Former CFTC Chair Massad on CFTC Lawsuit Against Binance: It's a 'Big Deal'

We've heard that the CFTC is alleging Binance offered unregistered crypto derivatives products and directed us customers to evade compliance controls through the use of VPN S. They are suing Binance. And one thing Emily, I guess you want to emphasize is that this is a big deal. This is a big deal. Yeah, I think that's sort of the main point here is that, you know, the CDC going after Binance, first of all, this may just be the beginning. So the C FTC may just be the first one. We could see the SEC, we could see the DOJ but Binance is the largest Cryptocurrency exchange in the world and we've known that us regulators have been eyeing it for a while. And I think the reason why this might not seem as big a deal as it actually is, is because there's been so many regulatory actions recently. It seems like every day, you know, the SCC is going after another player. But yeah, I just want to emphasize this is a really big deal. Yeah. And to dive into the details further, we've got uh who's our next guest? Yes. Uh former CFTC chair and Harvard Kennedy School research fellow and Digital Assets Policy project director, Timothy Massad, who is very well positioned to talk about this. Hi, Tim. Welcome back to the show. Good morning. Um, ok, I don't. Yeah, great to have you back. So there's a lot going on here. Um, ok, let's just start with kind of what we were just talking about. What does this mean? What are the implications of this? Where do you think this is going, you know, we have CF DC going after finance largest Cryptocurrency exchange in the world. Quite possibly, we'll see other regulatory agencies follow. Just can you just break this down for us? Like what does this mean? What do you see, what do you think is going to happen here? Well, I do, I agree with you that this is a big deal and it's a very powerful complaint uh particularly given the level of detail in the allegations. I think this reflects the overall view of our financial regulators that this is an industry which has not complied with the law in many respects. And as a result, investor protection is very, very weak. You have to also remember there's, there's kind of a philosophical gulf I think between many people in the crypto industry who believe in the value proposition of crypto, who believe it can be transformative and who look at the existing laws and think they don't really quite work for crypto. We need a new set of laws. And frankly, a lot of people in the government who are skeptical about that value proposition, who look at what's going on and see a lot of scams and fraud and lack of investor protection, who recall how financial innovation in other areas in other, in other past times has led to crises. And so they take the view, look, the existing laws need to be enforced. You don't get exceptions and you know, it takes a long time to put together an enforcement action like this. So while we have seen a spate of things recently, I think we should recognize that these things have probably been, you know, in the in the works for quite a long time, particularly the CFTC action. Again, given that level of detail that's in the allegations, you mentioned the level of detail, what from the FCFTC complaint really stuck out to you. Well, look, this is not simply a complaint that says this is an offshore platform which is trading contracts, futures contracts, which in the US can only be traded on a registered exchange. And therefore, you know, you should have had procedures to block access by us persons or you, you know, fail to uh have those procedures or failed to adequately enforce them. This complaint basically says that Binance and Zhao himself deliberately and systematically cultivated us business, helped us persons get around those restrictions and even did things internally to try to hide how much us business they were doing, if you read the complaint, there is so much detail to it, it suggests that they did have some uh information from people inside. Um And so that's what I mean by the level of detail, it's really quite striking. Yes, it's interesting that you mentioned that because I was wondering, where did they get all this from? I mean, there's been sort of rumors that they had access to his phone. I don't know if that's, I mean, there is a striking level of detail. So I guess, ok, so I just want to look forward a little bit. So what happens? I mean, what do you, how do you see this playing out? I mean, it, it seems like they have a pretty strong case against him again. I think I'm curious to hear your thoughts. A lot of people are saying the SEC is just gonna come out with something next. It seems in my view that seems quite likely iii I imagine that this is not gonna be only the CFTC. Um Where's this going? Well, you know, this will take a while to litigate assuming that bin does uh fight it, which is what they appear to be saying they will do. Uh as for the SEC, they have issued a wells notice with respect to coin base. So, you know, we're all sort of waiting to see what happens there. Are they going to be bring an enforcement action with respect say to staking products, are they going to bring an enforcement action with respect to saying coin base is basically, you know, should register as a securities exchange because it's trading, uh, crypto assets that are securities. So we'll have to wait and see. I still think this takes, you know, a while to play out. Now, stepping away from that, you could say, well, is there going to be any other change in the regulatory framework? I don't see movement toward a consensus, uh, on that in Congress? I think there's really quite a variety of views from those who are very skeptical about crypto and, and, uh, don't want to pass a law that they feel would legitimize it too much. And those who do believe in the innovative potential and would like to see, uh, greater regulatory clarity and perhaps rules that, um, uh, you know, allow for more innovation. Um, you know, I have been hopeful that we could do something on stable coins in particular. Uh, but, you know, we'll just have to wait and see whether, uh, Congress can do anything, I think for the moment it's unlikely. And I think we'll just have to watch these enforcement actions play out what were, what were the most egregious violations in your view from this complaint? Well, it's, it's, um, a set of things really. I mean, first they, they document or they allege what are the particular contracts that are being traded that would have to be registered in the US. And then they uh basically argue that there was this what I would call a systematic effort to cultivate us business and help us persons uh get around uh restrictions and a failure to comply with. Uh KYC. Um There was a reference to some program that uh Binance allegedly had called two BT C no KYC, which meant if you only withdrew uh two Bitcoin uh at a time, I think then, then they didn't have to KYC you or something like that. Um But also sort of the special group of us persons, they had that were helping uh cultivate business and so forth. There's quite a bit of detail in this, that's um that's quite striking. So Tim I'm sure, you know, there's a very popular argument right now in the Cryptocurrency industry, which is that because the US, because of the US approach and this is kind of a good example of the US approach, the sort of regulation by enforcement which they've been going after, you know, various players over the past few months. Basically, all that is going to happen is that more crypto exchanges are going to move offshore and we're just going to get sort of more finance type institutions that are kind of out of the reach of U regulators. And ultimately, this isn't really good for us investors because there's going to be even less that the SEC could do. And I'm just wondering what you sort of think about that. I mean, this idea that, you know, the argument that, you know, crypto advocates will make, which is that if the US had a clearer and sort of friendlier regulatory framework, an institution like finance or maybe not finance specifically, but some of these short exchanges would be more incentivized to work within the US system and that we wouldn't have kind of these sort of offshore entities causing great damage from afar. I mean, I don't know what you think about that argument. Well, you know, we do have a system for contracts. That's I think pretty clear. And we do have registered uh platforms trading in crypto derivatives, you know, FTX, uh had Ledger X and Ledger X. Um, you know, did not have the same problems that the rest rest of the FTX Empire had uh when it collapsed. Um I think the, uh, you know, the harder case is this question that we've all been struggling with which tokens are securities, which are commodities and how do we resolve that? I mean, that's where I've argued. Let's come up with some basic investor protection standards that would apply regardless of what bucket you put the tokens in, uh instead of continuing to battle uh over that issue. Um, as far as things moving offshore, you know, I think there is the risk of that. Um And I worry sometimes that regulators will instead of trying to set up a regulatory framework will cause uh activity to move offshore and excuse me in ways that make it harder to regulate. I I worry about that particularly with stable coins. Um So I'd still like to see us, you know, create a clearer framework uh which ensures high investor protection, but also allows for innovation. As I say, particularly in the stable coin area, I think that that would be uh very beneficial. Just want to also bring out some data that was revealed from this complaint. So we have finally bins revenue breakdown. And in one chart, we see August and July of 2019 and the United States has uh 16% of that share for the month of August, 19% for the month of July. China's second actually with 14% in August and July of 2019 just browsing through the complaint as well. I mean, what most, what a lot of people are talking about is that had 300 house accounts that were owned by C the CEO. Uh the worry there is that they were trading against customers. There was a section about sanctioned persons being offered accounts and ways to access bin as well as uh VIP S that were uh actually encouraged to move offshore so that they could trade on finance in terms of the sanctioned persons. Do you see criminal um violations here? There's certainly potential for that under the excuse me, under the Bank Secrecy Act. Um So we'll have to wait and see whether, uh, justice, um, does something, there have been rumors that Justice was working, the Department of Justice was working on a potential, uh, uh, case against Banan. But we'll just have to wait and see whether, whether, uh, they do assert something. I want to ask you sort of a very big question here that I think is kind of like, kind of at the core of the issue is the issue that Binance just didn't want to go through the trouble of like registering with the US and go through the whole bureaucracy or is it the issue that the stuff that Binance was doing would never be allowed in the US in the first place? Which one is it? Uh It's more the former in my book. Um There might have been uh some issues on some of the contracts, but basically, you have a situation where you have a platform uh that was trading uh derivative contracts which would be required to be uh registered here. Um And weren't and on top of that, uh they were, you know, deliberately cultivating the US business, not simply failing to prevent it. Um So I think that is the former of what you said is really more of the issue here and would they not want to go through the US process? What, what's the reason for that? Is it just because they just, I mean, in your opinion, obviously, like that they just could be, or the same reason, uh, other platforms would say they haven't registered as securities exchanges or, or, uh, otherwise I think, uh, you know, uh, people will say that it's because, well, the laws don't really quite fit and, you know, we really need, uh, a clear set of rules and they need to be a little bit different. Uh, critics would say no, they don't want to register because there's a cost to uh registration, uh a significant cost and you can't do all the things that maybe you're doing and you would have to say, prevent conflicts of interest and have stronger investor protection standards and have stronger standards on protecting customer assets. I mean, you know, the framework of law of regulations that we have for our securities and derivatives exchanges is much, much stronger than the typical policies that crypto trading platforms, whether they're trading just in the spot market or whether they're trading uh uh derivatives as, as uh finance was offshore. Uh the, the laws that we have are much stronger in terms of investor protection than the policies of, of most uh crypto exchanges. Now, some are better than others. I will grant that. Um but generally, um the standards of investor protection that these platforms follow on their own are very weak. I mean, look at simply the issue of, you know, there have been a variety of, of uh studies that have asserted that a lot of the trading that goes on on platforms is wash trading where someone is trading with themselves to uh inflate the price or volume um that would not be allowed on our securities and derivatives exchanges. But there have been studies that say that's 50% of the trading that goes on on many platforms. So you know, that's the problem. We have very weak investor protection. Can you make the argument though? Because a big part of the complaint talked about these VIP trading clients and they are, it sounds like they are big firms in Chicago and New York that are using B to trade off shorts. You would grow. They could argue ostensibly that they are sophisticated in finance, they know the risks that they're taking and that they don't need the CFTC or the regulator to tell them, you know, protect them as consumers. Uh What, what about that argument? Well, there's, there's a certain validity to that argument and our laws do recognize that in, in a variety of ways um in the derivatives area, for example, uh what are called eligible contract participants which are, you know, sophisticated investors can trade uh swaps on um certain types of platforms that don't have to register as full exchanges, retail persons can't we have other distinctions in our securities laws on, you know, qualified institutional buyers and accredited investors and so forth. So there are those types of uh distinctions, you could argue about whether they're sufficient uh for this industry. Um just as you could argue that, you know, look, some of the regulations maybe don't quite work in terms of disclosure and so forth. But you know, the point is that basically, uh this is this is a sector where investor protection just isn't up to the level that we have in our securities and derivatives markets in the US want to bring up uh Bernstein analysts that are predicting the CFCC could require Binance to cease operations in the United States as part of a potential settlement. Now, the report also says Binance US is a minor part of the overall business and makes up less than 5% of the exchange's global operations. Do you see this happening? Well, Binance US is not part of the complaint. Uh And I assume that's because Binance Us, number one was not trading the contracts that are at the heart of this complaint that are, you know, illegal derivatives because they weren't traded on exchange. Um I can't speak as to whether Binance Us, you know, was doing adequate KYC or whatever, but in terms of the remedies that the CFTC is, is seeking, they certainly want to stop uh Binance um uh the overseas uh part from engaging in US business. They've also though uh uh uh are seeking to prevent Bin Zao and limb from ever essentially registering in the US or engaging in the commodities business. Um uh So that's a, a another very strong remedy. And well, again, we'll just have to see how this plays out quickly. You had this great op ed a few months ago with in, in the Wall Street Journal, Jay Clayton, just kind of like with a few specific regulatory prescriptions for the United States. You know, stable coins was part of it. You talked about segregation of assets, a federal kind of more federal regulation for exchanges just given the current environment right now. And putting aside the stable coin question, which you already mentioned, what do you see simply, what are your, what are your prescriptions now realistically like what should, if, if you know, what should Congress or whoever be doing in the US? Like what are the most important? Um I don't know like actions that should be taken on the regular. Look. My, my approach is let's think incrementally here. Let's try to find a pathway to have some basic standards that will improve investor protection even if it's not a comprehensive solution that addresses every single problem. So for example, instead of Congress trying to come up with some comprehensive piece of legislation that creates a new category of digital assets or whatever I would do the following. I would have Congress say pass a law that says any platform that is currently trading Bitcoin or Ethereum or you know, you could list a few other uh very commonly traded tokens. Any such platform has to do one of three things. It has to register as a securities exchange with the SEC or register as a derivatives exchange with the CFTC or it has to follow the following 12 requirements or whatever number you want. And those requirements would be, you know, some basics on protecting customer assets, preventing fraud and manipulation, preventing conflicts of interest and so forth. And then Congress would say to the SEC and the CFTC, you guys get together and articulate some specifics around these 12 principles that we've said any such platform has to provide. So we're not trying to rewrite what's a security and what's a commodity. We're not trying to create a whole new category uh for regulation. We're basically saying either become a securities exchange, a derivatives exchange or follow these basic principles of investor protection. And that would be an incremental approach that I think could improve investor protection and you know, later we can come back then and say, ok, maybe we do need to revise uh this aspect of securities laws or, you know, address this issue, but it would be a way to begin to raise uh investor protection in the US. All right. Well, Tim Well said, thank you so much for your insights. I also want to bring up C's response to the CFTC complaint which states in part quote, the complaint appears to contain an incomplete recitation of facts and we do not agree with the characterization of many of the issues alleged in the complaint. All right. That was former CF DC chair and Harvard Kennedy School research fellow and Digitalize Policy project director, Timothy Masset.