customer policies and procedures, and an Anti-Money Laundering program. They are also accused of failing to retain required customer information and implement procedures to determine whether a customer appears on lists of known or suspected terrorists or terrorist organizations, such as those issued by OFAC.
Zhao is alleged to be liable as a control person for Binance's violations, as he directly or indirectly controlled Binance and did not act in good faith or knowingly induce the acts constituting these violations. ¶228. Binance is considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶230.
COUNT 7 of the CFTC Complaint: Violations of Regulation 1.6, 17 C.F.R. § 1.6 (2022) Anti-Evasion. ¶231 - 236.
Count 7 of the complaint alleges that Defendants Zhao, Lim, and Binance, along with its associated entities, violated Regulation 1.6 by conducting activities outside the United States in an attempt to willfully evade provisions of the Act and its Regulations. This includes entering into agreements, contracts, and transactions and structuring entities to bypass regulatory requirements.
Zhao is alleged to be liable as a control person for Binance's violations, as he directly or indirectly controlled Binance and did not act in good faith or knowingly induce the acts constituting these violations. ¶234. Binance is considered liable as a principal for each act, omission, or failure of its officers, employees, or agents, including Lim. Lim, while acting as Binance's Chief Compliance Officer, is accused of willfully aiding and abetting these violations and is therefore considered liable to the same extent as Binance. ¶236.
This blog post was prepared with the assistance of ChatGPT-4 AI. Nothing in this post should be considered legal advice or the creation of an attorney-client relationship. This blog is strictly for informational purposes only. Nothing in this post should be considered legal or financial advice.