Boardroom takes stock of the key events that spelled the dramatic fall of the cryptocurrency exchange and its controversial founder — and what happens next.
What a difference a year makes.
About a year ago, the popular centralized cryptocurrency exchange FTX, helmed by now disgraced founder Sam Bankman-Fried (a.k.a “SBF”), was readying Super Bowl ads, throwing around millions of dollars to secure sports arena naming rights deals, and attempting to shape the regulatory framework around the entire crypto industry in the United States. Several months later, we would see an unraveling of what many including the United States Department of Justice, the SEC, and the CFTC have described as one of the largest frauds ever perpetrated.
By now, most of us are familiar with the sequence of events that culminated in FTX declaring bankruptcy, a bizarre media tour against the advice of counsel by SBF, and ultimately Bankman-Fried’s indictment, arrest, and extradition from the Bahamas.
But it’s worth recounting all that’s occurred in order to set the stage properly for where we are now.
On Nov. 2, 2022, crypto industry publication CoinDesk dropped a report that suggested an unusually close link between Alameda Research, the crypto-centric hedge fund started by Sam Bankman-Fried and FTX. The story detailed how an inordinate percentage of Alameda’s balance sheet was tied up in FTX’s own utility token, “FTT” to the tune of $3.66 billion.
On Nov. 6, Changpeng Zhao (a.k.a. “CZ”), the CEO of rival cryptocurrency exchange Binance, announced via Twitter that as a result of the report and industry chatter calling FTX’s finances into question, Binance was liquidating their holding of FTT, which at the time was valued at roughly $530 million. This liquidation prompted a proverbial “run” on the bank as $5 billion was withdrawn from FTX by customers that same day.
The rush of withdrawals from the exchange created a liquidity crisis for FTX, which prompts SBF to seek out solutions to help bridge the gap between the amount of money required to satisfy all customer withdrawals and the amount of liquid assets his company held at the time. His first solution was to broker a transaction with Binance and CZ whereby Binance would acquire some or all of FTX for an undisclosed sum.
On Nov. 8, Binance entered into a non-binding agreement with FTX to purchase the company
One day later, Binance ultimately decided to pull out of the deal. The company cited insurmountable red flags during the course of due diligence, as well reports of ongoing investigations of FTX by various US regulatory agencies.
The ensuing days would represent what became a conceivably irreversible death spiral for FTX:
- First, one of their major investors, the blue-chip VC firm Sequoia Capital, sent out an email to their limited partners on Nov. 9 indicating in no uncertain terms that they believed the value of their investment had gone to zero and that they were now writing off the investment as a total loss.
- That same day, it was reported that FTX’s shortfall with respect to its financial obligations had swelled to about $8 billion and that Sam Bankman-Fried was attempting to raise the necessary money to satisfy all of the company’s financial obligations.
- Another day later, Bahamian financial regulators announced in conjunction with the American SEC that they had frozen all of FTX’s assets.
- SBF was then forced to resign as CEO of the company as FTX filed for Chapter 11 bankruptcy protection, which effectively enables them to reorganize their debt without having to completely liquidate the company (i.e. sell off the scraps for salvage value).
In the days and weeks that followed, the public began to learn more about the extent of the mismanagement of FTX’s assets and the incestuous relationship between Alameda and FTX, which included the alleged funneling of customer deposits to the former from the latter — in other words SBF and his alleged co-conspirators, which included his one-time girlfriend and CEO of Alameda Research, Caroline Ellison, were using FTX customers’ funds to bankroll their own gambling in the crypto markets.
John Ray, who was appointed as FTX’s bankruptcy CEO and who was previously entrusted with untangling the mess at Enron — of the biggest financial frauds in US history at the time — put it plainly:
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
Upon his ouster as CEO, Sam Bankman-Fried embarked upon a full-fledged media tour that would make any attorney worth their salt consider drinking bleach by the gallon. It included interviews with everyone from George Stephanopoulos to a live interview at a New York Times Dealbook event with Andrew Ross Sorkin during which the crowd laughed at his candor and light self-flagellation. If the walls were closing in on SBF, you wouldn’t be able to tell by how seemingly forthright he was with information (a fact that is even more surprising when you consider that his parents are law professors at Stanford).
On Dec. 12, Bahamian authorities arrested Bankman-Fried at the direction of the US government, and the very next day, the US Attorney’s Office for the Southern District of New York unsealed an indictment that charged SBF with a number of crimes related to his handling of FTX including wire fraud, conspiracy to commit wire fraud, conspiracy to commit commodities fraud, and conspiracy to commit money laundering.
At the same time the indictment was unsealed, both the SEC and the Commodity Futures Trading Commission (CFTC) filed separate complaints against Bankman-Fried alleging securities fraud and commodities fraud respectively. SEC Chairman Gary Gensler even went as far as to say that “We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto.”
To summarize, SBF is facing a number of federal criminal charges that could carry a maximum sentence of 115 years in prison if he is convicted, along with two civil suits filed by major federal regulators (the SEC and CFTC), plus a likely slew of additional civil lawsuits by investors and customers alike. While each of these suits alleges violations of a number of different statutes, they all revolve around the same theory: that SBF knowingly defrauded consumers, lenders, and investors alike by taking their money and (among other things) funneling it to Alameda Research for the purposes of speculative trading, issuing large loans to himself and others to purchase real estate in the Bahamas, making significant campaign contributions to various politicians and political organizations, and making risky venture investments.
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Sam Bankman-Fried’s most serious legal issues are the criminal charges he is facing in the Southern District of New York, which have the potential to put him behind bars for the rest of his life.
As with every criminal matter, the burden of proof on the government is extremely high, as they need to prove that SBF is guilty of each and every charge beyond a reasonable doubt. The thing that’s important to note with federal criminal investigations is that they typically take a long time (sometimes years) in order to allow the government to amass sufficient evidence to improve its odds of obtaining a conviction or a favorable plea agreement. One of the most remarkable aspects of this case is the speed with which the indictments were handed down, which signals that the government does not feel it is wanting for evidence, nor does it have any trepidations about its ability to obtain convictions for the majority of the charges.
If not all of them.
To complicate matters more for Bankman-Fried, it does not appear cooperation with the investigation in exchange for leniency is likely to be an option here. Typically, when the government attempts to take down a criminal enterprise, it will cut deals with certain individuals involved in the enterprise, whereby they offer the co-conspirator or accomplice leniency with respect to charges and/or sentencing in exchange for cooperating with the investigation and providing information that can help them convict those at the top of the criminal food chain. Unfortunately for SBF, he is the one at the top of the proverbial food chain; it is unlikely the government will be interested in offering him leniency.
Likewise, it is incredibly likely that Bankman-Fried would have anything tangible to offer that would prompt the government to seek lesser charges. It is unclear at this stage whether a plea bargain, whereby SBF would admit guilt in exchange for a lesser sentence is even something that federal prosecutors have or intend to offer. At this stage of the proceedings, Bankman-Fried has entered a not-guilty plea with respect to all the charges and is currently out on bail and on house arrest at his parents’ home in California as he awaits trial.
While SBF is represented by extremely competent attorneys whose previous clients include the cartel boss Joaquin “El Chapo” Guzman, all indications are that this will be an uphill battle to say the very least, and that Bankman-Fried didn’t necessarily help himself by creating a massive public record of various admissions and conflicting statements. Every criminal defense lawyer’s job is to find ways to create sufficient reasonable doubt in the minds of the jury in order to obtain a not-guilty verdict with respect to as many charges as possible, but even the world’s best and most creative barrister might be ultimately unable to turn such a losing hand into a winning one.
The one variable in all of this is what the US government would consider a win in their books. With a case that is as high-profile as this one, the bar in terms of what they would accept with respect to an outcome is much higher than your average white-collar criminal prosecution. Making matters even more difficult for Bankman-Fried is the fact that a week after his indictment was unsealed, it was announced that co-founder Gary Wang and Caroline Ellison pled guilty to several charges related to their dealings at FTX. In that same announcement, it was revealed that the two were cooperating with the government’s investigation.
In other words, Ellison and Wang rolled over on SBF to help save themselves as they likely received some form of leniency from prosecutors with respect to potential jail time.
Reading the proverbial tea leaves on this one, it would appear that anything less than significant jail time and restitution (i.e. money damages returned to customers and investors). At the end of the day, SBF’s lawyers, upon seeing the evidence the government has amassed against him and entering into preliminary discussions with prosecutors about potential plea bargains and related details, will need to make a strategic decision with their client about whether to accept a plea — to the extent that is even an option — or to go to trial.
My expectation is that Bankman-Fried will want to try his luck at trial, but it’s likely too early to tell at this juncture.
As to SBF’s pending lawsuits with the SEC and CFTC, both of which were filed in the Southern District of New York — the same court in which his criminal case is being tried — the stakes are much lower but are still significant. Both complaints allege different flavors of fraud, specifically securities and commodities fraud, each respectively stemming from his misuse of customer and investor funds while publicly touting the safety and security of FTX, as well as its ” top-notch, sophisticated automated risk measures” to protect customer assets. The SEC is specifically seeking money damages, as well as court orders that would prohibit Bankman-Fried from serving on the board of directors of a publicly-traded company and prohibiting him from participating in the offer or sale of securities including crypto asset securities.
The CFTC’s complaint also seeks money damages but the court order they are requesting is even broader than that of the SEC’s in that they are asking the court to prohibit Bankman-Fried from trading, owning, and seeking money for the purchase of commodities, which would include cryptocurrencies such as Bitcoin and Ethereum.
Collectively, the CFTC and SEC are trying to ensure that SBF is legally prohibited from being involved as a founder of any crypto-related venture or in the cryptocurrency industry altogether to ensure that he does not have the ability to replicate an alleged fraud of the magnitude of FTX.
Irrespective of the legal ramifications, the saga of Sam Bankman-Fried and FTX is just another cautionary tale of Silicon Valley and its various hype machines and media bullhorns lionizing young entrepreneurs and elevating them to “visionary” status on the basis of investments by blue chip firms and celebrities like Tom Brady and Steph Curry that create outsized “paper money valuations.” In other words, when enough well-connected cheerleaders tell a young founder that they are the next tech messiah, it should not come as a surprise that the end result is the founder drinking their own proverbial Kool-Aid and assuming that role in their minds, which in turn leads to devastating consequences.
The fall of SBF is more likely the story of a broken system with backward incentives rather than that of an industry outlier gone rouge. If and until the machine that produces a Sam Bankman-Fried, an Elizabeth Holmes, or an Adam Neumann decides to look inward and commit to rehabilitation, however, it very much appears to be a story destined to repeat itself.
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