Federal prosecutors and regulators at the US Securities and Exchange Commission and the US Commodity Futures Trading Commission all told a similar story Tuesday about Sam Bankman-Fried’s alleged plan to divert billions of dollars in customer funds from crypto exchange FTX to Alameda Research.
They all blamed Bankmann-Fried of fraud and claimed he repeatedly lied when he insisted FTX Customers’ money was safe and completely segregated from the affiliated but supposedly independent Alameda.
According to the indictment unsealed Tuesday in federal court in Manhattan and separate complaints filed Tuesday by the SEC and CFTC, Bankman-Fried knew or should have known that money was being diverted from FTX client accounts to fuel Alameda’s speculative trading fund, and that, despite repeated protestations to the contrary, FTX granted Alameda special trading privileges that ultimately proved disastrous for the platform and its customers.
Who were the victims of this alleged scam?
The CFTC’s complaint highlighted the deception of FTX users, who the regulator said were deceived into believing their money was safe. The Manhattan Attorney’s indictment also named FTX customers as victims of wire transfer and merchandise fraud allegations against Bankman-Fried.
The SEC’s lawsuit, however, focused on a different group of alleged victims: the investors, who poured $1.8 billion into FTX in a series of stock purchases between 2019 and 2022. (The 90 US-based FTX shareholders held a $1.1 billion stake, the SEC said.)
Reuters reported that FTX’s investors included such companies as Sequoia Capital, SoftBank Group, BlackRock and Temasek – not exactly small crypto Clients who wanted to trade on the FTX platform, trusting Bankman-Fried’s promises that their money would be safe.
An important note here: Bankman-Fried’s attorney, Mark Cohen of Cohen & Gresser, told Reuters Tuesday that his client is “reviewing the charges with his legal team and considering all of his legal options.” The SEC, meanwhile, did not respond to my question about the scope of their lawsuit.
And to be fair, as I mentioned earlier, the SEC’s complaint also sees FTX clients as victims, albeit in parentheses.
I mean it literally: The second sentence of the SEC’s complaint reads, “Unknowingly by these investors (and FTX’s trading clients), Bankman-Fried orchestrated a massive, year-long fraud and siphoned billions of dollars from the clients of the trading platform for his own personal money.” use and to grow his crypto empire.”
My point is that the SEC’s pleading strategy in Tuesday’s lawsuit demonstrates that crypto remains a major challenge for U.S. regulators. A suspected scammer is accused of embezzling billions of dollars from clients looking to buy and sell crypto, yet the top investor protection agency in the United States is not alleging securities fraud on behalf of those clients.
Ann Lipton, a professor of securities law at Tulane University School of Law, said this is likely due to regulatory uncertainty about which crypto assets meet the definition of a security. (As you know, this issue is again the subject of intense litigation between the SEC and Ripple Labs)
“The SEC is limited to suing for securities fraud — and that requires the existence of a security,” Lipton said via email. “At a minimum, each crypto asset would need to be analyzed individually to determine if it is a security, which is probably not feasible for clients who trade many different types of assets.”
Focusing instead on the individuals and funds that have acquired an equity interest in FTX, Lipton said, “The SEC is cowering on this offering – these investors have certainly bought securities in the form of stocks.”
Former Manhattan US Attorney Timothy Howard of Freshfields Bruckhaus Deringer agreed, “It’s easier and less complicated for the SEC to focus on stock investors.”
Unlike individual stockholders who sue for securities fraud, the SEC does not have to prove that investors have relied on alleged misstatements. (The U.S. Department of Justice, which has accused Bankman-Fried of defrauding FTX stock investors in addition to FTX clients, also does not need to rely on evidence of securities fraud.)
“This greatly simplifies SEC and DOJ law enforcement because it takes all questions related to the appropriateness of investor due diligence off the table,” Stanford Law School professor Joseph Grundfest said via email.
Many of the SEC’s allegations relate to allegations that FTX lied in publicly released statements and reports on its websites. But perhaps in anticipation of arguments from Bankman-Fried that he cannot be held liable for general corporate statements, the SEC complaint cited two instances in which FTX investors were allegedly misled by Bankman-Fried himself.
According to the SEC, he gave a US investor who bought $35 million worth of FTX stock in July 2021 a document promising that FTX and Alameda would not pool funds. And in late summer 2021, Bankman-Fried allegedly told a potential US investor, who eventually acquired a $30 million stake, that FTX did not own its native cryptocurrency, tokens known as FTT.
According to the SEC, Bankman-Fried knew what he said to the investor was, or should have known, false.
Those specific allegations, Freshfield’s Howard said, appear to be aimed at showing Bankman-Fried that FTX investors are cooperating with the government — and that he cannot escape liability simply by claiming he learned from the public statements of FTX knew nothing.
Looking at the possible fallout from FTX’s collapse, I’m curious if any FTX customers or creditors will attempt to blame the equity investors named as victims in Tuesday’s SEC complaint, arguing that their due -Failed diligence checks enabled the platform’s later alleged misconduct.
When that happens, it will be even more interesting to see if FTX stock investors point to their account in the SEC complaint as evidence that they, too, were bullied by Sam Bankman-Fried.
© Thomson Reuters 2022
