SECURITIES AND EXCHANGE COMMISSION v. BINANCE HOLDINGS LIMITED, et al.
Civil Action No. 23-1599 (ABJ)
UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA
June 28, 2024
Plaintiff the Securities and Exchange Commission has brought this action against defendants Binance Holdings Limited, its founder Changpeng Zhao, and two related U.S. entities, BAM Trading Services, Inc. and BAM Management US Holdings, Inc., alleging violations of federal securities laws. Compl. [Dkt. # 1] at 1. The SEC alleges that defendants violated the
BACKGROUND
Defendant Binance is a Cayman Islands limited liability company that does business as Binance.com. Compl. ¶ 27. It has operated the internet-based Binance.com international crypto
Defendant BAM Trading Services is a Delaware corporation that does business as Binance.US. Compl. ¶ 29. It has operated the Binance.US crypto asset internet-based trading platform since 2019. Compl. ¶¶ 7–8, 29. Defendant BAM Management, a Delaware corporation, is the parent of BAM Trading and other affiliated entities. Compl. ¶ 28. When the Binance.US platform launched in 2019, BAM Management was a Cayman Islands company, which was wholly owned by CPZ Holdings Limited, a British Virgin Islands company that Zhao owned and controlled. Compl. ¶ 28. Zhao now owns eighty-one percent of BAM Management. Compl. ¶ 28. Zhao served as chairman of the boards of directors of both BAM Trading and of BAM Management until approximately March 2022. Compl. ¶ 30.
Crypto Assets
To understand this case, it is appropriate to begin with a description of the assets at issue and the crypto industry in general. A crypto currency is a digital, encrypted, and decentralized medium of exchange, and individual units are often referred to as coins or tokens. See Compl. ¶¶ 62–64. They are traded on electronic platforms such as the Binance.com and Binance.US platforms operated by defendants. Compl. ¶ 73. Crypto assets are transferred and secured using technology known as a “blockchain” or distributed ledger: a database spread across hundreds and even thousands of computer servers that records transactions in digitally recorded data packages called “blocks.” Compl. ¶ 63; Joint Mot. to Dismiss Claims Against Binance and Zhao [Dkt. # 118] (“Binance Mot.“) at 4. There are a number of different blockchain networks in existence, with Bitcoin and Ethereum being two of the most well-known. Binance Mot. at 4.
Crypto asset trading platforms operate as a central depository for the crypto assets customers deposit or trade on the platforms. Compl. ¶ 73. Customers’ entitlements are “typically tracked and maintained on the crypto asset trading platform‘s internal ledgers,” Compl. ¶ 73, and platforms usually settle transactions by updating internal records with each investor‘s positions. Compl. ¶ 76. Because transactions on a blockchain are validated by consensus, rather than by a single entity such as a bank, the blockchains supply a decentralized location for recording transactions. See Compl. ¶¶ 67–68.
As the complaint explains, defendants’ crypto asset trading platforms – Binance.com and Binance.US – “are marketplaces that generally offer a variety of services relating to crypto assets, often including brokerage, trading, and settlement services.” Compl. ¶ 71. Both platforms permit their customers to purchase and sell crypto assets using other crypto assets or fiat currency – that is, currency issued by a government. Compl. ¶ 72. One of the concerns underlying this action is that according to plaintiff, Binance.com and Binance.US did not segregate their customers’ crypto assets from other customers’ assets or the firm‘s assets. Compl. ¶ 73.
Blockchains use cryptographic techniques to secure the recording of transactions, and like many digital systems, they can be subject to hacks. Compl. ¶¶ 63, 65, 349; Notice of BAM Trading Inc. and BAM Management US Holdings Inc.‘s Mot. to Dismiss [Dkt. # 117]; Mem. of Law in Supp. [Dkt. # 117-1] (“BAM Mot.“) at 34. To validate transactions, then, and to validate the state of the ledger, a blockchain will rely upon a “consensus mechanism,” the method or protocol that will be utilized to agree on which transactions are valid and when and how to update the blockchain. Compl. ¶¶ 66, 67. Independent users and “validators” apply the protocol to determine whether they agree if a particular transaction is valid, and if the requisite number of them agree,
The two primary consensus mechanisms that blockchains employ are “proof of work” and “proof of stake.” Compl. ¶ 68. Proof of work, used by the Bitcoin blockchain, involves computers, known as “validator nodes,” that attempt to “mine” a “block” of transactions, in part by solving a complex mathematical problem. Compl. ¶ 68. The first miner to successfully solve the problem earns the right to update the blockchain and is rewarded with the blockchain‘s native crypto asset. Compl. ¶ 68. Proof of stake, used by the Ethereum blockchain, involves the selection of block validators from the crypto asset holders who have committed or “staked” a minimum number of crypto assets as part of the validation process. Compl. ¶ 68.
Blockchain protocols compensate those participants who validate transactions and add new blocks to the blockchain. Compl. ¶¶ 67, 340. The compensation or “rewards” are usually paid in the form of new tokens, and they are funded by various sources, including fees charged to those engaged in transactions on the blockchain or through the blockchain‘s creation or “minting” of additional quantities of its native crypto asset. Compl. ¶¶ 67, 340, 341; BAM Mot. at 6.
Crypto assets “represented on” their own blockchain are considered “native” to that blockchain, although a blockchain may represent both native and non-native crypto assets. Compl. ¶ 64. Crypto assets are typically stored in a “crypto wallet” – software that enables owners to store and manage the cryptographic information necessary to identify and transfer their assets. Compl. ¶ 65. Crypto wallets allow asset owners to make transactions on the associated blockchains. Compl. ¶ 65. The wallets provide users with a “public key,” which is the user‘s blockchain “address” that can be shared with others, and a “private key,” which operates as a password and is needed to transfer a crypto asset. Compl. ¶ 65.
Transactions involving the transfer of a crypto asset from one blockchain address to another are called “on-chain” transactions, and those that are only tracked in the internal recordkeeping mechanisms of the platform and do not involve transferring crypto assets from one wallet to another are called “off-chain” transactions. Compl. ¶ 72.
The complaint focuses on five of defendants’ crypto assets and programs:
- “BNB,” which is also called “Binance Coin,” a crypto asset that was launched on the Binance.com platform in 2017. Compl. ¶¶ 4, 80–81.
- “BUSD,” a Binance “stablecoin” that is “purportedly backed with cash (and cash equivalent) reserves and redeemable on a 1:1 basis for U.S. dollars.” Compl. ¶¶ 4, 317. It is “a Binance-branded U.S. Dollar denominated crypto asset on the Ethereum blockchain.” Compl. ¶ 31.
- Binance‘s “Simple Earn,” which is marketed as set of “programs that pay interest to investors who lend their crypto assets to Binance for fixed or flexible lengths of time.” Compl. ¶ 327.
- Binance‘s “BNB Vault,” a program similar to Simple Earn that is limited to BNB holders and described on Binance.com as a “‘BNB yield aggregator’ whereby investors can lend their BNB to Binance to earn investment returns.” Compl. ¶¶ 4, 328, 331.
- BAM Trading‘s “Staking Program,” which allows crypto asset owners on the Binance.US platform to pool their assets to collateralize BAM Trading‘s validation of transactions on a blockchain, such as Ethereum. See Compl. ¶¶ 4, 339–51.
Procedural History
On June 6, 2023, the SEC sued defendants for unlawfully soliciting U.S. investors to buy, sell, and trade crypto asset securities through their unregistered trading platforms Binance.com and Binance.US. Compl. ¶ 2.1 It asserts thirteen violations of federal securities laws:
| Count One: | Binance violated Sections 5(a) and 5(c) of the Securities Act by offering and selling BNB without a registration statement. |
| Count Two: | Binance violated Sections 5(a) and 5(c) of the Securities Act by offering and selling BUSD without a registration statement. |
| Count Three: | Binance violated Sections 5(a) and 5(c) of the Securities Act by offering and selling Simple Earn and BNB Vault programs without registration statements. |
| Count Four: | BAM Trading violated Sections 5(a) and 5(c) of the Securities Act by offering and selling its Staking Program without a registration statement. |
| Count Five: | Binance violated Exchange Act Section 5 by operating the Binance.com platform without registering as an exchange. |
| Count Six: | Binance violated Exchange Act Section 15(a) by operating the Binance.com platform without registering as a broker-dealer. |
| Count Seven: | Binance violated Exchange Act Section 17A(b) by operating the Binance.com platform without registering as a clearing agency. |
| Count Eight: | Binance and BAM Trading violated Exchange Act Section 5 by operating the Binance.US platform without registering as an exchange. |
| Count Nine: | BAM Trading violated Exchange Act Section 15(a) by operating the Binance.US platform without registering as a broker. |
| Count Ten: | Binance and BAM Trading violated Exchange Act Section 17A(b) by operating the Binance.US platform without registering as a clearing agency. |
| Count Eleven: | Zhao violated Exchange Act Sections 5, 15(a), and 17A(b) as a control person over Binance in connection with the alleged violations related to the Binance.com platform. |
| Count Twelve: | Zhao violated Exchange Act Sections 5, 15(a), and 17A(b) as a control person over Binance and BAM Trading in connection with the Binance.US platform violations. |
| Count Thirteen: | BAM Management and BAM Trading violated Securities Act Sections 17(a)(2) and (a)(3) by making materially false and misleading statements to investors and engaging in acts and practices that operated as a fraud upon purchasers. |
STANDARD OF REVIEW
Failure to State a Claim: Fed. R. Civ. Proc. 12(b)(6)
To survive a motion to dismiss under
A claim is facially plausible when the pleaded factual content “allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678. “The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Id. A pleading must offer more than “labels and conclusions” or a “formulaic recitation of the elements of a cause of action,” id., quoting Twombly, 550 U.S. at 555, and “[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id.
In evaluating a motion to dismiss under
Pleading Fraud with Particularity: Fed. R. Civ. Proc. 9(b)
The D.C. Circuit applies
The D.C. Circuit has yet to rule on this issue, but courts in this district have held plaintiffs alleging violation of the Securities Act to the heightened pleading standard. See Hite v. Leeds Weld Equity Partners, IV, LP, 429 F. Supp. 2d 110, 115 (D.D.C. 2006) (noting that an action under Section 12(a)(2) of the Securities Act must satisfy
Other courts have also required plaintiffs to meet
Personal Jurisdiction over Defendants: Fed. R. Civ. Proc. 12(b)(1)
To survive a motion to dismiss for lack of personal jurisdiction, the “plaintiff must make a prima facie showing of the pertinent jurisdictional facts.” First Chi. Int‘l v. United Exch. Co., 836 F.2d 1375, 1378 (D.C. Cir. 1988). That is, the plaintiff must allege specific acts connecting the defendant with the forum. In re Papst Licensing GMBH & Co. KG Litig., 590 F. Supp. 2d 94, 97–98 (D.D.C. 2008), citing Second Amendment Found. v. U.S. Conference of Mayors, 274 F.3d 521, 524 (D.C. Cir. 2001). The plaintiff bears the burden of establishing personal jurisdiction over each defendant, Crane v. N.Y. Zoological Soc‘y, 894 F.2d 454, 456 (D.C. Cir. 1990), and “cannot rely on conclusory allegations” to establish personal jurisdiction. Atlantigas Corp. v. Nisource, Inc., 290 F. Supp. 2d 34, 42 (D.D.C. 2003).
“A court may consider material outside of the pleadings in ruling on a motion to dismiss for lack of . . . personal jurisdiction[.]” Artis v. Greenspan, 223 F. Supp. 2d 149, 152 (D.D.C. 2002). However, “the plaintiff is not required to adduce evidence that meets the standards of admissibility reserved for summary judgment and trial; rather, [plaintiff] may rest [its] arguments on the pleadings, ‘bolstered by such affidavits and other written materials as [it] can otherwise
ANALYSIS
I. The complaint plausibly alleges that Binance and BAM Trading were engaged in unregistered offers and sales of securities.
Defendants Binance and Zhao have moved to dismiss the complaint on multiple grounds, first and foremost that it fails to state a claim as a matter of law, see Binance Mot., and the BAM defendants similarly maintain that the action should be dismissed under
Section 2 of the Securities Act defines the word as follows:
The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security“, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
[A]n investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.
SEC v. W.J. Howey Co., 328 U.S. 293, 298–99 (1946).
Since Howey continues to be the touchstone of the investment contract analysis, it is helpful to review what the case was about. The W.J. Howey company was selling ownership in half of its citrus groves in Lake County, Florida, and would-be purchasers were offered both a land sales contract, which would result in the conveyance of a warranty deed for the acreage involved when executed, and a service contract with a related Howey company for the cultivation and development of the groves and the harvesting and marketing of the crops. Id. at 295. Prospective purchasers were told that it was not feasible to invest in a grove unless service arrangements were made. Id. Under the terms of the service contract, the landowner had no right to enter the land to market the crops; all of the produce was pooled, and each landowner would receive a pro rata share of the proceeds. Id. at 296. Purchasers tended to be out-of-state passive investors without the experience or equipment needed to cultivate citrus trees; they were “attracted by the expectation of substantial profits.” Id.
The Court found that its definition was satisfied because “the respondent companies are offering something more than fee simple interests in land . . . . They are offering an opportunity to
[A]ll the elements of a profit-seeking business are present here. The investors provide the capital and share in the earnings and profits; the promoters manage, control, and operate the enterprise.
There is binding authority in this circuit that the determination before the Court is controlled by Howey, which, as the Court of Appeals put it fifty years later, held that:
an investment contract is a security subject to the Act if investors purchase with (1) an expectation of profits arising from (2) a common enterprise that (3) depends upon the efforts of others.
SEC v. Life Partners, Inc., 87 F.3d 536, 542 (D.C. Cir. 1996) (“Life Partners I“), rehearing denied, 102 F.3d 587 (D.C. Cir. 1996).
In addressing this concept, the Supreme Court has repeatedly emphasized that the statutory definition in general, and the term “investment contract” in particular, must be read broadly to address the variety of investment vehicles and money-making schemes that could not possibly have been foreseen in 1934 when the Securities Act was passed.
In the Securities Act, the term “security” was defined to include by name or description many documents in which there is common trading for speculation or investment. Some, such as notes, bonds, and stocks, are pretty much standardized and the name alone carries well settled meaning. Others are of more variable character and were necessarily designated by more descriptive terms, such as “transferable share,” “investment contract,” and “in general any interest or instrument commonly known as a security.” We cannot read out of the statute these general descriptive designations merely because more specific ones have been used to reach some kinds of documents. . . . [T]he reach of the Act does not stop with the obvious and commonplace. Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as “investment contracts,” or as “any interest or instrument commonly known as a security.”
SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351 (1943).
This was the state of the law before Howey was decided. Indeed, the Supreme Court made reference to Joiner when it adopted the Howey definition in 1946 and explained that “[i]t embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” Howey, 328 U.S. at 299. The Court has not varied from that position. In 1967, it construed the term “security” in the
Thus, courts applying these principles to the crypto industry have clearly understood that Howey requires “an examination of the entirety of the parties’ understandings and expectations.” SEC v. Telegram Group Inc., 448 F. Supp. 3d 352, 379 (S.D.N.Y 2020), citing Howey, 328 U.S. at 297–98;2 see also SEC v. Terraform Labs PTE, Ltd., 684 F. Supp. 3d 170, 193 (S.D.N.Y. 2023),
A. There is no requirement that an investment contract involve a contractual arrangement.
The defendants insist that the plain text of the provision and the history behind it require that an “investment contract” must involve some sort of contractual relationship or arrangement between the offeror and the purchaser. See BAM Mot. at 12–16; Binance Mot. at 14–20. But their argument has been foreclosed by Supreme Court and Circuit precedent, and indignation alone cannot open that door.
Defendant Binance argued at the hearing that the requirement was “inherent” in the Joiner decision, Mot. Hr‘g Tr. at 8, but that is an inaccurate characterization. In Joiner, the Supreme Court found that the representations and economic inducements accompanying the marketing of oil leases made that offering an “investment contract.” 320 U.S. at 352–353. The sales literature assured potential purchasers that the Joiner Company would be drilling a test well on its own property to reveal the oil-producing prospects of the nearby leaseholds; the leases being sold offered purchasers the opportunity to share in the value of what the “current exploration enterprise” might discover, with no further effort expended on their part. Id. at 346–48.
The drilling of this well was not an unconnected or uncontrolled phenomenon to which salesmen pointed merely to show the possibilities of
the offered leases. The exploration enterprise was woven into these leaseholds in both an economic and legal sense; the undertaking to drill a well runs through the whole transaction as the string on which everybody‘s beads were strung.
Id. at 348. While the Court employed the vocabulary of traditional contract principles, see, e.g., id. (“[a]n agreement to drill formed the consideration upon which [Joiner] was able to collect leases“), it pointedly declined to determine whether the seller‘s representations gave rise to an enforceable contract.
Whether . . . the assignee acquired a legal right to compel the drilling of the test well is a question of state law which we find it unnecessary to determine.
Id. at 349.3 Instead, it was the expectations created by the seller, which were inextricable from the interest being offered, that brought the transaction within the scope of the federal securities law.
It is clear that an economic interest in this well-drilling undertaking was what brought into being the instruments that the defendants were selling and gave to the instruments most of their value and all of their lure. The trading in these documents had all of the evils inherent in the securities transactions which it was the aim of the Securities Act to end.
With that as its foundation, the Howey Court then defined an investment contract as “a contract, transaction or scheme,” 328 U.S. at 298–99 – using a comma after “contract,” the first option in the series of three nouns – and not as a contractual transaction or scheme. The language is deliberately broad, and the use of the word “scheme” pervades the Supreme Court‘s next
The defendants do not only misread Supreme Court precedent; they insist that the D.C. Circuit weighed in on the question in its decision denying rehearing en banc in SEC v. Life Partners, Inc., 102 F.3d 587 (D.C. Cir. 1996). But a review of that decision proves that defendants’ reliance on it is misplaced as well. In denying rehearing, the Court decided to clarify any misimpression left by the discussion in its initial opinion concerning the third element of the Howey test – that the expected profits must be generated by the “efforts of others” – and its observation that “post-purchase efforts” are “most obviously relevant.” See Life Partners I, 87 F.3d at 545. The Court did not address the need for an actual contract at all.
Furthermore, the notion that a contractual relationship is required has been consistently rejected by other district courts faced with crypto currency cases in recent years. See, e.g., Telegram, 448 F. Supp. 3d at 365 (“The Howey test provides the mode of analysis for an unconventional scheme or contract alleged to fall within the securities laws.“) (emphasis added); see also id. at 379 (”Howey refers to an investment contract, i.e. a security, as ‘a contract, transaction or scheme,’ using the term ‘scheme’ in a descriptive, not pejorative, sense.“) In granting a motion for a preliminary injunction, the court in Telegram pointed to an implicit understanding, and not a formal agreement, as the basis for its finding that there was a substantial
As part of its Howey analysis, the Court finds an implicit (though formally disclaimed) intention on the part of Telegram to remain committed to the success of the TON Blockchain post-launch. Indeed, Telegram, as a matter of fact rather than legal obligation, will be the guiding force behind the TON Blockchain for the immediate post-launch period while the 175 purchasers unload their Grams into the secondary market. As such, the initial 175 purchasers possess a reasonable expectation of profit based upon the efforts of Telegram.
Id. at 358–59; see also SEC v. Kik Interactive, Inc., 492 F. Supp. 3d 169, 178 (D. Conn. 2020) (“[A]n ongoing contractual obligation is not a necessary requirement for a finding of a common enterprise.... The contractual language is important to, but not dispositive of, the common enterprise inquiry, and courts regularly consider representations and behavior outside the contract.“); Terraform I, 684 F. Supp. 3d at 193 (“[T]here need not be – contrary to defendants’ assertions – a formal common-law contract between transacting parties for an ‘investment contract’ to exist.“).4
1. The Court finds it necessary to distinguish between the digital coins themselves and the offers to sell them.
The Court notes that several of the district courts presented with SEC enforcement actions involving crypto currencies have taken pains to differentiate the alleged investment contracts from the tokens themselves. See Telegram, 448 F. Supp. 3d at 379 (“While helpful as a shorthand reference, the security in this case is not simply the Gram, which is little more than alphanumeric cryptographic sequence. . . . This case presents a ‘scheme’ to be evaluated under Howey that consists of the full set of contracts, expectations, and understandings centered on the sales and distribution of the Gram.“); Terraform I, 684 F. Supp. 3d at 193 (the court need not “restrict its Howey analysis to whether the tokens themselves – apart from any of the related various investment protocols – constitute investment contracts“); see also Ripple Labs I, 682 F. Supp. 3d at 323 (”Howey and its progeny have held that a variety of tangible and intangible assets can serve as the subject of an investment contract. . . . In each of these cases, the subject of the investment contract was a standalone commodity, which was not itself inherently an investment contract. Here, defendants argue that XRP does not have the ‘character in commerce’ of a security and is akin to other ‘ordinary assets’ like gold, silver, and sugar. . . . This argument misses the point because ordinary assets – like gold, silver, and sugar – may be sold as investment contracts, depending on the circumstances of those sales.“) (internal citations omitted).
The Court finds these observations to be clarifying and persuasive, as the differentiation is consistent with the Supreme Court‘s earliest pronouncements concerning the meaning of the term “investment contract” buried within the lengthy list that comprises the definition of a “security“:
In applying acts of this general purpose, courts have not been guided by the nature of the assets back of a particular document or offering. The test rather is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out
to the prospect. In the enforcement of an act such as this it is not inappropriate that promoters’ offerings be judged as being what they were represented to be.
Joiner, 320 U.S. at 352–53. Obviously, orange groves are not securities, yet the seminal case on this point found the set of contracts and expectations surrounding their sale to be an investment contract for purposes of the Act. See Howey, 328 U.S. 293.
In the Court‘s view, then, the SEC‘s suggestion that the token is “the embodiment of the investment contract,” SEC Opp. at 29; see also Mot. Hr‘g Tr. at 93 (“The token represents and embodies that investment contract.“), as opposed to the subject of the investment contract, muddied the issues before the Court, ignored the Supreme Court‘s directive that the analysis is supposed to be based on the entire set of understandings and expectations surrounding the offering, and unnecessarily invited the defendants’ argument that a decision in the government‘s favor here would somehow encroach on the jurisdiction of the Commodities Futures Trading Commission. Mot. Hr‘g Tr. at 48–49. Therefore, the Court will endorse and follow the approach taken by the thoughtful judges who boldly wrestled with crypto assets before this case was filed, and it will assess the offerings identified in the complaint individually, resisting the government‘s implication that this ruling could go so far as to answer the definitional question that officials in the other branches of government appear to have been assiduously avoiding. In short, no one should read this case as deciding that crypto assets themselves are or are not “securities;” that is not the question presented.
There is no D.C. Circuit precedent directly on point, and while district courts in other jurisdictions have agreed on fundamental principles, they have sometimes diverged in important ways when applying them to the circumstances before them. As the court in Kik Interactive observed, this is a lonely place to be, but the general principles underlying securities jurisprudence can help illuminate a path through the uncharted waters:
With the same understanding in mind, this Court will undertake the task it has been assigned: to apply all of the principles set forth above to the allegations in the complaint, resolving any inferences in favor of the plaintiff. But that being said, it is worth noting that intangible digital assets do not fit neatly into the rubric set forth in the mere seven pages that comprise the Howey opinion. Also, the agency‘s decision to oversee this billion dollar industry through litigation - case by case, coin by coin, court after court - is probably not an efficient way to proceed, and it risks inconsistent results that may leave the relevant parties and their potential customers without clear guidance.
2. The investment of money in a common enterprise
Under Howey and Life Partners, an investment contract requires an investment of money by the purchaser in a common enterprise. 328 U.S. at 298-99; 87 F.3d at 542. Since neither motion to dismiss challenges the sufficiency of allegations with respect to the investment of money, the Court need not dwell on that aspect of the analysis further. But what is a “common enterprise“?
Howey did not define the term. It observed, though, that the purchasers had no desire or ability to occupy the land or develop it themselves, and that individual development of the plots would not be economically feasible given their small size. 328 U.S. at 300. “A common enterprise managed by respondents or third parties with adequate personnel and equipment is therefore essential if the investors are to achieve their paramount aim of a return on their investments.” Id.
Horizontal commonality ties the fortunes of each investor in a pool of investors to the success of the overall venture. In fact, a finding of horizontal commonality requires a sharing or pooling of funds.
Hart v. Pulte Homes of Michigan Corp., 735 F.2d 1001, 1004 (6th Cir. 1984), quoting Union Planters Nat. Bank of Memphis v. Com. Credit Bus. Loans, Inc., 651 F.2d 1174, 1183 (6th Cir. 1981).
The leading D.C. Circuit case on investment contracts advised that “[s]o-called horizontal commonality - defined by the pooling of investment funds, shared profits, and shared losses - is ordinarily sufficient to satisfy the common enterprise requirement.” Life Partners I, 87 F.3d at 543, citing Revak, 18 F.3d at 87. The Court added, “it is the inter-dependency of the investors that transforms the transaction substantively into a pooled investment.” Id. at 544. But it did not directly address the question of whether there was sufficient commonality in the situation before it; it disposed of the case based on its analysis of the third element: whether there was an expectation of profits based on the efforts of others, and it concluded that the test had not been met. See id. at 545-46.
In SEC v. Banner Fund International, 211 F.3d 602 (D.C. Cir. 2000), the Circuit upheld a trial court‘s ruling that an offering of interests in the Off Shore Banner Fund International Arbitrage Program was an investment contract. It repeated the Life Partners observation that a common enterprise is ordinarily met with a showing of horizontal commonality, which, it explained
Other circuits have determined that a showing of “vertical commonality,” which is based on the relationship between the promotor and the investors can also satisfy the requirement of a common enterprise. See, e.g., SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 479 (5th Cir. 1974).
In an enterprise marked by vertical commonality, the investors’ fortunes need not rise and fall together; a pro-rata sharing of profits and losses is not required. Two distinct kinds of vertical commonality have been identified: “broad vertical commonality” and “strict vertical commonality“. To establish “broad vertical commonality“, the fortunes of the investors need be linked only to the efforts of the promoter. . . . “Strict vertical commonality” requires that the fortunes of investors be tied to the fortunes of the promoter.
Revak, 18 F.3d at 87-88 (citations omitted) (emphasis in original).
District courts considering SEC actions against the issuers of crypto assets have referred to both horizontal and vertical commonality when addressing this element. In granting the agency‘s motion for a preliminary injunction in Telegram I, the court found that the SEC had satisfied the requirement of a common enterprise with a showing of both horizontal commonality and strict vertical commonality.
After the 2018 Sales, Telegram pooled the money received from the Initial Purchasers and used it to develop the TON Blockchain as well as to maintain and expand Messenger. The ability of each Initial Purchaser to
profit was entirely dependent on the successful launch of the TON Blockchain. * * *
Alternatively, the SEC has made a substantial showing of strict vertical commonality. Each Initial Purchaser‘s anticipated profits were directly dependent on Telegram‘s success in developing and launching the TON Blockchain. Telegram‘s own fortunes were similarly dependent on the successful launch of the TON Blockchain as Telegram would suffer financial and reputational harm if the TON Blockchain failed prior to launch.
Telegram I, 448 F. Supp. 3d at 369-70 (citations omitted).
Given the dearth of circuit precedent concerning the vertical theory, though, decisions relying on horizontal commonality alone tend to predominate. The court in Kik Interactive granted summary judgment in favor of the agency on a horizontal commonality theory: “[t]he economic reality is that Kik, as it said it would, pooled proceeds from its sales of [the token] Kin in an effort to create an infrastructure for Kin, and thus boost the value of the investment.” 492 F. Supp. 3d at 179; see also id. at 178 (“The success of the ecosystem drove demand for Kin and thus dictated investors’ profits. Kik recognized and repeatedly emphasized this.“). The court acknowledged that there was no pro rata distribution of profits as in the Howey situation, but it found that was not necessary for horizontal commonality as “investors reaped their profits in the form of the increased value of Kin.” Id., citing Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340, 354 (S.D.N.Y. 2019) (“a formalized profit-sharing mechanism is not required for a finding of horizontal commonality“). In Balestra, the court rejected the defendants’ contention that the purchasers’ ability to exercise individual control over their own tokens signaled the absence of a common enterprise; “[p]laintiff
3. The expectation of profits due to the efforts of others
The next element of the Howey standard is that the investor “is led to expect profits solely from the efforts of the promoter or a third party.” 328 U.S. at 299. The D.C. Circuit has softened the impact of “solely” by requiring only that profits be generated “predominantly” from the efforts of others. SEC v. Int‘l Loan Network, Inc., 968 F.2d 1304, 1308 (D.C. Cir. 1992).
Profits can mean a share of the earnings realized from the use of the investors’ funds, or “capital appreciation resulting from the development of the initial investment.” United Hous. Found., Inc. v. Forman, 421 U.S. 837, 852 (1975). With respect to crypto assets, courts have found that an anticipated increase in the market value of the coin falls within the category of a “profit” or financial return for purposes of the Howey test. See Kik Interactive, 492 F. Supp. 3d at 179.
When elaborating upon the Howey “efforts of others” requirement, the D.C. Circuit differentiated between pre-purchase activities and the efforts to be undertaken after the investment
Finally, the law in this Circuit is clear: “the expected profits must, in conformity with ordinary usage, be in the form of a financial return on the investment, not in the form of consumption.” Life Partners I, 87 F.3d at 543; see also Forman, 421 U.S. at 853 (“[W]hen a purchaser is motivated by a desire to use or consume the item purchased - ‘to occupy the land or to develop it themselves,’ as the Howey Court put it . . . the securities laws do not apply.“); Banner Fund, 211 F.3d at 614. “The inquiry is an objective one focusing on the promises and offers made to investors; it is not a search for the precise motivation of each individual participant.” Telegram, 448 F. Supp. 3d at 371.
The Court must apply the principles set out above to each of the offerings alleged to be “investment contracts” in the complaint.
1. The Initial Coin Offering
The complaint alleges that in 2017, Binance launched its Binance.com platform to provide services to crypto asset investors, and it created and marketed a new digital token called the Binance coin, or BNB, to finance the venture. Compl. ¶ 80. BNB is an ERC-20 token issued on the Ethereum blockchain. Compl. ¶ 287. During the initial coin offering (“ICO“), Binance created 200 million BNB on the blockchain and announced that it would never issue more. Compl. ¶ 293. It structured the offering in phases with planned price increases at each successive phase, thereby rewarding the earliest buyers with an effective discount and the potential for immediate returns upon resale. Compl. ¶ 293.
According to the SEC, “BNB was offered and sold as a security because Binance touted an investment in BNB as an investment in Binance‘s efforts to create a successful crypto asset trading platform centered around BNB.” Compl. ¶ 82. The complaint draws heavily on representations and marketing statements contained in a whitepaper entitled “Binance Exchange,” which was used to promote the ICO. Compl. ¶¶ 82-83, 290, referring to Binance Exchange, Whitepaper V1.1 (June 16, 2017) (“Binance Whitepaper” or “Whitepaper“).7
The Binance Whitepaper referred to the first purchasers of the new token coin as “investors,” and it began, “[w]ith your help, Binance will build a world-class crypto exchange,
We know this will be an ultra competitive space. There are probably hundreds, if not thousands of teams wanting, planning or doing exchanges. Competition will be fierce. But in this age, this is a common risk in any decent concept/startup or mature company. The question is: given our team, track record, experience, industry resources and product, do you believe we stand a better chance than the rest of the pack? If yes, then please join our ICO.
Compl. ¶ 292, quoting Binance Whitepaper.
Viewed in the light most favorable to the plaintiff, the complaint plausibly alleges that the BNB was offered as an investment contract at the time of the ICO. The allegations and the Whitepaper itself give rise to an inference that investors purchased coins with an expectation of profit, in the form of future appreciation, that would derive from a common enterprise dependent upon the managerial and entrepreneurial efforts of others. Binance made it clear that it was soliciting the funds for the specific purpose of building a strong exchange that would not be plagued by the problems that had stymied the growth of other crypto exchanges, such as “poor technical architecture,” “insecure platform,” “poor market liquidity,” “poor customer service,” and “poor internationalization and language support.” See Whitepaper. It assured the potential purchasers that its “matching engine is capable of sustaining 1,400,000 orders/second, making it
Also, the averment that “each BNB coin is identical to every other BNB token, and the price of all BNB tokens increases or decreases together,” Compl. ¶ 312, supports a finding of the horizontal commonality needed for the “common enterprise” element. The case law points to whether the proceeds of the offering were “pooled” as a critical aspect of analysis, and although the complaint is thin on this point, it does allege that “Binance pooled the proceeds of its BNB ICO to develop the Binance.com Platform as it stated publicly that it would,” Compl. ¶ 298, and the Court is bound to accept the truth of that statement at this time. The Whitepaper further reflects the shared stake in the success of the enterprise when it announced that Binance would reserve forty percent of all BNB tokens for its “Founding Team” and another ten percent for the “Angel Investors” who purchased before the ICO. Compl. ¶ 294; see also Compl. ¶ 313 (“Binance‘s distribution of tokens among investors and its Founding team aligned their incentives in building
With respect to the “efforts of others” that would be the engine behind future gains for the investors, it is notable that in addition to undertaking to develop a superior platform, Binance also vowed at the start that it would take steps to increase demand for BNB - and thus, its value - by taking planned steps to restrict supply. “[T]he Binance Whitepaper stated that Binance would ‘destroy,’ or burn, half of the BNB over time by using Binance‘s profits with respect to the Binance.com Platform to repurchase and then destroy BNB.” Compl. ¶ 295.
For all of these reasons, the Court finds that the complaint plausibly alleges that BNB was offered and sold as an investment contract, and therefore, as a security. There is no dispute that BNB was offered and sold without a registration statement filed or in effect, see Compl. ¶ 515, and therefore, to the extent that the First Claim for Relief is predicated on the initial coin offering in 2017, it states a claim for a violation of Sections 5(a) and 5(c) of the Securities Act.
That is not to say that the SEC‘s own allegations, and the materials upon which they are based, do not raise questions about what will be established at the end of the day. The question as to what motivated the reasonable purchaser at the time may prove to be a close one. As the court observed in the Telegram case, “[a] transaction does not fall within the scope of the securities laws when a reasonable purchaser is motivated to purchase by a consumptive intent.” 448 F. Supp. 3d at 371. In that case, the existence of an extended lockup period was one aspect of the first round of the offering that in the court‘s view “tend[ed] to negate the likelihood that a reasonable
It is also significant that one key selling point of the BNB coin detailed in the Whitepaper was that purchasers could use BNB to pay for any fees on the platform, including exchange fees, withdrawals fees, listing fees, and any other fees, and that when they used BNB to pay those fees, they would receive significant discounts: 50% the first year, 25% the second year, 12.5% the third year, and 6.75% in year four. See Whitepaper. This could support a contrary finding at a later stage in these proceedings that it was the ability to utilize the BNB to obtain discounts that served as the incentive for participation in the ICO. Indeed, the complaint alleges that when BAM “CEO B” looked back at the company‘s experience with BNB in an interview in 2021, he said:
[W]e have learned a lot from the BNB coin (the Binance token) about the power of coupling incentives inside of a smart contract with fungibility. Think about what the Binance token is - it represents the right to receive discounts on our trading fees, which people use it for, a lot. But increasingly, people are choosing to hold the token, rather than spend it for the discount because they found that the increased value of the token as the company grows, exceeds the financial value of the discounts. And so it gets our customers to act a little bit more like owners - people who want the company to succeed; their interests are aligned with that of the company.
Compl. ¶ 302(d) (emphasis added). The facts underlying observations such as this could bear on the ultimate objective analysis of what the reasonable purchaser‘s expectations were at the time of the ICO as opposed to how they may have evolved over time.
50% will be used for Binance branding and marketing . . . . A sufficient budget for various advertisement activities, to help Binance become popular among investors, and to attract active users to the platform.
15% will be kept in reserve to cope with any emergency or unexpected situation that might come up.
Whitepaper.
Looking at everything that has been alleged that bears on the economic reality of the overall transaction, though, and given the requirement that at this stage, it is required to accept the SEC‘s factual allegations as true and resolve every factual inference in its favor, the Court finds that the allegations are sufficient to state a plausible claim that the initial offering of BNB qualifies as an investment contract, and the claim will move forward.
2. Binance‘s ongoing sales of BNB after the ICO
The complaint does not stop at the ICO, however. It alleges that “from the time of the ICO to the present, BNB was offered and sold as an investment contract and therefore, as a security.” Compl. ¶ 288 (emphasis added). While this assertion is quite conclusory, if one considers the set of allegations concerning subsequent sales in the context of the other allegations in the complaint concerning the launch of BNB and the ICO, and resolves all inferences in favor of the SEC, what has been provided is sufficient to enable this aspect of the BNB claim to move forward for now as well.
- In an interview broadcasted globally on YouTube.com on October 10, 2018, Binance‘s Chief Growth Officer stated, “By having people invest in BNB token, they‘re even more interested in the success [of the Binance.com Platform] . . . . By holding BNB, you are effectively holding an influential share of the crypto project.”
- In an interview broadcasted globally on YouTube.com on January 10, 2020, Binance‘s Managing Director stated, “Recently we launched lending, we launched staking, we launched futures, all of those new businesses contribute to the value of BNB.”
Compl. ¶ 302.10 The complaint further alleges that Binance launched a $7.5 billion venture capital effort called “Binance Labs” that invested in grants to people developing applications for Binance blockchains, including BNB-related applications. Compl. ¶ 304. “And in October 2022, Binance announced that Binance Labs was investing in seven new projects that, as a Binance founder
The SEC also alleges that since 2019, Binance offered to pay their employees’ salaries in BNB, and that it made the public aware of that fact:
Publicly reminding investors what the economic reality made plain - that Binance and its employees’ fortunes with respect to BNB were tied to BNB investors’ fortunes - Binance has frequently touted the popularity of Binance‘s program of offering BNB as compensation to its employees. For example, in a February 11, 2019 interview, Zhao stated, “Almost all [employees] take some comp in BNB. Many take 100% in BNB. They know what we do, and how we do it, literally, from inside out. And it is an easy decision for them to make.”
Compl. ¶¶ 306-07 (alteration in original); see also Compl. ¶ 310 (“Zhao frequently touted Binance‘s Employee Stock Token Options Plan (‘ESTOP‘), which granted high performing employees BNB, essentially equivalent to employee stock options, as the best way for employees to profit from the growth of the Binance.com Platform. He has also encouraged Binance
The post-ICO aspect of Count One survives the motion to dismiss, but that does not mean that all questions have been put to rest. The SEC alleges that “[s]ince the ICO, Binance has encouraged the Binance.com Platform‘s customers to buy BNB by offering a 25 percent discount when investors use BNB to purchase a crypto asset. . . . Accordingly, Binance creates additional financial incentives to buy BNB, thereby increasing demand for BNB, and its value.” Compl. ¶ 300; see also Compl. ¶ 304 (“Binance has additionally worked to increase demand for BNB by
The absence of allegations on this point becomes even more problematical when one considers the SEC‘s contention that a determination that the BNB was sold as an investment contract at the outset necessarily means that any secondary sale of the token itself was a sale of a security. See Compl. at ¶¶ 288, 305; SEC Opp. at 15-17, 28-30. There is no circuit precedent on this issue, and district judges have differed in their approach.
The court in Ripple Labs I did not reach the issue, as it was addressing Programmatic Sales, but it observed in a footnote:
Whether a secondary market sale constitutes an offer or sale of an investment contract would depend on the totality of circumstances and the economic reality of that specific contract, transaction, or scheme.
682 F. Supp. 3d at 329, n.16, citing, inter alia, Tr. of Mots. Hr‘g at 34:14-16, SEC v. LBRY, 639 F. Supp. 3d 211 (D.N.H. 2023) (No. 21 Civ. 206), ECF No. 105 (declining to extend holding to include secondary sales).13 But the court in Terraform I expressly rejected that view:
[T]he Court declines to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not.
The Court is inclined to agree with the approach of the court in Ripple Labs, since the “it-is-what-it-is” approach of the SEC appears to be inconsistent with the clear Supreme Court directives quoted in its pleadings, which hold that it is the economic reality of the particular transaction, based on the entire set of contracts, expectations, and understandings of the parties, that controls. See SEC Opp. at 30-31, quoting Joiner, 320 U.S. at 352-53 (“[E]ven if these assets have some inherent use . . . [w]hat matters are the ‘economic inducements’ used to encourage the transaction. . . . All of the relevant circumstances surrounding the sale of the asset must be analyzed.“). The SEC repeatedly hearkens back to “the circumstances under which the assets in this case were offered and sold,” see, e.g., SEC Opp. at 31 (emphasis added), but those do not go so far as to establish its contention that “BNB is offered and sold an investment contract.” SEC Opp. at 14.
One cannot argue with the general proposition that once a thing is deemed to be a security, it remains a security; the thing has not changed its nature. But the SEC is not alleging or asking the Court to find that the thing in question - the BNB token - is a security. Its allegation is that during the ICO and after, it was offered as, or sold as, a security. See, e.g., Compl. ¶ 82. That determination, the SEC has explained, does not depend on the nature of the thing. It does not depend on what the thing represented. It depends on the economic reality of the transaction. See
It may be that the SEC can establish that sales after the ICO or certain groups of secondary sales meet the criteria of an investment contract. See, e.g., Telegram, 448 F. Supp. 3d at 380-81 (finding based upon all of the surrounding facts and circumstances that secondary sales of the crypto currencies at issue were an offering of securities under Howey because the crypto currencies were initially sold with the intent that the institutional buyers re-sell them on the secondary market; Telegram did not intend for the assets to “come to rest with the 175 Initial Purchasers but to reach the public at large via post-launch resales by the Initial Purchasers” and built incentives into the initial sales to ensure that the initial purchasers resold soon after launch). But the government‘s reliance on the assertion that “[t]he crypto assets are the embodiment of the investment contract,” SEC Opp. at 28-29; see also Mot. Hr‘g Tr. at 93-94, and its argument at the hearing about the nature of the technology and the interdependence of the platform and the performance of every token, is not enough, standing alone, to bring secondary sales of BNB under the investment contract rubric. Moreover, the agreement is somewhat inconsistent with the singular theory the government has been advancing since this action was filed: we aren‘t saying that the coins are securities - we are talking about investment contracts. For example, the case began with this colloquy at the hearing on the motion to a temporary restraining order.
THE COURT: When you use the formulation crypto asset versus crypto asset securities, can you tell me, what are the differentiating factors?
MR. SCARLATO: Whether they meet the Howey test.
THE COURT: That‘s it? The Howey test for each one -
MR. SCARLATO: Yes.
TRO Hr‘g Tr. at 11.14
The question came up again at the hearing on the motion to dismiss.
THE COURT: . . . Just to get started, is it fair to say that the SEC is not taking the position that every digital asset, token, or crypto asset is a security?
MS. FARER: Yes, Your Honor.
THE COURT: And it‘s . . . not your position that one of the these tokens standing alone is a security simply because somebody who buys it might make a profit?
MS. FARER: Yes, Your Honor.
THE COURT: Now, do you agree that there is a difference between the coins, the subject of the investment contracts, and the contracts themselves? That is, the totality of the circumstances, or as the Telegram case puts it, the full set of contracts, expectations, or understandings surrounding how any particular coin is sold or distributed, and it‘s the latter that‘s dispositive?
MS. FARER: Yes, Your Honor. The crypto asset, as we briefed, as Your Honor has seen in these cases, is simply a line of code and what we‘re
* * *
THE COURT: But as to [“the stablecoins“] in particular, or all of them, I guess, a standalone sale is not enough, it has to be based on how it was sold and marketed?
MS. FARER: Correct, Your Honor. You would have to take all of the complex realities, including promotion, the efforts of the issuers, the retention of any tokens. I could go through a variety of categories and factors that are evaluated in these cases.
Mot. Hr‘g Tr. at 66-67; see also Framework Analysis at 1 (“The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on
Insisting that an asset that was the subject of an alleged investment contract is itself a “security” as it moves forward in commerce and is bought and sold by private individuals on any number of exchanges, and is used in any number of ways over an indefinite period of time, marks
For these reasons, the Court will apply the only test the government has offered for assessing for whether a non-traditional asset is a security, and it finds that the complaint does not include sufficient facts to support a plausible inference that any particular secondary sales satisfy the Howey test for an investment contract. The SEC argues in its opposition and at the hearing that there were ongoing representations about the superiority of the platform that allegedly gave the tokens their value, but more is needed. It may well be, as the government maintains, that the “common enterprise” is ongoing, since the fortunes of all token holders rise and fall together and that their fortunes are largely tied to those of the company and its platform or “ecosystem,” but that element alone is not sufficient. What about the investment of money? Other courts have not been troubled by payments made to an exchange instead of the issuer, see, e.g., SEC v. Coinbase, Inc., 2024 WL 1304037, at *24 (S.D.N.Y. Mar. 27, 2024); Terraform I, 684 F. Supp. 3d at 197; see also In re Ripple Labs, Inc. Litig., No. 18-cv-06753-PJH, 2024 WL 3074379, at *7 (N.D. Cal. June 20, 2024) (declining in a private securities class action to find, based on those decisions, that there was no “investment of money” as a matter of law). And more importantly, the facts needed
4. Count One is not barred by the statute of limitations.
Binance has also moved to dismiss Count One‘s allegations that it offered and sold BNB without filing a registration statement, Compl. ¶ 515, on the grounds that the portion of the claim that involves the “offering” of BNB is barred by the statute of limitations. Binance Mot. at 35-36.
A court may dismiss a claim on statute of limitations grounds if the claim is conclusively time-barred on the face of the complaint; if the issue turns on contested questions of fact, dismissal is not appropriate. Bregman v. Perles, 747 F.3d 873, 875-76 (D.C. Cir. 2014), citing de Csepel v. Republic of Hungary, 714 F.3d 591, 603 (D.C. Cir. 2013) and Firestone v. Firestone, 76 F.3d 1205, 1209 (D.C. Cir. 1996) (per curiam) (“[C]ourts should hesitate to dismiss a complaint on statute of limitations grounds based solely on the face of the complaint . . . because statute of limitations issues often depend on contested questions of fact . . . .“)
The defense is correct that ordinarily, a five-year statute of limitations applies to actions for civil penalties,
The provision governing civil penalties states that an action “shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.”
Binance is a limited liability company based in the Cayman Islands. Compl. ¶ 27. While its violations of federal securities laws are alleged to have had effects within the United States, Compl. ¶ 24, they were undertaken from outside the United States. The complaint alleges that as of the launch of the Binance.com platform, Binance actively solicited customers in the United States, Compl. ¶ 104, and that U.S. based investors purchased BNB during the initial ICO. Compl. ¶ 297. When advisors and employees warned Binance and Zhao they were potentially running afoul of U.S. securities laws, they allegedly established mechanisms to circumvent those laws and created the BAM entities and the Binance.US platform, which they controlled from outside the United States. Compl. ¶¶ 110-208. The SEC asserts that Binance has been and remains outside of the United States, and the company does not contest this, so the statute of limitations with
D. Count Two does not plausibly allege that Binance offered and sold BUSD as an investment contract.
The complaint also alleges that Binance offered and sold another ERC-20 token issued on the Ethereum blockchain, BUSD, as an investment contract, and therefore, a security. See Compl. ¶¶ 315-24. But the description of the asset, how it was sold, and how the proceeds from its sale were to be distributed is quite different from the allegations concerning BNB, and the allegations do not align with the prongs of the Howey test.
The SEC alleges that in September of 2019, Binance entered into a “Stablecoin as a Service Agreement” with its affiliate, Binance (Switzerland) AG and Trust Company A, in which “the parties agreed to ‘build and manage a platform on which BUSD can be issued and redeemed’ in exchange for one U.S. dollar and to maintain reserves supporting redemption.” Compl. ¶ 317. Since then, Binance has marketed BUSD as a “stablecoin,” which can be redeemed on a 1:1 basis for U.S. dollars. Compl. ¶ 317.
Absent from all of this is any suggestion that purchasers were informed that the proceeds from BUSD sales were to be deployed, through the issuers’ managerial and entrepreneurial efforts, to generate a return for their benefit. While the complaint emphasizes with respect to BNB that potential buyers were told that proceeds from the offering would be used to strengthen the platform that would in turn give the tokens their value, for BUSD it simply states that the proceeds were to be spent on “profit-generating opportunities for the benefit of both Trust Company A and Binance.” Compl. ¶ 317. There are no facts alleged to support an inference that this advanced the fortunes of those who bought the BUSD tokens, or that they reasonably expected to share in the companies’ profits in the form of a return on their investment. The SEC makes the vague assertion that Binance used “at least a portion” of those returns to enable and promote the Binance ecosystem, which it says “gave BUSD its potential profit,” Compl. ¶ 321, but it does not explicitly link the value of the token - which was tied to the U.S. dollar - to the success of the platform. Nor does it spell out how promoting the ecosystem made BUSD more profitable when the alleged defining feature of the “stablecoin” was that its value would remain constant. And there is little
As for the “common enterprise” element, the most the SEC can say is “[t]he proceeds from investor purchases of BUSD were purportedly pooled in reserves, and Binance earned 50 percent of the investment returns on those pooled assets.” Compl. ¶ 321. But it does not allege that the coin holders would share in those returns in any way. For these reasons, the Court finds that the complaint does not plausibly allege that Binance offered and sold BUSD as an investment contract under the Howey test.
The SEC goes on to allege, though, that “from the outset,” Binance “marketed BUSD‘s profit-earning potential” and promoted “BUSD profit opportunities.” Compl. ¶ 322. One example identified is the “BUSD Reward Program,” which “promised interest payments to BUSD investors
E. Count Three plausibly alleges that Binance offered and sold “BNB Vault” as an investment contract, but the allegations are not sufficient as to “Simple Earn.”
Count Three relates to two types of programs or “profit-making opportunities” offered by Binance on the Binance.com platform - “BNB Vault” and “Simple Earn” - which the SEC alleges were offered and sold as investment contracts, or securities. Compl. ¶¶ 325-38. According to the complaint, Binance markets Simple Earn as a set of “programs that pay interest to investors who lend their crypto assets to Binance for fixed or flexible lengths of time. The interest paid depends on the crypto asset lent and the duration of the loan,” Compl. ¶ 327, and Binance determines the rate for each offering at its discretion. Compl. ¶ 328. “According to Binance, it may pool assets loaned through Simple Earn and use its managerial expertise to deploy them ‘for a variety of
While the SEC includes the words “profit-making,” “pooled,” and “managerial expertise” in its description of Simple Earn, its description of the program does not fit the rubric for an investment contract that the agency carefully laid out in its submissions to the Court. Compl. ¶¶ 326, 329. Not every “profit-making opportunity” is an investment contract, and the allegations concerning Simple Earn do not describe a scheme or transaction in which investors were urged to put their money in Binance‘s hands so that they could share in the return that Binance would generate through its managerial or entrepreneurial efforts. The holders of crypto assets simply agreed to loan them to the company for a specified period of time at a specified rate of interest,
By contrast, the complaint alleges that “BNB Vault” was advertised to BNB holders as a “‘BNB yield aggregator’ whereby investors can lend their BNB to Binance to earn investment returns.” Compl. ¶ 331. It was launched with the announcement, “Earn Daily Income from the $BNB Ecosystem.” Compl. ¶ 332. Binance stated on its website in November 2020 that “BNB ‘deposited’ in BNB Vault will be ‘flexibly allocated in different products to help users maximize potential rewards.‘” Compl. ¶ 333; see Notice of Incorporated Docs., referring to the April 2, 2023 Binance.com website page, “BNB Vault: One-Click to earn multi-benefits with BNB” (FAQ:
For these reasons, the Court finds that the complaint plausibly alleges that Binance offered and sold BNB Vault as an investment contract, but it finds the allegations as to Simple Earn to be insufficient.
F. Count Four plausibly alleges that BAM Trading offered and sold its Staking Program as an investment contract.
Count Four relates to the U.S. entity, BAM Trading, and the BAM Trading Staking Program, marketed on the Binance.US platform “as a way to earn ‘passive income’ through the efforts of Binance.” Compl. ¶ 339. While individual investors may stake their assets and participate in the “Proof of Stake” consensus mechanism used by some blockchains to determine which transactions are valid, BAM Trading‘s Staking Program was promoted “as a superior and much easier way to obtain staking rewards by, among other things, pooling the crypto assets of a large number of investors.” Compl. ¶¶ 339-40. The complaint explains that staking assets on
The BAM Staking Program was designed to attract investors who lacked the technical acumen and hardware requirements to operate on their own, and the SEC alleges that it was “marketed as a way for investors to rely on and profit from BAM Trading‘s technical expertise and knowhow, industry relationships, and infrastructure.” Compl. ¶ 343. “For each staking-eligible crypto asset that is a part of the Staking Program, BAM Trading, directly or through affiliates or other third parties, pools investor assets in a common ‘staking pool’ in which investors ‘combine their staking power and share the reward proportionally to their contributions to the pool.’ Moreover, for as long as the investors choose to stake their tokens, investors receive payouts from BAM Trading that are distributed to them pro rata.” Compl. ¶ 350. Participants in the program lose the ability to use their tokens for other purposes: “BAM Trading will not allow users to sell or withdraw crypto assets while they are staked.” Compl. ¶ 349.24
II. The complaint plausibly alleges that both Binance and BAM Trading were obliged and failed to register under the Exchange Act and that the Court has personal jurisdiction over Zhao for these violations.
A. The complaint plausibly alleges that both Binance and BAM Trading were obliged and failed to register as an exchange, as a broker-dealer, and as a clearing agency under the Exchange Act.
In Counts Five, Six, and Seven, the SEC alleges that by operating the Binance.com platform, Binance made use of the mails and the means and instrumentalities of interstate commerce to effect transactions in a security, to induce or attempt to induce the purchase or sale of any security, and to act as a clearing agency with respect to securities, and therefore, it was required to register under Section 5 of the Exchange Act as an exchange, as a broker-dealer, and as a clearing agency. Counts Eight, Nine, and Ten similarly allege that Binance and BAM Trading were required to register as an exchange, a broker-dealer, and a clearing agency due to their operation of the Binance.US platform.
Given the Court‘s findings that Binance.com offered BNB and the BNB Vault Program as investment contracts, and that BAM Trading offered its Staking Program as an investment contract, each of these counts will move forward. The registration requirements are triggered by transactions involving just one security, see
B. The Court may exercise personal jurisdiction over defendant Zhao with respect to Exchange Act allegations.
In Count Eleven, the SEC alleges that as “a control person of Binance” for purposes of Exchange Act Section 20(a), defendant Zhao is personally liable for Binance‘s alleged violations of Sections 5, 15(a), and 17A(b) of the Exchange Act in connection with the operations of the Binance.com platform. Compl. ¶¶ 544-48. Count Twelve alleges that as “a control person of Binance and BAM Trading,” he bears personal responsibility for the alleged violations of
1. The requirements for personal jurisdiction
The Due Process Clause protects an individual‘s liberty interest in not being subject to the binding judgments of a forum with which he has no meaningful “contacts, ties, or relations.” Burger King Corp. v. Rudzewicz, 471 U.S. 462, 471-72 (1985), quoting Int‘l Shoe Co. v. Washington, 326 U.S. 310, 319 (1945). It is undisputed that Zhao resides outside of the United States. Compl. ¶ 30. Accordingly, to have personal jurisdiction over Zhao, the Court must find that it has specific jurisdiction over him. See Lewis v. Mutond, 62 F.4th 587, 591 (D.C. Cir. 2023) (general jurisdiction applies when a defendant resides in the jurisdiction). Specific jurisdiction may arise when a defendant has “certain minimum contacts with [the forum] such that the maintenance of the suit does not offend ‘traditional notions of fair play and substantial justice.‘” Id., quoting Int‘l Shoe Co., 326 U.S. at 316 (alteration in original).
With respect to foreign defendants, due process “requires meaningful contacts, ties, or relations with the United States to create a fair warning that a particular activity may subject [them] to the jurisdiction of a foreign sovereign.” Lewis, 62 F.4th at 593 (alteration in original) (internal quotation marks omitted). Defendants’ contacts, ties, or relations “must be ‘purposefully directed’ at the forum to establish ‘foreseeability . . . that the defendant‘s conduct and connection with the forum . . . are such that he should reasonably anticipate being haled into court there.‘” Id. at 591, quoting Burger King Corp., 471 U.S. at 474 (citation omitted); see also Mwani, 417 F.3d at 12 (when deciding whether a court has specific jurisdiction over a foreign defendant, the question is whether the foreign defendant purposefully availed himself of the forum).
The plaintiff bears the burden of “establishing a factual basis for the exercise of personal jurisdiction” over each defendant. Crane, 894 F.2d at 456. “Each defendant‘s contacts with the forum . . . must be assessed individually,” Keeton v. Hustler Mag., Inc., 465 U.S. 770, 781 n.13 (1984), and “specific personal jurisdiction is claim-specific.” Smartmatic USA Corp. v. Powell, No. 1:21-cv-02995 (CJN), 2023 WL 3619346, at *4 (D.D.C. May 24, 2023), citing Seiferth v. Helicopteros Atuneros, Inc., 472 F.3d 266, 274-75 (5th Cir. 2006); Cockrum v. Donald J. Trump for President, Inc., 319 F. Supp. 3d 158, 175 (D.D.C. 2018). Courts must resolve factual disputes in favor of the plaintiff, and jurisdictional facts are plausible if they allow a “court to draw the reasonable inference that the defendant” intended to target the United States. Lewis, 62 F.4th at 592-93, citing Iqbal, 556 U.S. at 678, and Twombly, 550 U.S. at 556. If a plaintiff‘s assertions are conclusory or reflect bare allegations that “merely state the plaintiff[‘s] theory of specific jurisdiction[,] then exercising specific jurisdiction is improper.” Id. at 593 (alterations in original) (internal quotation marks omitted).
2. The requirements for control person liability
Section 20(a) of the Securities Exchange Act attaches liability to “[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder . . . unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.”
Defendants Binance and Zhao argue that control person liability under the Securities Exchange Act cannot support personal jurisdiction on its own, Binance Mot. at 44, and that the allegations in the complaint are insufficient to give rise to personal jurisdiction over Zhao for “the registration-based control person claims at issue.” Binance Mot. at 43; id. at 44 (arguing that allegations that “Zhao ‘actively solicited U.S. investors to trade on the Binance Platforms’ (Compl. ¶ 24) are insufficient to establish the requisite ‘suit-related conduct’ needed to create ‘a substantial connection’ between Zhao and the forum, and that the SEC alleges no direct contact between Zhao and U.S. users), quoting Cockrum, 319 F. Supp. 3d at 175.
Circuit courts are split on whether “control person” liability under the Securities Exchange Act, on its own, is enough to confer personal jurisdiction over a defendant. In San Mateo County Transit District v. Dearman, Fitzgerald & Roberts, Inc., 979 F.2d 1356, 1358 (9th Cir. 1992), the Ninth Circuit held that a plaintiff need only make “a non-frivolous allegation that the defendant controlled a person liable for the fraud” for a court to have personal jurisdiction over the defendant. But the Sixth Circuit rejected that approach, and it followed an opinion from this district instead. In City of Monroe Employees Retirement System v. Bridgestone Corp., the Sixth Circuit held that substituting a claim of statutory liability for establishing personal jurisdiction would “impermissibly conflate[] statutory liability with the Constitution‘s command that the exercise of
personal jurisdiction must be fundamentally fair.” 399 F.3d 651, 667 (6th Cir. 2005) (alteration in original), quoting In re Baan Co. Sec. Litig., 245 F. Supp. 2d 117, 129 (D.D.C. 2003).
The D.C. Circuit has not decided this issue, but the SEC does not appear to be relying solely on control person liability to support the Court‘s exercise of jurisdiction over Zhao. See SEC Opp. at 71 (recognizing the circuit split but noting that the factual inquiries into control person liability and personal jurisdiction “involve a similar contact-based analysis“), quoting City of Monroe Emps. Ret. Sys., 399 F.3d at 667. And the Court finds the reasoning in City of Monroe, 399 F.3d at 667, and in In re Baan Co. Sec. Litig., 245 F. Supp. 2d at 128-29, to be persuasive, so it will apply a traditional due process analysis without deciding whether control person status alone would be sufficient.
The complaint alleges that in November 2018, a consultant hired by Zhao to advise Binance on managing U.S. legal exposure recommended that Zhao and Binance create a U.S. entity, which the consultant referred to as the “Tai Chi” entity, and the SEC refers to the company‘s effort to follow this advice as the “Tai Chi Plan.” Compl. ¶ 112. According to the agency, “Binance implemented much of the Tai Chi Plan. In addition to creating BAM Trading and the Binance.US Platform, Zhao and Binance implemented policies and controls to give the impression that the Binance.com Platform was blocking U.S. customers while at the same time secretly subverting those controls.” Compl. ¶ 125. “On June 13, 2019, Binance issued a press release announcing that BAM Trading would soon be launching the Binance.US Platform. . . . ‘[T]o launch trading services for users in the United States.‘” Compl. ¶ 151. It quoted Zhao as stating that “Binance.US will be led by our local partner BAM and will serve the U.S. market in full regulatory compliance.” Compl. ¶ 152. The next day, “Binance updated the Binance.com Platform‘s ‘Terms of Use’ to provide - for the first time - that U.S. customers were not permitted to trade on the Binance.com
But, the SEC alleges, “Zhao and Binance engaged in widespread covert efforts to permit U.S. customers to continue to trade on the platform.” Compl. ¶ 127. Specifically, “Zhao directed Binance to implement a plan to encourage customers to circumvent Binance‘s geographic blocking of U.S.-based IP addresses by using a VPN service to conceal their U.S. location” and “to encourage certain U.S.-based VIP customers to circumvent the new [Know Your Customer (“KYC“)] restrictions by submitting updated KYC information that omitted any U.S. nexus.” Compl. ¶ 128.
The complaint further alleges that after launching BAM Trading, Zhao continued to control both its high-level and the day-to-day operations. Zhao was responsible, it says, for “[giving] final signoff on various decisions relating to the Binance.US Platform‘s trading services, including customer account opening processes, development of the front-end access, and creating a reserve to cover ACH deposits.” Compl. ¶ 157. He was allegedly responsible for personally approving BAM Trading employees obtaining certain real-time trading data for the Binance.US Platform, “at least through much of 2021.” Compl. ¶¶ 158-60. He was responsible for “direct[ing] which investment opportunities BAM Trading offered on the Binance.US Platform,” including the decision to have Binance.US Platform offer BNB for purchase and sale - despite the perceived legal risks it presented with respect to U.S. securities law and against the advice of BAM Trading‘s CEO. Compl. ¶¶ 161-64. And, the agency asserts, Zhao was responsible, at least through January 30, 2020, for approving “all BAM Trading expenditures exceeding $30,000,” and BAM Trading sought his and Binance‘s approval for such routine business expenses as “rent, franchise
In short, the complaint amasses considerable detail to show that Zhao effectively operated as the CEO of BAM Trading. The complaint alleges various failed efforts by the company‘s first CEO to gain independence from Zhao, Compl. ¶¶ 193-201, and it quotes testimony from company‘s second CEO, reporting: “[W]hat became clear to me at a certain point was CZ was the CEO of BAM Trading, not me.” Compl. ¶ 205 (alteration in original). BAM Trading‘s second CEO resigned three months later. Compl. ¶ 205.
According to the Supreme Court, allegations of direct contact between Zhao and U.S. users are not required to exercise personal jurisdiction over Zhao: “our ‘minimum contacts’ analysis looks to the defendant‘s contacts with the forum State itself, not the defendant‘s contacts with persons who reside there.” Walden v. Fiore, 571 U.S. 277, 285 (2014), citing Int‘l Shoe Co., 326 U.S. at 319. The SEC alleges that Zhao ran the day-to-day operations of BAM Trading, Compl. ¶¶ 157-205, a U.S.-based company created to provide trading services for users in the United States of the crypto assets at issue in this case. Compl. ¶ 151. And it claims that Zhao personally directed Binance to instruct customers to circumvent the Binance.com platform‘s “geographic blocking of U.S.-based IP addresses” and Know Your Customer restrictions. Compl. ¶ 128.
Construing the facts alleged in the plaintiff‘s favor, as it must at this stage of the litigation, Kowal, 16 F.3d at 1276, the Court finds that the SEC has set forth sufficient facts to plausibly allege that Zhao had “meaningful contacts, ties, or relations[] with the United States to create a fair warning” that his activity may subject him to this Court‘s jurisdiction. Lewis, 62 F.4th at 593 (alteration in original) (internal quotation marks omitted). Given these activities, the Court finds
Nonetheless, citing Mazza v. Verizon Washington DC, Inc., 852 F. Supp. 2d 28 (D.D.C. 2012), defendants argue that allegations that a parent company is “responsible for establishing” strategies for local subsidiaries are insufficient for establishing specific jurisdiction. Binance Mot. at 45, citing 852 F. Supp. 2d at 40. The Mazza case arose from a billing dispute between a D.C. consumer and a defendant telecommunications company. The plaintiff claimed that defendant Verizon Washington D.C., Inc. reported false information about his credit to consumer reporting agencies and engaged in abusive collection strategies, and that these actions should be imputed to its corporate parent Verizon Communications. Id. at 41. The court disagreed, ruling that allegations that the parent was “responsible for establishing revenue targets, operational goals and guidelines, customer acquisition and support strategies [and] for the infrastructure and client databases for [the subsidiaries]” were insufficient to “demonstrate that Verizon Communications directed any activity into the District of Columbia related to Mazza‘s claims” concerning bills collection and credit reporting. Id. at 40.
Defendants also argue that broad allegations that a defendant influenced and controlled a company‘s decision-making are insufficient to support personal jurisdiction. Binance Mot. at 45, citing In re Braskem S.A. Sec. Litig., 246 F. Supp. 3d 731, 770 (S.D.N.Y. 2017). In that case, investors in a Brazilian petrochemical company alleged that its failure to disclose a bribery scheme violated federal securities law. 246 F. Supp. 3d at 740-41. The plaintiffs also named a major shareholder of the company as a defendant, but the court ruled it had no personal jurisdiction over the shareholder. Id. at 770. It found that the complaint failed to plead specific facts that the shareholder was accountable for the statements: the complaint did “not allege, concretely, that [the shareholder] played any role in making, proposing, editing or approving [defendant‘s] public filings in the United States.” Id. (emphasis in original). Rather, it made only “sweeping and conclusory allegations” that the shareholder “had the power to influence and control and did influence and control, directly or indirectly,” the company‘s decision-making, including the dissemination of the allegedly false and misleading statements. Id. This is also easily distinguished from the case at hand.
Defendants suggest that the allegations that Zhao actively solicited U.S. investors to trade on the Binance Platforms are insufficient, but this is a narrow characterization of the complaint that ignores the many allegations of Zhao‘s significant involvement in activities, in and directed towards, the United States. See Compl. ¶¶ 125-28, 157-205. The complaint specifically alleges that Zhao directed Binance to maintain U.S. customers on the Binance.com platform and that he
III. The Securities Act and Exchange Act reach the offshore conduct in this case.
Defendants Binance and Zhao argue that the foreign components of Counts One and Two and all of Counts Three and Five through Seven against Binance, along with Count Eleven against Zhao, must be dismissed because the registration provisions of the Securities Act and the Exchange Act do not have extraterritorial reach. Binance Mot. at 36.27 The motion to dismiss on that basis will be denied.
A. The law on extraterritoriality
It is a “longstanding principle of American law ‘that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States‘” and is “presume[d to be] ‘primarily concerned with domestic conditions.‘” EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991) (”Aramco“), quoting Foley Bros. v. Filardo, 336 U.S. 281, 285 (1949). Extraterritoriality is a canon of construction, or a presumption about a statute‘s meaning, rather than a limit upon Congress‘s power to legislate. Morrison v. Nat‘l Austl. Bank Ltd., 561 U.S. 247, 255 (2010). So whether a statutory provision has extraterritorial reach is a merits question, not a matter that goes to subject matter jurisdiction. Id. at 253-54.
The Supreme Court has made clear that while its “cases sometimes refer to whether the ‘statute’ applies extraterritorially, . . . the two-step analysis applies at the level of the particular provision implicated.” Abitron Austria, 600 U.S. at 419 n.3, citing RJR Nabisco, 579 U.S. at 346; Morrison, 561 U.S. at 264-65. So the question here is whether
The “focus” of a statute is “the object of its solicitude, which can include the conduct it seeks to regulate, as well as the parties and interests it seeks to protect or vindicate.” Abitron
In the securities context, the Supreme Court has held that
Applying Morrison, the Second Circuit has held that “to sufficiently allege the existence of a ‘domestic transaction in other securities,’ a plaintiff must allege facts indicating that irrevocable liability was incurred or that title was transferred within the United States.” Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 62 (2d Cir. 2012). Irrevocable liability attaches when parties “becom[e] bound to effectuate the transaction or enter[] into a binding contract to purchase or sell securities.” Mia. Grp. v. Vivendi, S.A., 838 F.3d 223, 265 (2d Cir. 2016) (internal quotation marks omitted); Absolute Activist, 677 F.3d at 68 (internal citation omitted) (explaining irrevocable liability occurs “when the parties to the transaction are committed to one another“).
B. The complaint alleges domestic transactions.
Defendants argue that the SEC has failed to allege domestic transactions within the meaning of Morrison. They maintain that the allegations that Binance is a Cayman Islands
Morrison involved a provision of the
Defendants argue that to comply with Morrison then, the complaint must allege that irrevocable liability was incurred or that title was transferred in the United States. Binance Mot. at 39, citing Absolute Activist, 677 F.3d at 67-68. But Williams v. Binance, 96 F.4th 129 (2d Cir. 2024), which was decided after the parties briefed this issue, undercuts defendants’ argument. In
The plaintiffs in Williams were U.S. purchasers of seven Binance tokens: EOS, TRX, ELF, FUN, ICX, OMG, and QSP. Id. at 132-33. They claimed that Binance promoted, offered, and sold tokens in violation of the
Binance disclaimed having any location or being subject to any other particular jurisdiction, and its intransigence on that point led the court to reject its argument that the plaintiffs’ transactions were not domestic. Williams, 96 F.4th at 136, 139. The court explained that the
Since Binance and Zhao were the defendants in Williams, it is not surprising that the allegations in that case are similar to those here. The SEC alleges that Binance is a Cayman Islands limited liability company and Binance.com is “an international crypto asset trading platform.” Compl. ¶ 27. But neither is alleged to be headquartered or located in any particular jurisdiction. Rather, Zhao “has refused to identify the headquarters of Binance, claiming, ‘Wherever I sit is the Binance office. Wherever I meet somebody is going to be the Binance office.‘” Compl. ¶ 27.
The SEC further alleges that customers in the United States bought or traded tokens on the Binance.com platform, see Compl. ¶¶ 8, 106, 140, 320, 326, and that Binance accepted payment from them in U.S. dollars using U.S. banks. Compl. ¶¶ 98, 284. Further, Binance.com “offers
[W]hen an investor places an order on the Binance.com Platform, the order enters Binance‘s internal automated matching engine, called “MatchBox,” which matches buy-and-sell orders based on programmed, non-discretionary rules that govern how orders will interact. When separate customers’ buy and sell orders have prices that overlap, MatchBox executes the trade and removes the orders from the order book. Orders that do not execute immediately are typically ranked and displayed in price-time priority, meaning that orders placed earlier in time are prioritized for any given price. . . . Upon execution of a trade, other functionality in the Binance.com Platform settles the trade.
Compl. ¶¶ 90-91; see also Compl. ¶ 83 (alleging that the Whitepaper touted Binance‘s matching engine would be “capable of sustaining 1,400,000 orders/second, making Binance one of the fastest exchanges in the market“).
Given that Binance disavows being located anywhere, this Court agrees with the Second Circuit‘s analysis in Williams and concludes that the factual allegations here plausibly allege that irrevocable liability was incurred in the United States when customers in the United States placed trade orders and sent payments on the Binance.com platform. See Williams, 96 F.4th at 140; City of Pontiac, 752 F.3d at 181 n.33.29 And because Binance disclaims being located in any geographical jurisdiction, Compl. ¶ 27, there are no concerns about international comity or the risk
IV. Count Thirteen states a plausible claim that BAM Management and BAM Trading violated the anti-fraud provisions of the Securities Act.
In the final count of the complaint, the SEC alleges that the U.S. entities, BAM Management and BAM Trading, committed violations of
A. The anti-fraud provisions of the Securities Act
“The
It shall be unlawful for any person in the offer or sale of any securities . . . by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly -
(1) to employ any device, scheme, or artifice to defraud, or
(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
1. Section 17(a)(2)
To state a claim under
Parties can only be liable for a violation of
Because materiality is a mixed question of law and fact, courts have cautioned against granting a motion to dismiss based on the failure to plead materiality “unless [the information is] so obviously unimportant to a reasonable shareholder that reasonable minds could not differ on the question of their importance.” Kas v. Fin. Gen. Bankshares, Inc., 796 F.2d 508, 514 (D.C. Cir. 1986); Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 718 (2d Cir. 2011) (disagreeing with the district court “at this preliminary stage of litigation that the alleged omissions and misstatements” were “obviously unimportant“), quoting Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000); see SEC v. Brown, 740 F. Supp. 2d 148, 167 (D.D.C. 2010) (finding that the agency had alleged a material omission because “reasonable minds could differ as to whether” the information was “obviously unimportant“), quoting Ganino, 228 F.3d at 162.
2. Section 17(a)(3)
Under
While the D.C. Circuit has not addressed the issue, other circuits have agreed that to establish “scheme liability” under
In other words, scheme liability is only appropriate if
B. Count Thirteen plausibly alleges that material false statements were made to crypto currency investors in connection with the offer and sale of crypto asset securities and to equity investors in BAM Management.
The particular fraudulent practices or false and misleading statements that underlie this count are detailed in Section VI of the complaint, paragraphs 239 through 281. The gravamen of the count is that BAM Trading and BAM Management negligently misled customers and investors when they assured them that they had implemented controls to prevent manipulative trading, in particular “wash trading,” on the Binance.US platform, when in fact, they had not. Compl. ¶¶ 239-43. The complaint explains that in “wash trading,” the same trader is buying and selling assets among his own accounts, and it is not arm‘s length market activity. Compl. ¶ 240. “Wash trading gives the artificial appearance of, among other things, increased trading volume, liquidity, and trading interest for the asset at issue. It may also artificially inflate the aggregate trading volume of the platform upon which the asset is being traded.” Compl. ¶ 240. The SEC also alleges that BAM misled investors when it disseminated trading volume statistics without disclosing the fact that it lacked procedures that would enable it to verify the numbers. Compl. ¶¶ 250-58.
According to the SEC, from the time the Binance.US platform was launched in September 2019, “BAM Trading and BAM Management . . . publicly touted their supposed efforts to monitor and prevent manipulative trading.” Compl. ¶ 246. For example, the Trading Rules included in the
Also, two years later, when BAM Trading and BAM Management were seeking equity investors in BAM Management, they allegedly “falsely touted the trade surveillance and other measures purportedly in place on the Binance.US platform to detect and prevent manipulative trading.” Compl. ¶ 247. The complaint points to specific instances between September 2021 and
The complaint also alleges that the BAM defendants misled the public about the reliability of the trading volume figures for the Binance.US Platform, which were being disseminated to potential investors on such public resources as the market data API, the Binance U.S. Platform and its website, and data aggregators such a CoinMarketCap and CoinGecko, Compl. ¶¶ 250-53, and on social media. Compl. ¶ 255 (“[O]n November 1, 2019, BAM Trading tweeted that the Binance.US Platform had ‘$30M in 24hr Volume.’ Similarly, on January 8, 2021, BAM CEO A tweeted that the platform‘s total trading volume was ‘$500M.‘“). Statistics such as these were also reported in the Pitch Deck and other material provided to potential equity investors. See Compl. ¶¶ 256-58 (“In the Pitch Deck, BAM Trading and BAM Management reported, with respect to the Binance.US Platform, ‘$24B’ in average monthly trading volume, ‘$205B’ in trading volume to date, and favorable trading volume comparisons to the Binance.US Platform‘s competitors” and “that the
Why does all of this add up to fraud? According to the SEC, none of the surveillance and monitoring was in place at the time it was advertised, and what went unmonitored in its absence was wash trading among accounts connected to defendant Zhao himself.
The SEC alleges:
When the Binance.US Platform launched in September 2019, BAM Trading - contrary to its public statements - had no controls to monitor for and prevent manipulative trading on the Binance.US Platform, and through at least February 2022, it had implemented no such trade surveillance or controls.
Moreover, when BAM Trading and BAM Management reported trading volume without disclosing the extensive nature of the wash trading that they knew existed on the Binance.US Platform, . . . they deceived investors into thinking that the trading volumes on the platform were robust, real, and reliable.
Compl. ¶¶ 260-61.
The BAM defendants move to dismiss this count, arguing that: the complaint does not set forth a plausible claim under
The Court finds that the allegations are set forth with sufficient specificity to satisfy
The BAM defendants’ other attacks on this count are also unavailing. They argue that to the extent the claim is based on misstatements to crypto currency traders regarding the operation of the Binance.US platform,
BAM also argues that it did not receive “money or property” by means of the alleged misleading statements, BAM Mot. at 36, but the complaint expressly alleges that BAM received trading fees when it induced crypto asset investors to trade on its platform. See Compl. ¶ 281. Finally, the
V. Neither the major questions doctrine nor due process concerns warrant dismissal of the complaint.
Finally, the defendants have advanced two grounds for why the Court should not entertain this case at all. Defendants invoke the major questions doctrine and argue that the SEC does not have authority to regulate the crypto currency industry through litigation. Binance Mot. at 33-35; BAM Mot. at 31-32; see also Br. of Amicus Curiae Chamber of Digital Commerce in Supp. of Defs.’ Mot. to Dismiss [Dkt. # 169] (“Chamber Br.“) at 16-19. They also suggest that the lawsuit violates due process since the defendants lacked the necessary notice of the agency‘s position on crypto assets. Neither of these sweeping arguments warrants the dismissal of the action.
A. The major questions doctrine is not a basis to dismiss the complaint.
The major questions doctrine applies to “extraordinary cases . . . in which the history and breadth of the authority that [the agency] has asserted, and the economic and political significance of that assertion, provide a reason to hesitate before concluding that Congress meant to confer such authority.” West Virginia v. EPA, 597 U.S. 697, 721 (2022) (alteration in original) (internal quotation marks omitted).
This is not such a case. The Supreme Court has opined that when an agency claims the “power to regulate a significant portion of the American economy” that has “vast economic and
The Court has not been given grounds to find that the industry, while important, has the broad reach that has motivated courts to apply the doctrine to other industries. See, e.g., FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 137 (2000) (internal citation omitted) (describing the tobacco industry at the time as “one of the greatest basic industries of the United States with ramifying activities which directly affect interstate and foreign commerce at every point, and stable conditions therein are necessary to the general welfare“). Further, a ruling that certain of defendants’ sales of crypto assets are investment contracts, and therefore securities, would not have the economic reach that other regulatory actions found to be subject to the doctrine would have had. West Virginia, 597 U.S. at 735 (describing the challenged EPA rule as one that would have “force[d] a nationwide transition away from the use of coal to generate electricity“).
Also, with respect to the “power grab” argument, the SEC‘s enforcement action here does not reflect “enormous and transformative expansion in [the agency‘s] regulatory authority without clear congressional authorization.” Util. Air Regul. Grp., 573 U.S. at 324 (describing the EPA‘s
To be sure, a ruling that either BNB, BUSD, BNB Vault, or Simple Earn is an investment contract under the securities laws could have important implications for the broader crypto asset industry and how issuers or platforms market digital assets. But the SEC‘s lawsuit seeking that ruling is an unremarkable exercise of the agency‘s enforcement authority.
[T]he SEC‘s role is not to exercise vast economic power over the securities markets, but simply to assure that they provide adequate disclosure to investors. Thus, the SEC‘s decision to require truthful marketing of certain crypto-assets based on its determination that certain of such assets are securities hardly amounts to a “transformative expansion in its regulatory authority.”
Terraform I, 684 F. Supp. 3d at 190, quoting West Virginia, 597 U.S. at 724; see also FTC v. Kochava Inc., 671 F. Supp. 3d 1161, 1180 (D. Idaho 2023) (holding the major questions doctrine
As another district court ruled recently, the crypto asset industry “falls far short of being a portion of the American economy bearing vast economic and political significance.” Terraform I, 684 F. Supp. 3d at 189 (quotation marks omitted); see also SEC v. Coinbase, Inc., 2024 WL 1304037, at *14-*15 (S.D.N.Y. Mar. 27, 2024). This Court agrees and finds that the major question doctrine does not apply.
B. Defendants have had fair notice of the SEC‘s position on digital tokens.
It is “[a] fundamental principle in our legal system” that “laws which regulate persons or entities must give fair notice of conduct that is forbidden or required.” Karem v. Trump, 960 F.3d 656, 664 (D.C. Cir. 2020), quoting FCC v. Fox Television Stations, Inc., 567 U.S. 239, 253 (2012) (holding that a statute or regulation fails to comply with due process if it “fails to provide a person of ordinary intelligence fair notice of what is prohibited, or is so standardless that it authorizes or encourages seriously discriminatory enforcement“) (internal quotation marks omitted).
Defendants Binance and Zhao argue that the SEC failed to comport with these principles by failing to “identify, with ascertainable certainty, the standards with which the agency expects [an industry] to conform.” Binance Mot. at 42 (alteration in original), quoting SNR Wireless LicenseCo, LLC v. FCC, 868 F.3d 1021, 1043 (D.C. Cir. 2017) (quotation marks omitted). They assert that the SEC has shifted positions on whether crypto assets and transactions are securities subject to the SEC‘s jurisdiction, Binance Mot. at 42-43, citing Gen. Elec. Co. v. EPA, 53 F.3d 1324, 1332 (D.C. Cir. 1995), and that this lawsuit reflects a “new position” that “is at odds
There is no question that the agency‘s position has evolved and that the agency has not undertaken a comprehensive regulatory approach to the industry. But that does not mean that this case came as a surprise. The SEC filed a number of other lawsuits before this one alleging that the sale of crypto assets are investment contracts and, therefore, securities under Howey. They include SEC v. Terraform Labs Pte. Ltd., 23-cv-1346-JSR, filed in February 2023; SEC v. Ripple Labs, Inc., 20-cv-10832-AT, filed in December 2020, and SEC v. Kik Interactive Inc., 19-cv-5244-AKH, filed five years ago in June of 2019. So defendants’ suggestion that this case presents a “new position” rings hollow. See Binance Mot. at 9 (describing recent SEC enforcement actions alleging that crypto asset transactions are securities).
In those lawsuits, as in the instant case, the agency undertook to enforce a decades-old federal securities statute and 1943 Supreme Court precedent interpreting it. As court in Ripple Labs reasoned:
the caselaw that defines an investment contract provides a person of ordinary intelligence a reasonable opportunity to understand what conduct it covers. Howey sets forth a clear test for determining what constitutes an investment contract, and Howey‘s progeny provides guidance on how to apply that test to a variety of factual scenarios.
Ripple Labs I, 682 F. Supp. 3d at 332 (internal citations omitted), citing United States v. Zaslavskiy, No. 17 Cr. 647, 2018 WL 4346339, at *9 (E.D.N.Y. Sept. 11, 2018) (“[T]he abundance of caselaw interpreting and applying Howey at all levels of the judiciary, as well as related guidance issued by the SEC as to the scope of its regulatory authority and enforcement power, provide all the notice that is constitutionally required.“); see SEC v. Coinbase, Inc., 2024 WL 1304037, at *15-*17. Howey established “an objective test that provides the flexibility
Defendants focus on the SEC‘s failure to issue regulations on crypto assets and its inconsistent statements and approaches to regulating the sale of digital assets as investment contracts. See Binance Mot. at 7-10, 42-43. But this suit is consistent with the other enforcement actions that the agency has brought alleging that the sales of crypto assets are “investment contracts” within the meaning of Howey. See, e.g., Ripple Labs I, 682 F. Supp. 3d. 308; Telegram, 448 F. Supp. 3d 352; Kik Interactive, 492 F. Supp. 3d 169.
While the fair notice doctrine calls for sufficient notice to “provide a person of ordinary intelligence fair notice of what is prohibited,” Fox Television Stations, 567 U.S. at 253, quoting Williams, 553 U.S. at 304, and not a showing of actual notice, it is still notable nevertheless that the complaint alleges that Zhao and Binance knew their actions could trigger federal securities enforcement action. See Compl. ¶ 162 (alleging that in “an internal chat in September 2019, the Binance CFO and the Binance CCO agreed that . . . . if a ‘Kik [W]ells notice happens to BNB, BNB price can go down significantly,‘” referring to the prelude to the June 2019 enforcement action, SEC v. Kik Interactive); Compl. ¶ 162 (“They further quantified the legal risk of listing BNB on the Binance.US Platform as ‘$10 mm in legal fees and settlements, contrasted to the fact that BNB‘s price could ‘go up 20%.‘“). Further, it is alleged that Zhao and Binance were aware of and advised about possible US regulatory exposure and took steps to conceal their activity. See Compl. ¶¶ 110-40, 162.
Moreover, the agency put the industry on notice even before 2019. In July 2017, the SEC issued a report advising “those who would use . . . distributed ledger or blockchain-enabled means for capital raising[] to take appropriate steps to ensure compliance with the U.S. federal securities
Therefore, the Court finds no violation of due process or lack of fair notice that would warrant the dismissal of the complaint.
For these reasons and as summarized below, the BAM defendants’ Motion to Dismiss [Dkt. # 117] is DENIED, and the Binance and Zhao Motion to Dismiss [Dkt. # 118] is GRANTED IN PART and DENIED IN PART.
- Count One: The portions of Count One against Binance relating to the initial coin offering of BNB and Binance‘s ongoing sales of BNB after the ICO will move forward, while the portion concerning secondary sales of BNB, by sellers other than Binance, is dismissed.
- Count Two: The claim against Binance concerning sales of BUSD is dismissed.
- Count Three: The claim against Binance regarding BNB Vault will proceed, and the claim as to Simple Earn is dismissed.
- Count Four: The claim that BAM Trading offered and sold its Staking Program as an investment contract will proceed.
- Counts Five through Ten: The claims that Binance (Counts Five, Six, Seven, Eight, and Ten) and BAM Trading (Counts Eight, Nine, and Ten) failed to register under the Exchange Act will proceed.
- Counts Eleven and Twelve: The claims against defendant Zhao as a control person over Binance and BAM Trading for their alleged violations of the Exchange Act will proceed.
- Count Thirteen: The claim that BAM Management and BAM Trading violated the anti-fraud provisions of the Securities Act will proceed.
SO ORDERED.
AMY BERMAN JACKSON
United States District Judge
DATE: June 28, 2024
Notes
Paragraph 306 alleges that Binance “offered and sold BNB to its employees in the United States and elsewhere by offering to pay salaries in the form of BNB.” Compl. ¶ 306. Since the complaint does not have an independent claim alleging that the offer to employees was an “investment contract,” and the SEC appears to be highlighting the statements about compensation and the stock option plans to advance its claim that after the ICO, Binance continued to market BNB to the public as an investment contract, the Court does not find it necessary to determine at this time whether the SEC has shown that the offer to pay employees BNB itself includes all of the elements of an investment contract, in particular, the first element of an investment of money. See Ripple Labs I, 682 F. Supp. 3d at 330-31 (finding that distributions to employees as compensation do not satisfy the first prong of Howey); Ripple Labs II, 2023 WL 6445969 at *6 (finding no substantial ground for difference of opinion about the holding in SEC v. LBRY, 639 F. Supp. 3d 211 (D.N.H. 2023), because the defendant in that case did not dispute the “investment of money” element).
At the hearing, the SEC cited One-O-One Enterprises, Inc. v. Caruso, 668 F. Supp. 693, 700 (D.D.C. 1987), for the proposition that the investment of money prong can be satisfied with the provision of services. Mot. Hr‘g Tr. at 85. But that non-binding opinion does not discuss employee compensation, and it is not particularly helpful. The case involved an agreement in which the defendants, who owned a successful chain of steakhouses, purchased ten “debt ridden” restaurants from the plaintiffs and had a six year option to purchase twenty-five more. The plaintiffs alleged fraud in what they claimed was a securities transaction. 668 F. Supp. at 695-96. The court found that the option for defendants to buy some of the restaurants was not a security, even though the “investment of money” element was established: the defendants did not give the plaintiffs any money in exchange for the restaurants, but they did give plaintiffs valuable consideration in the form of waiving franchise fees, which had the same effect as giving them money. Id. at 700. The court added that the defendants provided plaintiffs with “training, ongoing advice on operations, and marketing and promotional services,” all of which also had financial value. Id.
The SEC seemed reluctant at that time to clarify fundamental aspects of its position.
THE COURT: But you have said all over the complaint crypto assets - and you differentiate that specifically from crypto asset securities, and you make it clear that one category is larger than the other category and that both categories are on the Binance.com platform and the Binance.US platform, correct?
MR. SCARLATO: Yes.
THE COURT: So I‘m asking you, the ones that you are not putting in the securities category, what are they? Are they commodities?
MR. SCARLATO: We are not - thank you, Your Honor. We are not taking a position at this time. . . .
TRO Hr‘g Tr. at 12.
Id. at 92-93 (emphasis added). In short, the SEC appears to be insisting that the representations made at the outset travel with the token. That is different from saying that after the ICO, Binance continued to market the BNB to new buyers as an investment contract. While counsel added that Binance makes “representations about profitability” and “there are ongoing representations about what they‘re going to do,” and that the token‘s “value derives solely from the blockchain” and “they have to maintain the blockchain,” id. at 93, the complaint does not lay out enough of the facts and circumstances surrounding ongoing secondary sales to support to a plausible inference that the reasonable secondary buyer would expect Binance to use their investment to generate profits on the buyer‘s behalf.QUESTION BY THE COURT: . . . So if the buyer [in] the ICO could reasonably think Binance is going to use my investment and it‘s going to develop this platform and it‘s going to support this coin, and you‘re not saying that carries over, necessarily, after the buyer sells it to someone else, what are the expectations and understandings for contracts that are the circumstances that surround any resale?
MS. FARER: So, Your Honor, the token itself represents the investment contract. . . . [W]hat is occurring here [with] the purchase of the token is you‘re buying into the enterprise. . . . [H]ere there is a pooling at the initial ICO and the investors purchase based on marketing and the promise of profitability, . . . and that . . . was based on the efforts of the issuers and promoters. That then carries through with the token. The token represents and embodies that investment contract. And nothing has changed simply because someone buys it directly from the purchasers on the - in a primary sale ICO or on a resale. . . .
See Notice of Suppl. Auth., Letter brief filed by the government in United States v. Eisenberg, ECF No. 145, Case No. 1:23-cr-10 (S.D.N.Y. Apr. 13, 2024) [Dkt. # 236] (citations omitted). This representation was based on the state of the evidentiary record at trial, it does not purport to represent the position of the U.S. government as to all stablecoins, and the Court is not relying upon it in making its ruling concerning BUSD. But it does point out the need for consistency in how these investments are treated, and the fact that it may be more difficult to make the Howey showing when stablecoins are involved.[T]here is no factual basis for treating USDC as a security or putting that question to the jury. A core component of a security is that the holders of the security “expect profits” from the efforts of others. The evidence at trial uniformly showed that holders of USDC do not expect profits from the token because the token is advertised as “maintain[ing] a value of one U.S. dollar.” While that dollar peg is not always successful, there is no basis for a jury to conclude that holders of USDC expect to profit from holding it, so there is no basis for putting an instruction to the jury requiring them to find that USDC is not a security.
Given those statements, it is not clear to the Court how the SEC could summarily allege that “[i]n both the Simple Earn and BNB Vault programs, Binance pools the crypto assets lent by investors and uses those assets to generate revenue that was used to pay returns to investors . . . . Investors share pro rata the benefits of their pooled assets investment in the Simple Earn and BNB Vault programs.” Compl. ¶ 335. The Simple Earn materials do not inform potential participants in the program that the loaned crypto assets were pooled or, more importantly, that they would be utilized by Binance to generate revenue that would be the source of the returns.