Two secret companies controlled by Binance’s CEO are at the heart of the US securities regulator’s lawsuit against the crypto exchange, with the agency alleging misuse of client funds on the world’s largest digital asset trading platform.
At the center of the lawsuit filed this week by the Securities and Exchange Commission were allegations involving Merit Peak and Sigma Chain, two trading firms directly or indirectly owned by Binance CEO Changpeng Zhao.
The companies were used to mix and divert client funds, as well as conduct “manipulative trading” on Binance’s U.S. arm, the lawsuit said: Zhao and Binance used client assets “at their own discretion”.
The indictments mark the most aggressive intervention yet by the SEC, led by the hardline Gary Gensler, against what it considers unlicensed crypto activity in the US. The SEC also filed a lawsuit this week against Coinbase, another of the most high-profile names in the market.
While accusing both Coinbase and Binance of running unregulated stock exchanges — allegations both companies deny — the SEC continued its allegations against Binance. In addition to allegations of misuse of client funds, the regulator has requested a temporary freeze on several Binance-linked entities. Zhao said on Thursday that Binance US had about $2 billion in user funds “as far as I know”.
“The question is: was there fraud involved and can the agency . . . proof that?” Yuliya Guseva, vice dean and head of the fintech and blockchain program at Rutgers University in New Jersey, said of the SEC’s case against Binance.
The rush to freeze the funds was based on what the SEC said was the free movement of client funds, primarily pooled or diverted to Merit Peak.
The two units are beneficially owned by Zhao, according to the SEC. Based in the British Virgin Islands, Merit Peak is a proprietary trading firm trying to make money from changing market prices. It also offers market shaping, luring buyers and sellers to the market with competitive prices.
Meanwhile, the regulator said Sigma Chain, which is based in Switzerland, engaged in wash trading – a form of market manipulation – that artificially inflated trading volume on Binance US.
Accompanying documents and Monday’s lawsuit contained a series of points that showed the extent of Binance’s relationship with Sigma and Merit Peak, which it deemed inappropriate.
Exchanges typically match buyers and sellers at the best price, while market making and prop trading are usually conducted by separate companies seeking to profit from the price differences between assets on rival trading venues.
The regulator alleges that Merit Peak received $22 billion from Binance and related entities while using Sigma Chain to boost trading volume on Binance US, the US arm of the company.
The relationship is in stark contrast to Zhao’s repeated claims that the companies and their actions are independent.
“Credibility is the most important asset for any exchange! If an exchange faked their volumes, would you trust them with your money?” Zhao said in 2019, according to the SEC.
“Crypto companies often claim that there is no regulatory clarity for the industry, but when it comes to running a traditional, centralized exchange, the standards have been in place for decades,” said Henri Arslanian, managing partner at crypto asset management firm Nine Block Capital Management. “It’s not that complicated.”
Binance said it was disappointed and discouraged by the SEC’s action, adding that while it took the regulator’s allegations seriously, they “should not be the subject of any SEC enforcement action.” Binance US called the lawsuit “unfounded”.
The agency is seeking a so-called disgorgement, whereby Binance would refund all the money it had made from alleged fraud and other penalties. “Sleep in is the strongest remedy. It’s known to kill projects,” Guseva said, adding that if the SEC won, “it could be existential” for Binance’s US operations.
Senators Elizabeth Warren and Chris Van Hollen, meanwhile, urged the US Department of Justice to investigate Binance and Binance US. They said the companies told Congress they were separate entities prioritizing compliance.
“If the allegations in the SEC filing are correct, then it appears that neither allegation is true,” they wrote Thursday.
Sigma Chain and Merit Peak engaged in a series of transactions with Binance-affiliated companies starting in 2019, the SEC said, with their actions hitting the regulated financial system through crypto-friendly banks Silvergate and Signature, which facilitated the payments. The transactions underlined how the seemingly independent trading firms Binance and Zhao actually operated.
SEC filings also alleged that Merit Peak and Sigma Chain had accounts with crypto-friendly banks Silvergate, and Merit had one with Signature. Both banks went bankrupt earlier this year.
Between 2019 and 2021, accounts at Silvergate Bank and Signature received approximately $70 billion from Binance entities.
Nearly all of those funds were sent from Merit Peak to a foreign subsidiary of Paxos, a New York-regulated group that issued BUSD, a Binance-branded cryptocurrency that once accounted for about 40 percent of Binance’s trading volume.
In February, New York regulators halted BUSD issuance, citing “several unresolved issues” regarding Paxos’ relationship with Binance for the token.
Despite Zhao’s repeated claims that Binance US is independent of the broader platform, the SEC said he used Merit Peak to send more than $16 million to a Binance-related entity to fund Binance US’s operations. The SEC described these funds as “critical” to the platform’s spending.
Sigma Chain engaged in wash trading in 48 of the 51 cryptoassets newly listed between January 2022 and June 23, 2022 to boost the appearance of activity, the SEC said.
The day after Binance US opened for trading, wash trading between Sigma Chain accounts owned by Zhao or associated with senior Binance employees accounted for more than 99 percent of first hour trading volume in at least one crypto asset, according to the SEC.
“They misled investors into thinking that trading volumes on the platform were robust, real and reliable,” the SEC said, adding that the entity “had no trading oversight mechanisms in place until at least February 2022.”
“It is red meat for prosecutors and regulators when you see evidence that senior executives deliberately flouted the rules. Authorities simply cannot overlook that. . . that kind of thing can put you at the top of the target list,” said a former federal prosecutor in Washington DC.