On June 5th and 6th, 2023 the SEC filed complaints against Binance¹ and Coinbase², respectively, for acting as an exchange, broker, and a clearing agency without registering accordingly as a result of offering tokens and staking products that the SEC alleges are securities. In addition to the SEC’s actions, ten states have filed their own actions against Coinbase amounting to cease and desist orders with regard to Coinbase’s staking program. This client alert summarizes the actions by the SEC and state regulators and includes answers and recommendations based on client inquiries we have received. For a more detailed description of the SEC and state actions, please see our blog post on the subject.

The Binance complaint includes a stablecoin

In a departure from previous approaches in similar types of actions, each of the suits lists a number of tokens listed on, and the staking programs offered by, the exchanges³ that the SEC alleges are securities under U.S. laws. In Binance’s case, one of the tokens included in the suit is BUSD, a stablecoin issued by Binance. While stablecoins can be structured in a way that they are not deemed to be securities in the U.S., the facts alleged by the SEC with respect to BUSD would support a conclusion that BUSD as offered could be deemed a security. Of interest, ETH, the native token of the Ethereum blockchain, is not included in either complaint.

The Binance complaint includes fraud allegations, and the SEC has applied for a TRO

Some of the Binance defendants are also being accused of fraud. The SEC alleges that some Binance defendants agreed to implement certain types of procedures, such as surveillance and controls to prevent manipulative trading on the U.S. platform, but never did; that they comingled and diverted billions of dollars in customer assets to CZ-controlled companies, and that they engaged in manipulative wash trades to create the false appearance of liquidity. On June 6th, 2023, one day after it filed its suit against Binance, the SEC filed a temporary restraining order (“TRO”) in federal court to repatriate and freeze Binance’s assets and repatriate the assets of Binance.US customers. On June 9th, 2023, Binance.US announced that it would “pause USD fiat channels as early as June 13, 2023” and transition to a crypto-only exchange. On June 12, 2023, Binance filed its opposition to the motion to grant the TRO.

The complaints not only target tokens but also staking products

In addition to the accusations filed against Binance and Coinbase with respect to operating as unregistered exchange, broker, and clearing agency, the SEC is also accusing Binance and Coinbase of offering and selling securities through their respective staking program without registering the offers or sales of the staking product, which the SEC alleges are securities under applicable securities laws. The SEC has alleged that these unregistered offers and sales deprive investors of material information, thereby undermining investors’ interests.

The SEC may inadvertently have added support to one of the complaints the blockchain industry has levelled against the SEC

There were also notable differences in the coins named as securities in the Coinbase and Binance suits as filed by the SEC. The SEC failed to include ATOM, COTI, MANA or ALGO in the Coinbase lawsuit, despite these tokens being listed as securities in the Binance suit. Similarly, CHZ, NEAR, FLOW, ICP, VGX, DASH, and NEXO were not included in the Binance complaint as securities, although they were listed as securities in the Coinbase complaint. This action by the SEC has made it difficult to discern which tokens should be deemed unregistered securities— these tokens should be included in both suits if they are securities, or excluded completely if they are not. By including different sets of securities in the two suits (even though all of the coins except for BUSD and BNB are listed on both exchanges), the SEC is bolstering the arguments raised by many in the blockchain industry that the SEC has not provided sufficient clarity on what constitutes a security and which tokens are deemed securities by the SEC.

States have filed actions to enjoin Coinbase from offering its staking products

In addition to the SEC’s action, ten states (Alabama, California, Illinois, Kentucky, Maryland, New Jersey, South Carolina, Vermont, Washington and Wisconsin) have filed actions against Coinbase amounting to cease and desist orders with regard to Coinbase’s staking program. None of the state actions list any assets or products other than the staking program.

Other governmental agencies may decide to file charges or bring actions

On June 8, 2023, U.S. Senators Van Hollen (D-Md) and Warren (D-Mass) delivered a letter to Attorney General Merrick Garland asking the Department of Justice to investigate Binance and Binance.US for potentially making a series of false statements to Congress in their responses to the Senators’ March 2023 letters about their business practices. It would not be surprising if other governmental agencies or bodies seek to bring charges against Binance, Binance.US or Coinbase.

Practical Effects

Anyone doing business with Binance and Coinbase should consider the following potential consequences of the actions by the SEC and state regulators:

• The SEC will consider everyone on notice that the tokens listed in the two complaints are securities, and everyone holding or trading them should consider treating them as securities.  This does not mean that all of them will be securities when all is said and done, but anyone treating any of these 19 tokens (plus those listed in previous suits brought by the SEC⁴) as a non-security should do so only after careful consideration and analysis, including the potential consequences in the event that the SEC prevails.
• The actions brought by the regulators do not mean that it is illegal to engage in trades on either exchange; however, anyone acting as an adviser trading on either exchange should evaluate whether its applicable disclosure to investors may need to be updated to reflect any additional risks resulting from these actions (some of which are briefly highlighted in this list).
• Anyone with USD balances at Binance.US should withdraw such balances (or convert them to cryptocurrencies).  Advisers opting for the latter option should consider their risk and cash management policies for the relevant crypto strategy.
• There is a risk (however small) that Binance or Coinbase could delist any of the tokens mentioned in the complaints, which would affect a holder’s ability to trade such tokens (though we would expect that a holder would still be able to transfer such tokens to a wallet not hosted by such exchange).  Delisting may also result in decreased liquidity, which could result in higher costs borne by the holder attributable to exchanging such tokens to USD through alternative means.
• Anyone using the staking program at Binance or Coinbase should evaluate the risks arising from the SEC’s claims and, more immediately, the actions taken by the ten states mentioned above (e.g., whether it has adequately disclosed the risks of staking, including the potential loss of staking rewards, the inability to access the staked assets for an indefinite period of time and even the potential loss of such assets).
• If you are holding assets on one of these exchanges (or for that matter, on any other crypto trading platform), you should evaluate whether these assets are held in such a manner that they do not become part of the debtor’s estate in case of a bankruptcy filing or similar insolvency event of one of the exchanges.
• Registered investment advisers managing client assets that are held through either of these exchanges (regardless of whether the assets are some of those listed in the complaints) need to make sure that they have the necessary policies and procedures in place to comply with their regulatory and fiduciary obligations (such as requirements regarding personal trading and qualified custodians, as well as related client disclosures).
• Any fund that has determined that it is not an investment company because it only invests in cryptocurrencies or tokens that are not securities (or that it does not meet the threshold of investment securities because of its investments in cryptocurrencies or tokens that are not securities) needs to confirm that the tokens listed in the SEC’s complaint do not affect that determination.
• Binance and Binance.US seem to have updated their terms of use since the SEC filed its complaint, and it would not be a surprise if either of them, or Coinbase, decides to make significant changes to their terms of use as a result of the complaints or any other actions by regulators.  In the case of the recent changes by Binance and Binance.US, those changes were not announced, even though those changes could have a significant impact on a holder’s accounts or assets.⁵  It is advisable to anyone using any of these platforms to monitor their terms of use for changes.