By Angus Berwick and Tom Wilson

(Reuters) - Global cryptocurrency exchange Binance had secret access to a bank account belonging to its purportedly independent U.S. partner and transferred large sums of money from the account to a trading firm managed by Binance CEO Changpeng Zhao, banking records and company messages show.

Over the first three months of 2021, more than $400 million flowed from the Binance.US account at California-based Silvergate Bank to this trading firm, Merit Peak Ltd, according to records for the quarter, which were reviewed by Reuters. The Binance.US account was registered under the name of BAM Trading, the U.S. exchange's operating company, according to the records. Company messages show the transfers to Merit Peak began in late 2020.

Reuters couldn't determine the reason for the transfers or whether any of the money belonged to Binance.US customers. The exchange's public terms of use at the time said its customers' dollar deposits were held at Silvergate and a Nevada-based custodian firm called Prime Trust LLC. Prime Trust made $650 million in wire transfer deposits into the Binance.US account during the quarter, the bank records show.

A Binance.US spokesperson, Kimberly Soward, did not address Reuters' questions about the transfers detailed in the bank records. In a statement, she said Reuters' reporting used "outdated information" without elaborating further. She added: "Merit Peak is neither trading nor providing any kind of services on the Binance.US platform" and "only Binance.US employees have access" to the bank accounts of the U.S. company. Soward didn't specify when Merit Peak's activities ceased.

The Binance global exchange, Binance CEO Zhao and Prime Trust did not respond to detailed questions about the transfers. A Silvergate spokesperson said the bank does not comment on individual customers.

Binance.US's executives were concerned by the outflows because the transfers were taking place without their knowledge, according to messages reviewed by Reuters. The CEO of Binance.US at the time, Catherine Coley, wrote to a Binance finance executive in late 2020 asking for an explanation for the transfers, calling them "unexpected" and saying "no one mentioned them."

"Where are those funds coming from?" she wrote in one message.

In a response to Coley, seen by Reuters, the Binance executive, Susan Li, did not explain the transfers. Li wrote that Merit Peak was a "vendor that facilitated trading" on Binance.US and also provided loans and capital injections to the American exchange.

Coley, who left Binance.US later in 2021, didn't respond to questions sent via her legal representatives. Li also didn't respond.

Reuters was unable to trace what became of the $400 million. An unspecified portion of the money was subsequently sent to the Silvergate account of a Seychelles-incorporated firm called Key Vision Development Limited, according to a person with direct knowledge of the transfers. A 2021 corporate filing by another Binance unit identified CEO Zhao as a director of Key Vision. A former Silvergate executive confirmed that Key Vision held an account at Silvergate at the time.

Key Vision's local registered agent did not respond to requests for comment.

The money transfers suggest that the global Binance exchange, which is not licensed to operate in the United States, controlled the finances of Binance.US, despite maintaining that the American entity is entirely independent and operates as its "US partner." The Department of Justice and the Securities and Exchange Commission have sought information from Binance and Binance.US about their relationship as part of ongoing investigations into potential breaches of financial rules, including whether Binance is using the American exchange as cover for doing business in the U.S. The SEC and the Justice Department declined to comment for this article.

Reuters reported last year that Binance created Binance.US as a de facto subsidiary in 2019 in order to draw the scrutiny of U.S. regulators away from the global exchange. Binance.US's operator, California-based BAM Trading Services, is registered with the U.S. Treasury as a money services business, a category that includes foreign currency traders and money transmitters. BAM's beneficial owner is Zhao.

Binance.US's chief financial officer, Jasmine Lee, told the Wall Street Journal on Feb. 8 that "the extent of our relationship" with Binance.com is a shared name and a licensing agreement for technology. "We do not transfer our funds back and forth," Lee said.

Susan Li, the Binance finance executive, had access to the Binance.US Silvergate account, however, along with several senior Binance.US employees, according to the messages and the person with direct knowledge of the transfers. In one message, a Binance.US finance manager asked Li to give another Binance.US employee authority to approve payments from the account. A 2021 Binance.US document that described the American exchange's technology architecture identified Silvergate as a payment channel controlled at the time by Binance.com.

The Binance.US account records reviewed by Reuters detail each transaction between January and the end of March 2021. Reuters has not reviewed account records for other periods.

The transfers to Merit Peak took place on the bank's proprietary Silvergate Exchange Network (SEN), which Binance.US joined in November 2020 to serve its corporate clients. SEN allows these clients to transfer dollars between their accounts at the bank. Silvergate's investor prospectus says SEN transfers are "push only," which means they must be authorized by the account's controller.

The former Silvergate executive told Reuters the movement of funds from a company account without approval of that firm's management would be a breach of the bank's compliance rules. Silvergate's prospectus says "multiple steps are required to create, authorize and approve a SEN transfer." The Silvergate spokesperson didn't address the transfers in their response to Reuters.

Over the January-March 2021 quarter, the Binance.US account received $1.3 billion in SEN transfers from corporate clients trading on Binance.US, along with the $650 million in wire transfer deposits from Prime Trust.

BLACK BOX

The role of trading firms at crypto exchanges such as industry leader Binance has been under scrutiny since rival FTX collapsed in November. Trading firms often play a "market-making" role, typically buying and selling assets to deepen an exchange's trading volume and thus facilitate dealing. The market maker profits from the difference, or "spread," between the prices bid by buyers and asked by sellers.

The SEC has accused FTX founder Sam Bankman-Fried of secretly diverting billions of dollars in customer funds to his trading firm, Alameda Research, which functioned as a market maker on the exchange. Alameda received "undisclosed special treatment" on the FTX platform that concealed the flows, the SEC alleged in its December complaint against Bankman-Fried, who has pleaded not guilty.

The SEC's chair, Gary Gensler, told Bloomberg TV on Feb. 10 that crypto exchanges, in general, were "co-mingling customer funds with their businesses" by also operating as broker-dealers and hedge funds that were trading against their own clients. He didn't single out Binance or other exchanges in his comments, but said firms should expect more enforcement actions by the agency.

"We don't let the New York Stock Exchange also run a hedge fund and trade on the exchange. Why would we do it here?" Gensler said.

Among the dealers on Binance.US was Merit Peak, according to company messages, the trading firm managed by CEO Zhao.

Binance.US employees had little visibility into how Merit Peak was executing trades, the person with knowledge of the transfers said, because the software that matched customers' orders was managed by Binance as part of the technology licensing agreement between the two exchanges. The document that described Binance.US's technology architecture designated this software as "BlackBox" because, ex-staff said, Binance.US employees didn't know how it functioned.

Former regulators, along with former executives at Binance and Silvergate, told Reuters that Merit Peak's role on Binance.US created potential conflicts of interest between the exchange and its customers because Binance.US disclosed no information about Merit Peak's activities or its owner. The SEC described Merit Peak as a Binance entity when it sought information about the trading firm as part of a subpoena issued to Binance.US in December 2020.

"When you have that lack of transparency, you don't know if Binance customers are being disadvantaged," said Howard Fischer, a former senior SEC trial counsel and now a partner at U.S. law firm Moses Singer.

Merit Peak was incorporated in the British Virgin Islands in January 2019. That December, Zhao signed a purchase agreement for Merit Peak to invest $1 million into Binance.US operator BAM Trading's holding company in return for a portion of the holding company's preferred shares. The agreement identified Zhao as Merit Peak's "Manager."

The BVI corporate registry does not name Merit Peak's directors or shareholders, and only identifies its local registered agent. The agent did not respond to requests for comment about Merit Peak's ownership. Like Binance.US, Binance too has not provided any public information about Merit Peak, nor mentioned it in submissions to regulators and corporate registries that were reviewed by Reuters.

The 2021 document that described Binance.US's technology architecture noted that an unidentified "Market Maker" was under the control of Binance.com. In a Twitter Spaces event last November, Zhao said he was a shareholder in one unspecified market maker, but stressed that it did not earn profits and was "just providing liquidity in the market."

The SEC's subpoena, addressed to Coley, requested information on all of Binance.US's market makers, their owners, and their trading activity. The Wall Street Journal reported the subpoena last year. Reuters could not establish how Binance.US responded to the SEC.

Binance.US and Binance didn't respond to Reuters' questions about the SEC's case, but Binance's chief strategy officer, Patrick Hillmann, told the Wall Street Journal on Wednesday the company was "working with regulators to figure out what are the remediations" to resolve investigations. The Justice Department is also investigating Binance for suspected money laundering and sanctions violations, Reuters has previously reported.

Silvergate, the bank used by Binance and other crypto exchanges, is also drawing scrutiny. It is under investigation by the Justice Department's fraud section, which is examining Silvergate's hosting of accounts tied to Bankman-Fried's businesses. Silvergate didn't comment and the Justice Department declined to comment.

After this article published, Silvergate's shares extended losses, hitting a daily low of $17.35, and were last down around 22%. They have fallen 86% over the past year.

"STEADY CASH DRAIN"

Coley announced Binance.US had joined the Silvergate Exchange Network in November 2020, telling a crypto news outlet, "We've launched SEN for our corporate clients."

Merit Peak gave Binance.US $5 million to fund the "minimum balance" of the exchange's new SEN account, according to a message a senior Binance.US employee later sent to counterparts at Binance.com. The transfers to Merit Peak began soon after, the messages show.

Coley, on the morning of Dec. 23, flagged a "very large withdrawal" by Merit Peak of $7.5 million from the Binance.US account. Binance.US staff referred to the transfers to Merit Peak as "withdrawals," messages show, because Binance.com employees were initiating them.

"This transaction is unexpected," Coley wrote. As a result, she told Susan Li, who was named as team leader of Binance's finance department in a company employee list that year, that Binance.US's SEN account had hit its daily withdrawal limit of $10 million and she would lift the threshold to $20 million.

Coley asked Li to advise Binance.US staff in the future when the SEN account was close to hitting its limit. "Given we do not have portal access, can we have eyes and ears helping us," she messaged. She didn't identify the portal, but Silvergate says SEN accounts can be accessed via an "online banking portal."

Coley followed up with Li again later that day. "Can you explain more – maybe over the phone – about the flows that are happening via SEN? I want to understand them better as no one mentioned them until today when they got caught in our limit," Coley wrote.

"Who is directing this?" Coley asked, noting that other senior Binance.US employees were not aware of the transfers either.

Li replied in a message to Coley that Merit Peak's role was as an "OTC vendor." She didn't elaborate or directly address Coley's questions.

In OTC or over-the-counter trades, two parties agree on a price outside an exchange. Reuters could not establish what trades Merit Peak was involved in. But in a message to a colleague in early 2021, seen by Reuters, a senior Binance.US employee said Binance.com was sending crypto to Binance.US to sell to American traders, and then "withdrawing" the income via Merit Peak. This led to a "steady cash drain out of SEN," despite a booming crypto market, the employee wrote.

From January to March 2021, the account records show that Merit Peak received 89 transfers from the Binance.US SEN account totalling $404 million. Over that period, Merit Peak made four payments into the Binance.US account, for a total of around $160,000.

The transfers to Merit Peak were almost all for precise million-dollar figures, made at one- or two-day intervals. These transfers often immediately followed a deposit into the Binance.US account by Prime Trust, the crypto custodian firm for Binance.US client funds.

Merit Peak then transferred funds from its Silvergate account to the account belonging to Key Vision, the Seychelles firm, said the person with direct knowledge of the transfers.

Reuters was unable to determine why the money was moved around in this way.

That year, Binance.com was also directing international customers on its platform to deposit dollars into Key Vision's Silvergate account, according to screenshots of the instructions posted on a crypto blog. The Seychelles' business registry says Key Vision, which was incorporated the same day as Merit Peak, remains active and is in "Good Standing."

Binance.US in April 2021 unexpectedly announced it would replace Coley as CEO. She has not made any public statements since leaving.

(Reporting by Angus Berwick and Tom Wilson in London; Additional reporting by Chris Prentice in New York; Editing by Janet McBride)