After the collapse of FTX late last year, we in the risk management space waited on pins and needles for the SEC’s next big move. And the agency didn’t fail us. Only one day after the SEC sued Binance and its founder Changpeng Zhao, the agency sued Coinbase, both cryptocurrency exchange platforms. While these allegations didn’t make our jaws drop like the FTX nosedive, this particular crypto crash furrowed our brows. As the SEC cracks down on crypto, let’s review the agency’s lawsuits against Coinbase and Binance. How did we get here, after all? Plus, let’s look into the relevance of these incidents to risk management in digital asset companies and the implications for management liability insurance.
Background on SEC’s Lawsuit against Binance and Coinbase
As school-age children file in one by one for the lunchline, cryptocurrency exchanges seem to be doing the same. First, FTX collapsed in November of 2022, dragging its founder Sam Bankman-Fried (SBF), down in the messiest ways. Strangely enough, before the SEC began raining digital asset lawsuits, Binance and FTX were fierce crypto trading rivals. Naturally, these dynamics changed swiftly, bumping Binance to the top — albeit a short-lived reign. Here are their stories.
SEC Sues Binance and Founder Changpeng Zhao
Changpeng Zhao, a successful investor and software engineer, founded Binance in 2017. Within only a few months, the crypto-to-crypto trading platform became one of the most significant exchanges in the world, listing more than 360 cryptocurrencies globally. However, in 2019, Binance was banned from the US because of regulatory concerns.
Fast forward to 2023, when the SEC and Binance continued their legal squabbles. At this point, though, Binance had created Binance.US to sidestep the heap of regulatory issues here in the states. Although Binance had been attempting to negotiate a settlement with regulators, the SEC finally had enough and brought a case against the crypto giant.
In short, the SEC alleged that Binance violated US securities laws, totaling 13 charges. The many complaints include:
- Operating unregistered exchanges.
- Misrepresenting investor protections on Binance.US.
- Engaging in the unregistered offer and sale of securities.
If you think these charges sound steep, they are.
What does Binance have to say about these allegations? In a Monday blog post, Binance expressed dissatisfaction with the SEC. The company remarked that the case was a “misguided and conscious refusal to provide much-needed clarity and guidance to the digital asset industry.” From our perspective, Binance is ready to fight. Now, let’s review how Coinbase ties into this tangled crypto web.
SEC Sues Coinbase
In 2012, Brian Armstrong and Fred Ehrsam founded Coinbase when a bitcoin was worth only $6, and very few people were familiar with digital money. The cryptocurrency exchange became massive in two years, employing more than 1,000 people globally. The company has experienced extreme highs and lows since its founding; however, as the current CEO, Armstrong consistently rallied its troops.
Although crypto is a sprawling ecosystem, Coinbase has faced plummeting stocks and a slew of SEC litigation. Here’s the deal, the SEC sued Coinbase, claiming it operated as an unregistered exchange and broker. The agency also alleged that 13 assets on Coinbase’s platform were considered crypto asset securities.
Coinbase responded to the complaint by saying that it “has for years defied the regulatory structures and evaded the disclosure requirements” of US securities law. Additionally, Coinbase chief legal officer Paul Grewal discussed the situation in detail with CNBC. Grewal stated, “The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation. In the meantime, we’ll continue to operate our business as usual.”
Risk Management and Controls for Digital Asset Exchanges
Unsurprisingly, neither Binance nor Coinbase is thrilled about their situation as the SEO cracks down on crypto. This litigation doesn’t come as a shock for many involved in the finance space. For starters, the SEC believes (most) crypto tokens issued by cryptocurrency exchanges must be treated as securities under federal law. But this concept requires explaining.
Let’s back up; traditional brokerage firms are members of the Securities Investor Protection Corp. (SIPC). Conversely, cryptocurrency exchanges are not SIPC members. As a result, investors with crypto assets could potentially lose their funds as unsecured creditors when those assets become blended on a custodial cryptocurrency exchange.
Messy? Yes, indeed. Sometimes the crypto complexity or “mess” is too much for regulators to stomach — notably SEC Chair Gary Gensler.
As you may know, many believe that Gensler has had crypto in his sights for years, making the recent double-barrel assault unsurprising. Strangely enough, Gensler’s affairs curiously intertwined with crypto on a handful of occasions, including professional and personal ties to SBF and an attempt to serve as an advisor for Binance. So, what’s really going on?
The short answer is that we’re still determining, though water cooler chatter presents various perspectives. We know that the SEC is changing its approach to crypto, and that’s not entirely a bad thing. However, digital asset leaders must seek clarity in current regulations and proactively engage with them to establish a fine-tuned crypto framework. Additionally, as crypto laws change, risk management for the space will also follow suit.
Impact on Management Liability Insurance
Through the risk management lens, our team of experts expects a ripple effect in the management liability landscape. Along with changes in underwriting practices and premium costs, we may also experience regulatory changes.
Matt McKenna of Scale Underwriting offers his perspective, “Crypto companies won’t be alone in monitoring the development of these cases: underwriters of management liability insurance for crypto companies will be watching with bated breath.
Both the Binance and Coinbase suits have the potential to provide landmark precedents for the interpretation of securities law and dictate how the SEC chooses to wield its regulatory powers in the future.
These factors directly impact both the viability of certain crypto strategies and the likelihood and potential severity of D&O claims driven by legal action from shareholders, consumers, and regulators, so it’s not an exaggeration to say that the future of D&O coverage and premiums for crypto exchanges hangs in the balance.
It’s also safe to say Coinbase’s D&O premiums will be going up at renewal…”
As the SEC cracks down on crypto, digital asset companies must reconsider the importance of comprehensive insurance coverage to protect against regulatory actions and lawsuits. Otherwise, the “lunch line” mentioned earlier will likely only become longer.
Broader Implications for Risk Management in Digital Asset Companies
The recent lawsuit from the SEC against giants in the digital asset industry like Binance and Coinbase signals a significant shift in the risk landscape. Let’s look at this concept through a risk management lens. Potential Ripple Effects on Risk Management Practices: For starters, regulatory action of this magnitude often leads to increased scrutiny and could potentially trigger a domino effect, causing other regulatory bodies globally to follow suit.
This scenario could redefine risk management practices across the industry, prompting crypto exchanges and digital asset companies to reassess their operational, strategic, and compliance risk exposures. Companies may have to intensify their focus on governance and internal controls, enhancing their risk assessment capabilities to identify and mitigate potential regulatory infractions proactively. Ways to deal with risk will become a crucial consideration in this evolving landscape.
Potential Ripple Effects on Risk Management Practices
For starters, regulatory action of this magnitude often leads to increased scrutiny and could potentially trigger a domino effect, causing other regulatory bodies globally to follow suit.
This scenario could redefine risk management practices across the industry, prompting crypto exchanges and digital asset companies to reassess their operational, strategic, and compliance risk exposures. Companies may have to intensify their focus on governance and internal controls, enhancing their risk assessment capabilities to identify and mitigate potential regulatory infractions proactively.
Need for Clearer Regulatory Guidance
The cryptocurrency industry has long existed in a regulatory gray area, with laws and regulations struggling to keep pace with technological advancements. This lawsuit underlines the urgent need for clearer, more comprehensive regulatory guidance for digital asset companies. Regulatory ambiguity not only increases compliance risk but also hampers the growth potential of these businesses.
A well-defined, universal regulatory framework would not only streamline compliance but also enhance investor trust in digital assets. Until such clarity emerges, digital asset companies should engage in regular dialogue with regulators and legal advisors to ensure they are prepared for potential regulatory changes.
Role of Self-Regulatory Efforts
In the absence of comprehensive regulatory oversight, the role of self-regulatory efforts becomes paramount. Crypto exchanges and digital asset companies should consider establishing industry standards and best practices, possibly through a self-regulatory organization.
This approach could foster greater transparency, consistency, and accountability across the industry, effectively addressing regulatory concerns and mitigating risk exposure. It would also demonstrate to regulators and the public that the industry is committed to operating with integrity and safeguarding the interests of its participants.
However, these self-regulatory initiatives should complement, not replace, the need for effective regulatory oversight from governmental bodies. The ideal scenario is a robust regulatory environment supported by proactive self-regulation within the industry.
Understanding the details of what coverage your digital assets company needs can be confusing. Founder Shield specializes in knowing the risks digital assets companies face to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.