What You Need To Know

• Although the Court allowed claims based on Binance’s own post-ICO sales of its token BNB to proceed, it dismissed claims based on other parties’ subsequent sales of BNB. The Court found that the SEC had not plausibly alleged that purchasers on secondary markets expected Binance to use their “investment” to generate profits.

• Binance’s stablecoin BUSD was not credibly alleged to be offered or sold in a securities transaction. The Court found implausible the SEC’s allegation that Binance’s promises to develop the BUSD “ecosystem” would lead purchasers to expect an increase in value “when the alleged defining feature of the ‘stablecoin’ was that its value would remain constant.”
• The Court followed the reasoning in Coinbase in holding the SEC plausibly alleged BAM Trading’s staking-as-a-service product was a securities offering.
• The Court found that the SEC reasonably alleged that Binance and BAM Trading were each obliged to register with the SEC as an exchange, a broker-dealer, and a clearing agency.
• The SEC’s fraud claim asserting BAM Management and BAM Trading misled investors about its internal controls survived the motion to dismiss.
• On June 28, 2024, Judge Amy Berman Jackson of the District Court for the District of Colombia issued a lengthy order resolving the pending motion to dismiss in SEC v. Binance, 2024 WL 3225974 (D.D.C. June 28, 2024). The SEC’s June 2023 complaint alleged thirteen claims against Binance Holdings Ltd., its founder Changpeng Zhao, and two U.S.-based entities, BAM Trading Services Inc. and BAM Management US Holdings, Inc. With its thorough analysis, the decision is likely to be cited often.

Of particular importance for the crypto industry, the opinion analyzes the SEC’s allegations that Binance and BAM offered and sold various tokens and programs to investors as investment contracts without registering them with the SEC under Section 5 of the Securities Act of 1933 or procuring a valid exemption from registration.

The SEC also alleged both Binance and BAM Trading were required but failed to register under the Exchange Act as exchanges, broker-dealers, and clearing agencies, and that Zhao was personally liable as a control person of control person over Binance and BAM Trading for their failures to register. Additionally, the SEC alleged that BAM Management and BAM Trading violated anti-fraud provisions of the Securities Act by making allegedly untrue statements about monitoring and control of wash trading on their platform.

Key Holdings

• Secondary sales are dismissed. Although the Court allowed claims based on Binance’s own post-ICO sales of its token BNB to proceed, it dismissed claims based on other parties’ subsequent sales of BNB. The Court found that the SEC had not plausibly alleged that purchasers on secondary markets expected Binance to use their “investment” to generate profits.
• Binance’s stablecoin BUSD was not credibly alleged to be offered or sold in a securities transaction. The Court found implausible the SEC’s allegation that Binance’s promises to develop the BUSD “ecosystem” would lead purchasers to expect an increase in value “when the alleged defining feature of the ‘stablecoin’ was that its value would remain constant.”
• The Court followed the reasoning in Coinbase in holding the SEC plausibly alleged BAM Trading’s staking-as-a-service product was a securities offering.
• The Court found that the SEC reasonably alleged that Binance and BAM Trading were each obliged to register with the SEC as an exchange, a broker-dealer, and a clearing agency because Binance offered and sold investment contracts in the form of its own sales of BNB and the BNB Vault program, and BAM Trading offered and sold investment contracts in the form of a staking-as-a-service program. The Court did not consider on this motion the SEC’s allegations that other tokens unaffiliated with defendants were resold on Binance or Binance.US as investment contracts.
• The SEC’s fraud claim asserting BAM Management and BAM Trading misled investors about its internal controls survived the motion to dismiss.

Binance Explains How Howey Applies to Crypto Assets

The SEC alleged the following were unregistered securities offerings:

• Binance’s initial coin offering (“ICO”) of BNB,
• Binance’s post-ICO BNB sales,
• Other parties’ secondary sales of BNB,
• Binance’s offers and sales of the stablecoin BUSD,
• Binance’s lending programs, Simple Earn and BNB Vault, and
• BAM Trading’s staking-as-a-service offering.

According to the SEC, each of these tokens and programs were “investment contracts” under SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and therefore securities offerings. Howey provides that a “contract, transaction, or scheme” is an investment contract where there is: (1) an investment of money (2) in a common enterprise, (3) with an expectation of profits from the efforts of others. Id. at 298-99.

The opinion sets forth several guiding principles in applying Howey to crypto assets. First, following other district courts,¹ the Court rejected defendants’ argument that an “investment contract” requires a “contract,” finding that, in pre-Howey cases, “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.” Binance, 2024 WL 3225974, at *8. The Court added that Howey defined an investment contract as “‘a contract, transaction or scheme’—using a comma after ‘contract,’ the first option in the series of three nouns—and not as a contractual transaction or scheme.” Id. at *9.

Second, the Court agreed with recent rulings treating crypto assets as possible subjects of investment contracts—and not treating the tokens themselves as securities.² The Court explicitly rejected “the SEC’s suggestion that the token is ‘the embodiment of the investment contract’ . . . as opposed to the subject of the investment contract.” Id. at *11. Rather, the Court noted that Howey must be applied to the particular transaction or offering alleged. Judge Jackson also expressed frustration that “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” because “intangible digital assets do not fit neatly into the rubric set forth in the mere seven pages that comprise the Howey opinion.” Id.

Finally, the Court rejected the SEC’s “ecosystem” theory. At oral argument in this case, the SEC argued, secondary sales of BNB by others than Binance are investment contracts because of the “continuing, ongoing efforts on the part of Binance and Mr. Zhao and others with respect to the marketing and promotion as an investment, the marketing of their efforts and tying the value of BNB to their ecosystem and the efforts that they are developing the platform, bringing in all these new programs, including relationships with third parties. . . .” Hearing Transcript at 90, SEC v. Binance, No. 23-cv-1599, 15 (D.D.C. Jan. 22, 2023), ECF No. 212. The Court found that proposition “somewhat inconsistent” with the SEC’s principle that a token itself is not a security and that “the SEC seemed to speak out of both sides of its mouth on the issue.” Binance, 2024 WL 3225974, at *20, *21 n. 15.

Although It Allowed Most of the SEC’s Claims To Survive, the Court Expressed Serious Skepticism Toward the SEC’s Theories

Applying these principles to each alleged offering, the Court found many were sufficiently alleged at the motion to dismiss stage. Specifically, Binance’s offers and sales of BNB during and after the ICO, BNB Vault, and BAM’s staking-as-a-service offering were sufficiently alleged to be investment contracts. By contrast, the Court rejected claims related to secondary sales of BNB, Binance’s offers and sales of BUSD, and Simple Earn. We briefly address the Court’s reasoning as to each of these, below.

• Binance’s Offers and Sales of BNB. Relying heavily on Binance’s statements about BNB, the Court found the SEC had plausibly alleged that offers and sales of that asset by Binance, both during and after the ICO, were securities transactions. For example, the Court credited allegations that “Binance and its CEO expressly linked the future value of the coins to the success of the exchange it planned to develop with the proceeds of the ICO.” Id. at *15.

  But the Court was dubious that the SEC ultimately could sustain these claims through discovery, saying the ruling “does not mean that all questions have been put to rest.” Id. at *19. As Judge Jackson explained, “the question as to what motivated the reasonable purchaser at the time [of purchase] may prove to be a close one.” Id. at *16. For example, the Court noted that ICO purchasers may have been motivated, not by the token’s future value, but by the chance to secure discounted trading fees on Binance’s platform available to holders. Id. The Court also observed that only 35% of the ICO proceeds used to build Binance’s exchange and that the allocation of the remainder had a “more attenuated” connection to the token’s value. Id. at *17.

• Secondary Sales of BNB. The Court rejected the SEC’s claim that sales of BNB by third parties on secondary markets were actionable. The Court recognized the disagreement among district courts in the Southern District of New York about Howey’s application to sales on secondary markets. Last summer, in Ripple, Judge Torres dismissed claims based on defendant’s sales (through a market maker) on secondary markets, reasoning that in “blind bid/ask” sales, purchasers would not reasonably believe that defendants would feed proceeds back into their business. 682 F. Supp. 3d at 328-29. A few months later, in Terraform, Judge Rakoff expressly considered and rejected this reasoning in Ripple, declining “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.” 684 F. Supp. 3d at 197.

  Judge Jackson found Ripple’s rationale more persuasive and that the Terraform position was inconsistent with accepted notions that (1) tokens themselves are not securities and (2) Howey applies to the particular facts of a given offering or transaction. Binance, 2024 WL 3225974, at *19-20. As the Court explained, “[i]nsisting 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 a departure from the Howey framework that leaves the Court, the industry, and future buyers and sellers with no clear differentiating principle between tokens in the marketplace that are securities and tokens that aren’t.” Id. at *22.

• BUSD. The Court also found that BUSD (Binance’s stablecoin) was not offered or sold as an investment contract because there was no “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,” and the SEC failed to “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.” Id. at *24. The Court noted that “it may be more difficult to make the Howey showing when stablecoins are involved.” Id. at *24 n.19.
• Simple Earn and BNB Vault. As for Binance’s crypto lending programs, acknowledging that “[n]ot every ‘profit-making opportunity’ is an investment contract,” id. at *26, the Court applied Howey to the allegations regarding each program separately. The Court found that “Simple Earn” was not a securities offering because, under that program, participant’s assets earned a simple interest rate unrelated to use of the tokens. Id. The Court found plausible, however, allegations that “BNB Vault” was a securities offering, because there, the lender’s returns allegedly depended on income Binance generated based on a basket of projects. Id. at *27.
• Staking-as-a-Service. Finally, the Court concluded that the SEC had plausibly alleged that Binance offered and sold the BAM staking-as-a-service program as an investment contract, where it was marketed as an investment opportunity and non-technical investors would both rely on BAM’s technical expertise and profit from those efforts. Id.

The SEC Plausibly Alleged that Binance Must Register as an Exchange, Broker-Dealer, and Clearing Agency

The Court sustained the SEC’s Exchange Act claims to the same extent that its unregistered securities offering claims survived. In other words, the Court noted that if Binance’s offerings of BNB, BNB Vault, and staking-as-a-service were in fact investment contracts, then the Binance exchange and other services where they were offered needed to be registered. Id. at *28.

An exchange that offers both securities and non-securities cannot register. Yet the decision ostensibly places Binance’s retail exchange in that very position: offering both securities (BNB sold by Binance) and non-securities (BNB sold by non-Binance, BUSD) at the same time. The opinion never grapples with this disconnect.³

Finally, the Court questioned the SEC’s approach of filing cases against exchanges that list numerous third-party tokens as securities, noting that “the SEC fattened the complaint with thirty-eight additional pages, comprised of 157 paragraphs asserting that the defendants made at least ten other crypto assets, that had been offered and sold by their issuers as investment contracts, available on their platforms.” Id. Declining to address the merits of these allegations, the Court noted it would be “highly irregular to do so since the issuers are not parties to this action and have not had an opportunity to weigh in on the claims that the offerings satisfy the requirements of an ‘investment contract’ or security; the parties have not submitted memoranda measuring the allegations against the Howey framework; and the SEC has not yet specified which crypto assets should be brought under the umbrella of this case or why.” Id. How the Court will manage discovery requests that one would expect on the non-parties associated with these ten assets will be interesting to see.

The SEC’s Fraud Claims Survive

The SEC brought negligence-based misrepresentation claims against BAM Trading and BAM Management for allegedly misleading Binance.US customers and equity investors in BAM Management regarding Binance.US trading volume and about internal controls designed to detect and prevent so-called “wash trading.” According to the SEC, Zhao conducted wash trades on Binance.US to artificially inflate volume numbers, and this trading was not monitored, contrary to BAM Trading and BAM Management’s public statements. These claims were found to be adequately pleaded. Id. at *38-41.

The Court Rejected Defendants’ Other Challenges

Statute of Limitations. Binance argued that claims based on the BNB ICO were barred by the five-year statute of limitations for unregistered offering claims. However, the Court found that the statute does not begin to run until a defendant is present in the United States. Because it was uncontested that Binance “has been and remains outside of the United States,” the Court found that the statute had not run. Id. at *23-24.

Personal Jurisdiction. Although Zhao challenged jurisdiction, the Court found sufficient facts alleged to exercise specific personal jurisdiction over him. While recognizing that claims “must aris[e] out of or relat[e] to the defendant’s contacts with the forum” and must be alleged as to each defendant on each claim, the Court found that Zhao’s control over “both [the] high-level and the day-to-day operations” of BAM Trading, a U.S. entity, were sufficiently alleged. Id. at *30-32. For example, the Court quoted a former CEO of BAM Trading: “[W]hat became clear to me at a certain point was CZ was the CEO of BAM Trading, not me.” Id. at *31.

Extraterritoriality. The Court rejected challenges that the application of securities laws over Binance on these facts was impermissibly extraterritorial. Id. at *34-36.

Major Questions and Due Process. Like all other district courts to consider these issues, Judge Jackson rejected defendants’ arguments that the SEC’s claims were precluded the major questions doctrines or lacking due process. Id. at 41-44.

Key Takeaways

• “Ecosystem” theory rejected. The D.D.C. is the first court to opine on the SEC’s recently invented “ecosystem” theory, which posits that markets and courts can distinguish between tokens that are securities and tokens that are not based on whether there is a corresponding “ecosystem” around the token. Binance squarely rejects this argument.
• Ripple is not an outlier. The D.D.C. is the first court to apply the reasoning in Ripple to reject the SEC’s attempt to bring failure-to-register claims on secondary sales.
• Stablecoins do not neatly fit into the Howey framework.
• Staking-as-a-service programs remain risky. Notwithstanding the Court’s general skepticism of the SEC’s approach, the Binance court had no difficultly determining that staking-as-a-service programs are investment contracts.
• Crypto lending programs can be securities offerings if not structured and marketed carefully.

Sofiya Andreyeva contributed to this alert.

Footnotes

1 E.g., SEC v. Coinbase, Inc., 2024 WL 1304037, at *25 (S.D.N.Y. Mar. 27, 2024) (“Coinbase”); SEC v. Terraform Labs PTE, Ltd., 684 F. Supp. 3d 170, 193-94 (S.D.N.Y. 2023) (“Terraform”); SEC v. Ripple Labs, Inc., 682 F. Supp. 3d 308, 322-23 (S.D.N.Y. 2023) (“Ripple”).

2 E.g.¸ SEC v. Telegram Grp. Inc., 448 F. Supp. 3d 352, 379; Terraform, 684 F. Supp. 3d at 193; Ripple, 682 F. Supp. 3d at 323.

3 This inconsistency was addressed in SEC Commissioner Hester M. Peirce and Mark T. Uyeda’s statement on the Shapeshift AG enforcement action. Hester M. Peirce and Mark T. Uyeda, On Today’s Episode of As the Crypto World Turns: Statement on ShapeShift AG, Securities and Exchange Commission (March 6, 2024), https://www.sec.gov/newsroom/speeches-statements/peirce-uyeda-statement-crypto-world-turns-03-06-24.