Binance refuted the SEC lawsuit point by point. How did the SEC respond?
Original source: Protos authorized by Wu Shuo to compile
Original compilation: GaryMa Wu Shuo Blockchain
On June 5, 2023, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against Binance and its CEO Changpeng Zhao (CZ) with a multi-billion-dollar fine. This week, the SEC responded to Binance’s formal motion to dismiss, restating and clarifying its claims.
The SEC’s lawsuit accuses Binance of illegally selling two of its tokens, BNB and BUSD, to numerous U.S. investors. That financing, combined with millions more earned from selling other unregistered securities, gave it at least $11.6 billion in revenue.
In explaining its reasoning, the SEC focused on the Howey test, which is commonly used by U.S. courts to determine whether someone is illegally selling crypto assets. The Howey test refers to the 1946 U.S. Supreme Court decision SEC v. W.J. Howey Co. In the SECs victory, the Supreme Court defined an investment contract as a transaction that meets the following four conditions:
Use money to invest,
into a common enterprise,
Have reasonable profit expectations,
Produced by the efforts of others.
Part of the SECs argument focused on the courts flexible interpretation of the Howey test in previous cases involving alleged securities. For example, it cites three court decisions that money can take many forms, not just fiat currencies such as the U.S. dollar. For example, goods and services for which someone is willing to pay a monetary value can be exchanged in kind for securities.
Binance says it is not listing securities despite lawsuit
The SEC used decades of legal precedent to refute Binance’s claims that it does not list securities. It clarifies that investment contracts are a purposeful umbrella term that encompasses a broad range of instruments used by sponsors to facilitate capital raising.
In fact, the SEC summarized decades of court rulings in support of its view: “Congress defined securities broadly to embody a flexible rather than a static principle, one capable of accommodating the myriad and diverse sources of money that seek to profit from the promise of others. The court has found that a variety of novel or unique investment vehicles are investment contracts, including those involving orange groves, animal breeding schemes, cattle embryos, mobile phones, businesses that exist only on the Internet, and cryptoassets.”
The SEC claimed that the price of the BNB token could change based on Binance’s efforts and luck, making it a business with “vertical commonality.” It rejected Binance’s claim that BNB’s long-term performance is ultimately irrelevant to Binance’s efforts.
Binance lawsuit involves vertical commonality
Vertical commonality exists where the fate of token holders aligns with the fate of the token leader. BNBs vertical businesses include token holders keeping the price high enough so that Binance executives can pay for the development of the digital asset ecosystem, attracting new users through Binance.com, promoting BNB through Binances platform and marketing channels, and providing BNB blockchain funding development.
In this way, all efforts by Binance executives are fully aligned with the financial interests of retail BNB token holders. In fact, Binance executives themselves are the largest BNB token holders. Therefore, all BNB token holders share vertical commonality with Binance executives.
The SEC cited the BitConnect case, in which the court ruled that BitConnects platform itself is a joint enterprise. In BitConnect, members have vertical commonality; the value of BitConnect Token (BCC) depends on the collaborative efforts of BCC token holders and promoters.
Pre-orders on Kickstarter are not securities
To clarify that investment contracts do not cover all financial provision, the SEC cited a case in which profits must be consistent with ordinary usage, in the form of financial returns and not in the form of consumption. This rules out most Kickstarter campaigns, considering whether benefits received for contributions to fundraising count as securities. In other words, simply pre-ordering a product does not create a situation where there is a reasonable expectation of profit.
Of course, this may not preclude situations where a certain fundraising implies that the benefits can be resold to others at a higher price. At that point, a simple reservation may turn into an unregistered securities offering.
The element of “financial return rather than consumption” also became important in the LBRY case, where tokens could be used to acquire rights to publish digital files on the LBRY platform, which seemed innocuous. Unfortunately, its supporters further promoted the LBRY Token as a way to make profits, and these marketing claims turned the LBRY Token into an unregistered security.
The Howey test does not require a written contract
Binance asked the court to consider the idea that the BNB purchase did not involve any investment contract at all. It said a strict interpretation of the Howey test would require contractual arrangements whereby the buyer must have a contractual right in a joint enterprise to share in future profits.
The SEC disputed that claim, saying the Howey test did not require any written contract. It simply requires the existence of a contract, transaction or scheme that meets the conditions of the Howey test.
The SEC also rejected Binance’s argument that transactions on the Binance.com platform did not occur on U.S. soil and were therefore not subject to U.S. securities laws. It claimed that Binance sold many securities to many U.S. investors.
It cites Changpeng Zhao’s “Tai Chi Plan,” first exposed by Forbes’ Michael del Castillo and Jason Brett, which allowed Binance .com secretly serves U.S. customers by using BAM Trading as a deceptive agent. The second CEO of BAM Trading resigned because, according to the CEO, CZ is the CEO of BAM Trading, not me.
In conclusion, the SEC has issued a formal response to Binance’s request to dismiss its multi-billion dollar lawsuit. The SEC pointed out weaknesses in Binance’s defense and pointed to Binance’s efforts to distort the meaning of the Howey test.
