(Bloomberg) -- US regulators are investigating whether Binance Holdings Ltd. broke securities rules by selling digital tokens just as the crypto exchange was getting off the ground five years ago, according to people familiar with the matter.
Most Read from Bloomberg
The Securities and Exchange Commission’s review pries into the firm’s origins and those of its BNB token, which is now the world’s fifth-biggest. Investigators are examining if the 2017 initial coin offering amounted to the sale of a security that should have been registered with the agency, said the people who were granted anonymity to discuss the confidential probe.
Scrutiny of BNB’s beginnings may be a troubling development for Binance as it faces multiple investigations in Washington. The SEC has brought dozens of enforcement actions over ICOs, which involve issuing virtual coins to raise money. BNB has been a feature of Binance’s expansive crypto empire
In a statement, Binance said “it would not be appropriate for us to comment on our ongoing conversations with regulators, which include education, assistance, and voluntary responses to information requests.” The company added that it works with authorities and “we will continue to meet all requirements set by regulators.”
The SEC declined to comment.
A virtual currency may fall under the SEC’s remit if investors buy it to fund a company or project with the intention of profiting from those efforts. That determination is based on a 1946 US Supreme Court decision defining investment contracts.
Binance, which runs the world’s biggest exchange and says it’s not domiciled in any one country but has affiliates scattered across the globe, has emerged as a focal point for American investigators seeking to rein in the crypto industry. Bloomberg News has previously reported it faces investigations from the Justice Department, the Commodity Futures Trading Commission and the Internal Revenue Service.
Ahead of BNB’s launch in 2017, Binance laid out its plans in a white paper. The document said its circulation would be limited to 200 million with half of the tokens being sold through the ICO, which took place on multiple platforms throughout the world. Another 80 million would be reserved for Binance’s founding team, which includes its billionaire chief executive officer, Changpeng Zhao.
In the white paper, which was reviewed by Bloomberg, Binance said as much as 85% of the funds raised in the ICO were to be used to build and market Binance’s global exchange. It made no mention of restrictions on who could participate.
In order to entice investors to BNB, Binance has offered lower fees for traders paying with the token. It’s also paid many of its contractors in the currency, including at least one US resident who said said he purchased BNB during the ICO -- a detail that could be key for the SEC asserting jurisdiction in any case it might bring.
An SEC enforcement investigation may not lead to the regulator suing a firm or individuals. The probe involving BNB is likely months away from any conclusion, one of the people familiar with the matter said.
Beyond BNB, the SEC is also probing possible trading abuses by Binance insiders and whether Binance.US, an American affiliate formed in 2019, is appropriately hived off from its global counterpart, one of the people said.
Another person with direct knowledge of the review said the SEC is also looking at market-making companies tied to Zhao, who is widely known as CZ. The SEC has expressed interest in Zhao’s ownership stakes of market makers on Binance.US and whether the exchange has conducted broker-dealer activities, the person said.
Binance emphasized that Binance.com and Binance.US “are separate entities,” with the former only for non-US users. “Binance.US is a separate US-focused trading platform that services US users by offering products and services that are compliant with US federal and state regulations,” the firm said.
In a separate statement, Binance.US said it was “committed to upholding the highest standards of compliance.”
Amid crypto’s meteoric rise during the Covid-19 pandemic, BNB has surged in value. The coin is currently valued around $300 and has a market capitalization of about $48.5 billion. It’s also been an integral part of Binance’s ever-expanding crypto ecosystem, which now includes everything from digital wallets to its own blockchain.
Recently, as part of a broader rebranding of its blockchain, Binance switched BNB’s full name to Build and Build from Binance Coin. The company said it made the changes based on feedback from users about “the need to further solidify the decentralized nature of the chain and reinforce the community’s governance over the chain.”
The firm also backed away from plans laid out in the ICO’s white paper to spend 20% of the exchange’s profits every quarter to buy back BNB. Zhao in a 2020 blog post said the change was made in response to legal advice “indicating the potential for being misunderstood as a security” in some regions.
A finding that the BNB is a security could put Binance in a similar position as Ripple Labs Inc., which is locked in a bitter court battle with the SEC after the regulator sued the firm and two of its executives in December 2020 for allegedly breaking rules in selling a crypto token known as XRP. Ripple argues the token functions as a medium of exchange for virtual currency rather than a security, and that the SEC’s legal theory is flawed.
Since taking over in April 2021, SEC Chair Gary Gensler has said that virtually all ICOs are securities and should be regulated by his agency.
Most Read from Bloomberg Businessweek
©2022 Bloomberg L.P.