Prosecutors demanded US hedge funds disclose ties with Binance

Investment companies received subpoenas demanding that they hand over their correspondence with the exchange to prosecutors

09.01.2023 - 07:05

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9 min

Federal prosecutors are examining American hedge funds’ dealings with cryptocurrency exchange Binance as part of a long-running investigation into potential violations of money-laundering rules at one of the world’s leading crypto companies.

In subpoenas sent in recent months, the U.S. attorney’s office for the Western District of Washington in Seattle directed investment firms to hand over records of their communications with Binance, according to two people, each of whom reviewed one of the subpoenas and spoke on the condition of anonymity to discuss the confidential matter.

The subpoenas, which have not been previously reported, do not necessarily mean authorities are likely to bring charges, legal experts said. Prosecutors are discussing a possible settlement with Binance, and they are weighing whether they have enough evidence to bring indictments against the company, Reuters reported this past month.

In an interview, Binance chief strategy officer Patrick Hillmann said the company is talking to “virtually every regulator across the globe on a daily basis,” but he declined to comment on the status of any U.S. investigation. Joshua Stueve, a Justice Department spokesman, also declined to comment.

The federal probe into Binance is unfolding at a time of deep uncertainty for the crypto industry. The implosion of FTX, a popular trading platform that authorities say was a years-long scheme to defraud investors, has fueled concerns about the freewheeling, largely unregulated online marketplaces where digital assets are bought and sold.

Crypto company failures are becoming more common and interconnected. Celsius, a cryptocurrency platform that collapsed in July, lent heavily to FTX affiliate Alameda Research, which went bankrupt five months later. Binance’s founder and chief executive, Changpeng Zhao, was an early FTX backer, and his decision to sell off a large chunk of the company’s digital tokens helped spark a customer panic and run on bank deposits that FTX could not meet.

Binance’s Hillmann acknowledged that the company had shortcomings in its approach to regulatory compliance in the first few years of its rapid expansion. But more recently, he said, Binance has heavily invested in compliance programs, worked closely with law enforcement and developed new technology for catching criminals on its platform.

“Over the last two years, the company has completely changed its posture,” Hillmann said. “Now that we have those resources, we are easily one of the most proactive parties to identify, freeze and get back funds” that were laundered, he said, adding that he believes overall incidents of criminal activity in crypto are going down.

A report last year by data provider Chainalysis showed that cryptocurrency crime hit an all-time high in 2021, with illicit addresses receiving $14 billion, up from $4.6 billion in 2017, the year Binance was founded. Over the same time period, as crypto adoption boomed, the portion of overall transactions that were illicit shrank considerably, Chainalysis found.

Based on his experience with these types of cases, Ghose said he believes that prosecutors are examining whether Binance violated the Bank Secrecy Act, which requires financial institutions to verify the identities of their customers and report suspicious activity that might be a sign of money laundering, tax evasion or other crimes.

The recent subpoenas could mean prosecutors are scrutinizing Binance’s relationships with U.S. investors, said Ghose, who cautioned that he does not have firsthand knowledge of the Binance investigation.

“The basis of those charges is whether there are U.S. customers,” he said. “If there are U.S. customers, there are charges for avoiding the money laundering requirements.”

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As part of its response to growing regulatory interest, Binance has embarked on a Washington charm offensive. The company this fall formed a global advisory board chaired by Max Baucus, the former Democratic senator from Montana and Obama administration ambassador to China; the board also includes former top Obama adviser David Plouffe. Last month, the company joined the Chamber of Digital Commerce, a Washington-based crypto lobbying association.

Baucus and Plouffe did not respond to requests for comment.

Meanwhile, Binance.US, a Palo Alto, Calif.-based trading platform owned by Zhao, hired two outside lobbying firms and launched a political action committee, allowing it to raise funds from its own ranks and distribute the proceeds as campaign contributions, federal records show. It also hired former FBI agent BJ Kang, who directed high-profile probes of insider trading on Wall Street, as its first head of investigations.

A spokeswoman for Binance.US said the company has no current plans to make any PAC donations.

Zhao “is trying to do the right thing” by meeting with government leaders, advocating for regulation and offering to bail out other crypto firms facing hardship, said Carlos Gomez, chief investment officer at Belobaba Crypto Asset Fund, which invests on the Binance platform. “He is trying to position himself as a trustworthy person.”

But there are signs that Zhao, a crypto superstar with 8 million Twitter followers, is losing the trust of some customers. Over one 24-hour period in December, investors withdrew $3 billion more from Binance than they deposited, the most net withdrawals in a single day from the exchange since June, according to crypto analytics firm Nansen.

“People are getting scared,” said Carol Alexander, a crypto expert and finance professor at the University of Sussex. “The whales,” or professional traders, “are starting to move out of Binance as regulatory pressure mounts,” she said.

Zhao has said Binance has more than enough reserves to back all user deposits, a fact he said was substantiated by an independent auditor’s review this past month. “Every user could withdraw their assets from Binance and the company will continue to function as normal,” a Binance spokesman said in an email.

Nine days after releasing its assessment, however, Paris-based auditing firm Mazars said in a statement that it was suspending work with crypto companies “due to concerns regarding the way these reports are understood by the public.” Although Binance had referred to its work with Mazars as a “third-party audit,” the auditor said its assessment does not constitute a legally binding assurance or audit opinion.

“Providing an audit opinion or assurance on its review of Binance reserves would significantly increase Mazars’ risk of being sued if it later turns out that Binance doesn’t have enough money to cover customer assets,” said Vivian Fang, an accounting professor at the University of Minnesota.

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One challenge facing U.S. prosecutors will be proving that Binance is even subject to American laws.

Zhao founded Binance in China, but he later moved the company to Japan and then Malta. Since 2020, he has claimed the business has no singular headquarters. Binance Holding Ltd., a shell company that operates several Binance subsidiaries, is based in the Cayman Islands, but Zhao is also connected to dozens of business units around the world, including in the British Virgin Islands, Singapore, Ireland, Liechtenstein and the Seychelles, according to Reuters.

Industry experts attribute part of Binance’s success to its marketing of risky financial products, such as crypto derivatives, which let users place high-leverage bets on speculative digital tokens such as dogecoin. Such products are generally prohibited in the United States, and since 2019, Binance has barred Americans from accessing its main offshore exchange where derivatives can be bought and sold. (Binance.US, the American exchange owned by Zhao, offers a more limited menu of investment options to U.S. residents and says it operates independently from the main Binance exchange.)

Binance’s website lists the United States as one of its “restricted jurisdictions,” along with Cuba, Crimea, Iran, Syria and North Korea.

Some Americans claim they can bypass Binance’s restrictions. In Reddit discussion threads and YouTube videos, crypto traders have shared tips for how to access the site from the United States. One content creator known as Full Value Dan posted a tutorial on “How I Beat Binance KYC” — shorthand for “know your customer” verification laws — which included setting up a shell business in Taiwan and obtaining residency documents from that country.

On the video, Full Value Dan said he used those documents to get approved for trading on Binance despite being a U.S. citizen. He did not respond to a request for comment.

Hillmann, the Binance executive, said the company has tested this and other supposed loopholes for accessing its trading platform and found that they do not work. “There is no ability for any user today in the U.S. to be able to access Binance.com” without committing fraud, Hillmann said.

In interviews with The Washington Post, several large crypto-focused hedge funds in the United States said they either do not use Binance or only have accounts on the more limited Binance.US trading platform. Some said they preferred Coinbase, a publicly traded crypto exchange that provides quarterly financial statements to investors.

The CEO of one New York investment firm, which manages $2.5 billion in assets, said his company trades on the Binance offshore exchange through corporate entities it owns outside the United States. While Binance strictly prohibits U.S. citizens from trading, “corporations and citizens are very different,” said this executive, who spoke on the condition of anonymity because he worried about raising the profile of his firm with regulators.

Binance has said it complies with all U.S. laws and assists law enforcement agencies with their investigations. But it has not registered Binance.com, its primary offshore exchange, with the Treasury Department’s Financial Crimes Enforcement Network, or FinCEN, a baseline requirement for complying with the Bank Secrecy Act, records show.

Because Binance.com does not operate in the United States, the company does not believe it needs to register with the Treasury Department, Hillmann said. A spokesperson for FinCEN declined to comment.

That defense has not worked for others. Last year, three co-founders of BitMEX, another offshore crypto exchange, pleaded guilty to “willful” failure to verify the identities of its customers. According to the indictment, BitMEX had courted thousands of American investors, despite billing itself as a Seychelles-based exchange with no American users.

BitMEX agreed to pay as much as $100 million to settle the charges, and the co-founders were ordered to pay $10 million each. Arthur Hayes, who stepped down from his role as chief executive after the charges were filed, was sentenced to six months of house arrest and two years of probation.

This material is taken from the website washingtonpost.com.

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