CFTC Enforcement Highlights Potential Compliance Risks For Derivatives Trading Crypto Exchanges | Proskauer – Blockchain and the Law
Binance is the latest major crypto industry player to be sued by a US regulator. On March 27, 2023, the CFTC announced that it had filed a civil enforcement action against Binance Holdings Limited (and related entities) (collectively, “Binance”), its CEO, Changpeng Zhao (“Zhao”), and its former chief executive. compliance officer, Samuel Lim (“Lim”), for violations of the Commodity Exchange Act and CFTC regulations. (CFTC v. Zhao, no. 23-01887 (ND ill. submitted 27 March 2023)). The CFTC alleges, among other things, that Binance allowed US customers to use its centralized digital asset trading platform without Binance first properly registering with the CFTC and also allegedly failed to implement an effective anti-money laundering (“AML”) program required under applicable law. The complaint says that Binance “has never been registered with the CFTC in any way.” The CFTC is seeking disgorgement, civil monetary penalties, permanent trading and registration bans, and a permanent injunction against further violations of the Commodity Exchange Act and CFTC regulations.
Binance is a crypto-asset exchange that, according to the CFTC, offers trading of digital assets and related derivatives, among other financial products and services, to over 100 million customers worldwide, including in the United States. In response to the CFTC’s complaint, Binance CEO Zhao responded in a blog post that Binance refutes the allegations and lamented the filing as “an unexpected and disappointing civil complaint, despite our cooperation with the CFTC for over two years.”
The Commodity Exchange Act and CFTC regulations require all exchange trading platforms that are located in the United States or that serve US customers to be registered with the CFTC as a swap execution facility or designated contract market. Anyone holding US client funds to margin commodity derivative transactions is required to register with the CFTC as a futures commission merchant (“FCM”).[1] The CFTC notes that FCMs are “a critical component of the US financial system” and must comply with a number of regulatory requirements, including know-your-customer, AML and customer protection rules.
Note that the CFTC states in the complaint that certain digital assets, such as bitcoin, ether, litecoin, and certain stablecoins (ie, tether (USDT) and Binance USD (BUSD)), meet the definition of “commodity” under commodity. Exchange Act. Interestingly, such statements in the complaint perhaps indicate a quiet battle over which financial regulator, the CFTC or the SEC, should be the lead regulator over certain crypto-asset transactions. SEC Chairman Gary Gensler has previously stated that crypto exchanges and DeFi platforms “likely trade in securities” as “many of the tokens traded on these platforms may well meet the definition of ‘securities.'” Gensler recently reiterated that while Bitcoin is not a security , most other cryptocurrencies and digital assets are likely securities and therefore subject to the jurisdiction of the SEC (and not the jurisdiction of the CFTC). Gensler has also suggested that both agencies should continue to work together on how best to register and regulate platforms “where trading securities and non-securities are intertwined.”
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFTC has jurisdiction over all “swaps,” which is defined to include any option, forward or swap on a commodity. The SEC has jurisdiction over “security-based swaps” (swaps based on a single stock, loan or narrow-based security index) and the CFTC and SEC have joint jurisdiction over “mixed swaps” (a swap that meets the definition of both “swap” and “security-based Exchange”). Whether the other coins mentioned in the CFTC’s complaint against Binance (ether, litecoin, tether and Binance USD) fall under the definition of “commodity” and are therefore properly subject to the CFTC’s jurisdiction, or meet the definition of “security” and are subject to the SEC’s jurisdiction; has not yet been finally decided.
We will be following this latest enforcement closely. In addition to affecting market liquidity in the cryptoasset space (especially given the recent bank failures in the US), the CFTC action could have other consequences, including providing some clarity on how certain US regulations apply to crypto entities operating globally and spurring other exchanges to to review legal compliance controls relating to derivatives trading.
[1] As outlined in the complaint, a “futures commission merchant” (“FCM”) is a person, association, partnership, corporation or trust that (i) is engaged in soliciting or accepting orders for regulated transactions, including futures, swaps, commodity options, or retail commodity transactions, or (ii) acts as a counterparty to retail commodity transactions; and which, in connection with any of these activities, “accepts money, securities or property (or gives credit in lieu thereof) to margin, guarantee or secure any trade or contract resulting from or likely to result therefrom .” Commodity Exchange Act, § la(28)(A), 7 USC § la(28)(A).
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