The worst scam of all: how Binance got away with a slap-on-the-wrist

November’s settlement between the cryptocurrency exchange Binance, its founder and former CEO, Changpeng Zhao and the Department of Justice is already starting to fray.

The government trumpeted the $4.3 billion penalty and Zhao’s forced resignation as CEO as “historic penalties” at the time. But considering that Binance knowingly routed transactions on behalf of ISIS and Hamas, received millions of dollars of ransomware proceeds, and facilitated every other crypto-related fraud and scam known to man, it is fair to ask why the company was allowed to survive at all.

The answer lies in a less heralded component of the settlement — the imposition of an independent compliance monitor for five years as part of a parallel action by the Treasury Department’s Financial Crimes Enforcement Network.

The monitorship will make Binance an open book to the U.S. government. The monitor will have complete access to company records, as well as access to current and former employees, and can provide information to the government upon request, no questions asked. The monitor will also review all transactions that occurred by or through Binance between 2018 and 2022 and file suspicious activity reports for all transactions that should have previously been flagged.

For the Justice Department, this unprecedented access, and the value of the information it will provide, was worth keeping Binance afloat. But for this bet to pay off, there must be dozens of successful prosecutions of terrorists, drug dealers, pedophiles, and fraudsters. Let’s hope this happens.

The Commodity Futures Trading Commission (CFTC) also took part in the settlement. That agency had sued Binance and Zhao last March for multiple violations of the Commodity Exchange Act, including operating an illegal derivatives exchange in the U.S. and failing to implement know-your-customer and anti-money laundering procedures. For these sins, Binance will pay a $1.35 billion penalty; stop doing business with several quantitative trading firms that do not meet know-your-customer requirements; and implement basic corporate governance structures, including a Board of Directors with independent members, a compliance committee, and an audit committee.

Apparently pleased with the terms of this settlement, CFTC Chair Rostin Behnam, standing alongside Attorney General Merrick Garland and Treasury Secretary Janet Yellen, crowed: “The resolution of the [CFTC’s lawsuit] against Binance and Zhao — within just eight months of its filing — solidifies the CFTC’s reputation as the proven leader in the civil enforcement space when it comes to digital assets.”

Behnam’s comment was a not-so-subtle dig at the SEC, which was notably absent from the settlement announcement. The SEC sued Binance and Zhao last June for operating unregistered national securities exchanges, broker-dealers, and clearing agencies, as well as for conducting an unregistered offer and sale of securities in the form of BNB — Binance’s exchange token — and the BUSD stablecoin.

SEC Chair Gary Gensler has repeatedly noted that crypto exchanges currently perform multiple functions that must be separated under traditional securities regulation. They are frequently the broker, the exchange, the clearing agency, and the custodian. Combining these functions creates enormous conflicts of interest, as we saw with FTX and Alameda Research.

The SEC has brought similar charges against the crypto exchanges Coinbase and Kraken. In response, the industry is waging a take-no-prisoners legal and public relations campaign to convince the courts, Congress, and anyone else who will listen that they only list and trade commodities. This strategy is understandable, given the existential risk that cryptocurrency exchanges are facing.

If the courts determine that they are listing securities, they will be forced to separate the multiple functions they currently perform, and their business may no longer be viable. This is why Binance is refusing to settle with the SEC or register BNB or BUSD as a security.

While Binance and other crypto exchanges may now be complying with the same anti-money-laundering and sanctions compliance laws as traditional financial institutions, it is deeply troubling that they refuse to implement any of the basic prudential safeguards that are required at traditional securities exchanges and broker-dealers. These include registration and disclosure requirements; segregation of customer assets; listing standards; best execution requirements; recordkeeping and post-trade reporting; net capital requirements; and public audits, to name a few.

If Binance truly wanted to demonstrate its commitment to being a good corporate citizen, a public audit would be a good place to start. Unfortunately, the company has not been receptive to such suggestions in the past.

In late 2022, Binance released a “proof-of-reserves” from the global audit firm Mazars that raised more questions than it answered. Shortly thereafter, Zhao appeared on CNBC where he said, among other questionable things, that the big four audit firms “don’t even know how to audit crypto exchanges.”

The next day, Mazars deleted all proof-of-reserves for crypto exchanges from its website and announced it was suspending all work with crypto firms. The whole episode prompted the Public Company Accounting Oversight Board’s Office of the Investor Advocate and the SEC’s Office of Investor Education to release separate bulletins warning investors that proof-of-reserves are not equivalent to financial statement audits and lack important investor protections.

At the press conference announcing the Binance settlement, Attorney General Garland said: “The message here should be clear: Using new technology to break the law does not make you a disruptor, it makes you a criminal.” Unfortunately, Binance did not receive the message.

Speaking at a conference last month, Binance’s new CEO, Richard Teng, refused to disclose the location of the company’s global headquarters and asked his questioner why they felt “so entitled to those answers.” And according to the Wall Street Journal, Zhao’s partner and the mother of three of his children, Yi He, “has wielded her influence over the selection of Binance’s new majority-independent board.”

Maybe the “proven leader” in crypto regulation is the one agency that refuses to settle with unrepentant defendants.

Lee Reiners is a lecturing fellow at Duke University’s Financial Economics Center.