A hammer is going to fall on crypto exchange FTX. The question is how heavy it might be.
The collapse of FTX will likely give rise to a number of criminal and civil actions against the exchange and its executives, like former FTX CEO Sam Bankman-Fried. It’s also likely to push forward actual regulatory changes, either via lawmakers or through federal agencies themselves, a number of individuals told CoinDesk.
FTX filed for bankruptcy last Friday, days after halting withdrawals and a little over a week after CoinDesk first reported that the balance sheet of FTX sister company Alameda Research held a surprisingly large amount of FTT, an exchange token issued by FTX. FTX was “fine,” Bankman-Fried said in response to questions about his exchange’s solvency, before a series of events showed otherwise.
Rep. Brad Sherman (D-Calif.), a member of the House Financial Services Committee, said in a statement that the collapse is “a dramatic demonstration of both the inherent risks of digital assets and the critical weaknesses in the industry that has grown up around them.”
Senate Banking Committee Chair Sherrod Brown (D-Ohio) and Sen. Elizabeth Warren (D-Mass.) are among those in Congress calling for investigations into the collapse as well as Sam Bankman-Fried, who was a major party donor.
Other lawmakers, like Rep. Patrick McHenry (R-N.C.), the current ranking member on the House Financial Services Committee, Rep. Warren Davidson (R-Ohio) and Sen. Pat Toomey (R-Pa.), the outgoing ranking member on the Senate Banking Committee, said it was regulatory ambiguity in the U.S. that allowed FTX to grow as large as it had as an offshore exchange. They called for Congress or regulatory agencies to provide clearer guidelines for crypto exchanges to operate.
The fact that regulators apparently had no view into some of the major projects that fell apart this year – such as Celsius, Three Arrows, Luna and now FTX – is “precisely the problem,” said an industry participant who works closely with policymakers.
Still, the individual told CoinDesk that they don’t expect any major legislative action to occur this year. Most likely, Congress will look at bills like the Digital Commodities Consumer Protection Act, a bill that Bankman-Fried supported but was written prior to that, in the upcoming year.
According to an attorney who requested anonymity, the SEC may have an easier time kicking off the investigation just due to its mandate.
“The SEC is in a much better position to go to court and get a freeze [on assets] if they believe there's a reason to do that,” the attorney said. “The SEC also has a less cumbersome process for subpoenaing testimony and freezing documents.”
The SEC and DOJ are likely to cooperate though, to the extent that DOJ investigators may sit in on SEC interviews.
The fact that FTX is registered and headquartered in the Bahamas is not likely to impact these investigations, the attorney said. FTX has various U.S. connections, which is all the SEC and DOJ need to assert jurisdiction for their investigations.
FTX appears to be preparing for these investigations, with FTX US General Counsel Ryne Miller having already told the entire company to preserve documents.
A former federal prosecutor told CoinDesk that the bankruptcy court may also shed light on the situation, thus assisting government investigators with their probes.
"The bankruptcy court has the ability to now oversee the company and to obtain information from the company that, let's say the DOJ might not have been able to obtain as easily pre-bankruptcy, and they'll likely have access to a new trustee or an examiner and be able to learn in essentially real-time what's going on,” the former prosecutor said.
Executives like Bankman-Fried may also “be in a tough spot with respect to” deciding whether to cooperate or assert Fifth Amendment rights against self-incrimination, the former prosecutor added.
A complicating factor – for FTX anyway – may be the fact that Bankman-Fried has tweeted his way through his company’s collapse.
On Nov. 7, a few days after CoinDesk first reported on Alameda’s balance sheet, the one-time crypto wunderkind tweeted that “FTX has enough to cover all client holdings.” He went so far as to say that speculation about his company’s solvency was a rumor spurred by a competitor (Binance) but that “assets are fine.”
Later in the week, he tweeted that FTX US was also fine and fully liquid. Only hours later, FTX US warned users it might suspend withdrawals.
Within a day, Bankman-Fried agreed to a buyout/bailout of his reeling exchange by rival Binance (Binance walked away from the deal less than 24 hours later, precipitating the bankruptcy filing, including for FTX US). The tweets were deleted.
“It’s a complete nightmare,” said Ken White, a former federal prosecutor and a partner at the Brown White & Osborn law firm. “This is a situation where all sorts of agencies are going to be looking at this, the SEC, the FTC, and probably the Department of Justice. There are all sorts of potential criminal and civil consequences – lawsuits. Civil lawsuits are a certainty. And here he is sort of tweeting out his thoughts about it. It's every attorney’s nightmare of what a client might do.”
Other attorneys agree, including John Sparacino, a principal at McKool Smith, who suspected Bankman-Fried did not run his tweets through a lawyer.
The former FTX CEO’s conduct is “going to be under a microscope,” said Sparacino, and it seems likely that some of Bankman-Fried’s tweets may come back to haunt him as litigation works its way through the courts.
Sparacino said he did not know if there were any regulatory or criminal aspects to the tweets, but would still expect them to show up in litigation.
The fact that Bankman-Fried repeatedly took to Twitter to reassure his exchange’s users that everything was fine before the various stages of its fall could make any case against him easier, said White, calling the tweets “extraordinarily foolish.”
“It creates new bases for criminal or civil claims against him just based on those tweets,” White said. “So if he says that everything's fine, that their assets are real assets, and that's not true, then that can be securities fraud, and wire fraud, all sorts of other stuff, not to mention all sorts of civil causes of action … It is just disastrously reckless.”
Investigators may look at what Bankman-Fried’s tweets would indicate to individual investors, as well as what FTX’s representations were. And while it is entirely possible that Bankman-Fried may have believed that his exchange was safe and stable before being proven wrong by unanticipated events, it is also possible that he tweeted inaccurate information. The exchange’s ties to Alameda will also raise scrutiny – if Bankman-Fried was transferring user funds into Alameda and losing those investments, that may become a liability during litigation.
Asked what advice he’d give Bankman-Fried, White said, “My advice is shut the f*** up or I quit.”
“Even if the money is good, sometimes you just don't as a lawyer,” he said. “You don't want to be attached to someone who's deciding to self-immolate.”
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