Because I was traveling yesterday, your truly is giving only a starter post on the accelerating fall of former crypto king Sam Bankman-Fried. As nearly all of you likely know, SBF was indicted a month after his FTX crypto exchange entities and his hedge fund Alameda Research filed for a Chapter 11 bankruptcy.1 The criminal filing, made in the Southern District of New York, was unsealed yesterday. The same day, the SEC and CFTC each filed a civil suit.
Needless to say, this is lightening speed for a complex case, confirming out theory that the officialdom could not ignore a “sure looks rotten” money sinkhole this big and high profile, particularly since SBF kept it on the front pages of the business press with his ongoing ‘splaining tour.
However, the FTX fraud may not be hard to unpack. Tuesday in testimony before the House Financial Services Committee, new FTX CEO John Ray said:
This is really old-fashioned embezzlement. This is just taking money from customers and using it for your own purpose” and there’s nothing sophisticated about it.
Nevertheless, there is a bit to unpack. Here are links to the three filings:
The Department of Justice filing is extremely spare on statements of facts and substantially cites the provisions of law SBF allegedly violated. One might view that as evidence of haste; some have argued one reason for the quick legal action was concern that SBF might flee. Recall former Nissan-Renault chairman Carlos Goshn escaped Japan while under house arrest and having posted a $9 million bond. It’s even easier to skedaddle if you haven’t been charged.2
The eight criminal charges, as recapped by Bitcoin Magazine:
Conspiracy to commit wire fraud on customers
Wire fraud on customers
Conspiracy to commit wire fraud on lenders
Wire fraud on lenders
Conspiracy to commit commodities fraud
Conspiracy to commit securities fraud
Conspiracy to commit money laundering
And conspiracy to defraud the United States and violate the Campaign Finance Laws.
Note that the money laundering charges relate to the second count, wire fraud on customers. So this is an allegation that SBF laundered purloined funds, not that SBF laundered money for customers. With FTX’s terrible “Know Your Customer” policies, it’s just about certain they also laundered money for customers. For instance, I have read that customers could set up accounts using a VPN as part of hiding their real address and nationality. However, these eight charges, if the DoJ prevails, are more than enough to put SBF behind bars for a very very long time. Hence prosecutors are unlikely to want to overegg the pudding by adding more causes of action unless they tie closely into the basic plot line.
One rule of criminal cases is confused juries tend not to convict. So while a comparatively focused case may frustrate crypto experts, it’s the best shot at winning. And remember other players (state attorneys general, private plaintiffs, the IRS) can also have a go.
Some experts argue that the DoJ must have an overwhelming amount of evidence and therefore doesn’t have a strong need to present it in the filing. Others contend that since SBF will have to be extradited, the broadest and most general complaint gives the prosecutors maximum latitude in responding to challenges. Keep in mind that if at some point, procedurally, it becomes advantageous to plead more facts, the DoJ can always file an amended complaint. Note also the SEC (and CFTC) filed in parallel with the DoJ, when the SEC often waits till the criminal case is well along (as in they can leverage discovery) before they file an action. Again this speaks to the perceived need to get moving as well as the presumption that the existing evidence is plenty strong.3
For instance, the Bahama prosecutors, in arguing that SBF be remanded (incarcerated rather than allowed to post bail) pursuant to an expected US extradition filing and separate filings by the Bahamas, stated per the Daily Mail:
They [Bahama prosecutors] claimed he hid $300million in a Brazilian fund in September, months before the collapse of his crypto trading platform, as a means of setting himself up for an escape when the inevitable happened.
By contrast, the SEC lodged a more conventional filing, with a lot of factual claims tied together in a not-overwhelming storyline. The SEC contends SBF was defrauding both investors in FTX Trading as well as customers of the crypto exchange, “from at least May 2019,” as in the inception of FTX:
Throughout this period, Bankman-Fried portrayed himself as a responsible leader of the crypto community. He touted the importance of regulation and accountability. He told the public, including investors, that FTX was both innovative and responsible. Customers around the world believed his lies, and sent billions of dollars to FTX, believing their assets were secure on the FTX trading platform. But from the start, Bankman-Fried improperly diverted customer assets to his privately-held crypto hedge fund, Alameda Research LLC (“Alameda”), and then used those customer funds to make undisclosed venture investments, lavish real estate purchases, and large political donations…
He told investors and prospective investors that FTX had top-notch, sophisticated automated risk measures in place to protect customer assets, that those assets were safe and secure, and that Alameda was just another platform customer with no special privileges. These statements were false and misleading. In truth, Bankman-Fried had exempted Alameda from the risk mitigation measures and had provided Alameda with significant special treatment on the FTX platform, including a virtually unlimited “line of credit” funded by the platform’s customers.
The CFTC filing tracks the SEC on the time frame of SBF’s alleged misdeeds.
The SEC filing describes how SBF persistently misrepresented FTX’s operations and controls to investors in the course of raising $1.8 billion over several funding rounds. And of course this was bad for customers too! For instance:
From the start of FTX’s operations in or around May 2019 until at least 2021, FTX customers deposited fiat currency (e.g., U.S. Dollars) into bank accounts controlled by Alameda. Billions of dollars of FTX customer funds were so deposited into Alameda-controlled bank accounts.
At least some of these bank accounts were not in Alameda’s name, but rather in the name of North Dimension Inc. (“North Dimension”), an Alameda subsidiary. North Dimension’s website does not disclose any connection to Alameda.
Some commetators were suspicious of the indictment being filed just before SBF’s scheduled House Financial Services testimony, as if this were a nefarious plot to protect SBF by making sure he would not appear before the committee. It’s hard to see that. SBF has been running his mouth almost non-stop since the bankruptcy filing, in some cases with pretty crypto/finance savvy interviewers who had a go at him and elicited damaging admissions (on top of the damaging admissions SBF made all on his own).
The idea that SBF might say something new before the House Committee that would add materially to a case was vanishingly low, particularly since House members are limited to 5 minutes with a witness, making it easy for SBF to deflect. So the opportunity cost was the lost theater, to see who if anyone on the Financial Services Committee were able to pin SBF down in a very compressed interrogation time. The flip side is Congresscritters, unlike journalists and crypto mavens, could have shut down SBF’s blather and pressed for yes/no or simple answers to direct question.
The only possible protection racket I see is of crypto bought-and-paid House committee members who could become embarrassed and angry if they offered a defense of FTX and/or SBF and were shortly made to look like fools with an indictment being filed soon after the hearing.
However, the hearing did wind up providing a window into SBF’s ever-more warped world view. Forbes obtained a copy of what is presents as SBF’s draft testimony, which I strongly urge you to read in full. It’s yet more evidence that SBF thinks he is a rule onto himself.
The format for Congressional hearings is the witness gives a short verbal statement, at most five minutes, and they can also submit a much longer written account. The Forbes document reads as if SBF thought he could hold court in the House Committee and go on with no time limits on how he was misunderstood and done wrong.
Many of his claims are fantastic, like that there are still plenty of investors willing to rescue FTX if SBF were allowed to pursue older letters of intent. Another howler:
SBF has always pleaded the false poverty of having only $100,000 in his bank account (he ran the same line in his infamous Lunch with the Financial Times, when the pink paper pointed out he soon had over $700 million to buy some crypto venture). Needless to say, SBF seems to have forgotten about the $300 million that Bahamas officials believe he squirreled away in Brazil.
He also tries to play lawyer, arguing that Ray and the bankruptcy team are overstepping their bound and dealing with legal entities outside their purview. However, it is common in much bigger institutions for lines of business to operate with little regard for corporate structure; this is a big reason the US authorities punted on the TBTF “living wills” exercise. They could not make their product/service lines map onto legal entities, which is what is needed to have a tidy failure.
Ray noted other issues. The CEO said FTX Group’s operations were not segregated and that FTX.com, FTX U.S., Alameda Research, and another entity making different investments operated as one company.
SBF’s planned testimony also whined that Ray was ignoring SBF’s offers to help and then flat out misrepresents what FTX did. See this section:
FTX was not a derivatives exchange. That was only one of its set of services. We have yet to see how many customers used FTX for custody and unlevered trading but it appears that unlevered trading was a meaningful and potentially leading part of FTX transaction volumes.
Here is the SEC’s overview of FTX offerings. You can see only item 2, if you squint hard, could conceivably qualify as derivatives (although I don’t buy that, a derivative is a contract and among other things has a termination date;4 margin accounts are not derivatives).
FTX offered its customers a number of services. For example:
a. FTX offered a “spot market,” a trading platform through which customers
could trade crypto assets with other FTX customers in exchange for fiat
currency (i.e., currency such as U.S. Dollars) or other crypto assets.
b. FTX offered “spot margin trading” services, which allowed FTX
customers to trade using assets they did not have (i.e., to trade “on margin”) by posting collateral in their FTX accounts and borrowing crypto assets through the “spot market” on the FTX platform. FTX also allowed customers to lend their crypto assets to other FTX customers who would then use those crypto assets to spot trade.
c. FTX offered an off-platform (over-the-counter or “OTC”) portal that enabled customers to connect and request quotes for spot crypto assets and to conduct trades.
In his overlong House Committee script, SBF then whined about how he and members of his team were roughed up by Sullivan & Cromwell to file for bankruptcy (given how SBF admits to ignoring the strong views of his lawyers to shut up, it’s not hard to imagine that outside counsel would have to hit SBF between the eyes with a two by four to get his attention). SBF also isn’t clear if he had his own counsel. Sullivan & Cromwell was presumably acting as counsel to FTX, not to SBF. SBF’s and FTX’s interests diverged. If FTX was bleeding out, it would be the duty of executives and officers to the corporation(s) to stem losses even if that shut down SBF’s hopium rescues.5
There is more of this ilk in the SBF text, which is fascinating as an indicator of SBF’s growing divorce with reality. Further confirmation from the Daily Mail:
He has been holed up in the Bahamas for weeks, but today was denied bail after prosecutors argued in court that he was a flight risk…
SBF, 30, protested, telling Chief Magistrate Joyann Ferguson-Pratt he couldn’t go to jail because he is vegan and ‘depressed.’
She however denied him bail, remanding him in custody until February 8. He will spend his detention at Fox Hill, The Bahamas’ only prison.
Fox Hill inmates reported removing human waste by buckets and developing bed sores from lying on the bare ground, according to a 2021 human-rights report on the Bahamas by the U.S. State Department. Cells were also infested with rats, maggots and insects, the report said.
Inmates are supposed to get an hour every day outside for exercise. Due to staff shortages and overcrowding, there are times when they only get 30 minutes a week, said Ms. Farquharson.
The Bahamas Department of Correctional Services facility has different sections that separate those serving terms for violent crimes from those who aren’t. But due to space constraints, some inmates awaiting trial for minor crimes have been sent to the maximum-security facility, said [local attorney] Ms.[Romona] Farquharson.
“I think they’ve got to be careful not to have him in really rough areas in the prison,” she said.
Back to the Daily Mail:
During proceedings on Tuesday, is Stanford law professor mother, Barbara, laughed when prosecutors referred to him as a ‘fugitive’.
Even though this mini-outburst would not have changed the outcome, it’s a bad look. It suggests at best that his parents are in deep denial as to what their darling son has been up to, despite his father having been actively involved in the business, and/or harboring the illusion that their elite status will lead the court to cut SBF a lot of slack. This simply is not in the cards.
In addition, SBF thinking that veganism and depression were sufficient reasons for not being remanded is…lunatic. Anyone with a casual acquaintance with the court system knows that single mothers who are charged with crimes and remanded will have their kids sent to protective services if there’s no relative to care for them.
I doubt SBF has suffered any major setbacks in his life. He’s openly pleading fragility to try to get a break at the outset of the court process. The odds that he will attempt and maybe even succeed at suicide seem high, and not questionable-plausibility Jeffrey- Epstein-style, but a bona fide attempt because he will see himself as unable to endure his future.
1 With the records and systems a mess, odds favor the bankruptcy becoming a liquidation.
2 SBF had been “under supervision” of Bahaman authorities but I am not sure what that amounted to.
3 Readers may feel there are other charges that should have been lodged. The point in a case like this is to score a clean win, not throw all possible causes of action against the wall and see what sticks. SBF would face up to 155 years in jail on these charges if found guilty, which seems more than adequate. Yours truly is gratified to see the SEC take interest in SBF’s loans to himself, which they identified as $1.33 billion, due to finds some in addition to the $1 billion personal loan identified in the original bankruptcy statement.
4 From Investopedia: “A derivative is a securitized contract whose value is dependent upon one or more underlying assets.”
5 Some commentators are complaining that the bankruptcy court, presumably at the behest of Sullivan & Cromwell, is withholding the names of the 50 biggest institutions, which is pretty irregular. However, the judge was lauded at the time of appointment, so I doubt he is a pushover. One reason could be that some of the creditors (as expected) are wobbly crypto players (or other plain wobbly leveraged players) and listing how big their exposures are could lead to a rapid unwind that could blow back and hurt FTX recoveries.
Another thing most don’t realize is that if you are anything other than a very top client of a big kahuna firm, or are lucky enough to have a motivated partner on a narrow matter, the cost of renting their brand name is they may not always do what is best for you in the interest of serving their broader franchise. And they were probably smart enough to get you to sign a waiver.