In the SEC lawsuit against Bankman-Fried, what about the customers?

Federal prosecutors and regulators from the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission all told a similar story Tuesday about Sam Bankman-Fried’s alleged scheme to embezzle billions of dollars of money from FTX crypto exchange customers to Alameda Research.

They all accused Bankman-Fried of fraud, saying he repeatedly lied when he insisted that FTX customer money was safe, secure and completely separate from the affiliated but supposedly independent Alameda.

According to the indictment unsealed Tuesday in Manhattan federal court and separate complaints filed Tuesday by the SEC and the CFTC, Bankman-Fried knew or should have known that money was being diverted from FTX client accounts to fund Alameda’s speculative trading and that, despite its repeated protests 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 fraud?

The CFTC complaint exposed the deception of FTX users who the regulator said were tricked into thinking their money was safe. The Manhattan U.S. Attorney’s indictment also named FTX customers as victims of wire fraud and commodity fraud charges against Bankman-Fried.

But the SEC lawsuit focused on another group of alleged victims: the investors who invested $1.8 billion in FTX in a series of stock purchases between 2019 and 2022. (The 90 shareholders of U.S.-based FTX held a $1.1 billion stake, the SEC said.)

Reuters reported that FTX stock investors included companies such as Sequoia Capital, SoftBank Group, BlackRock and Temasek – not exactly small crypto clients who wanted to trade on the FTX platform and trusted Bankman-Fried promises that their money would be safe.

An important note here: Bankman-Fried’s attorney, Mark Cohen of Cohen & Gresser, told Reuters on Tuesday that his client is “reviewing the charges with his legal team and considering all of his legal options.” The SEC, meanwhile, did not answer my question about the framing of its lawsuit.

And to be fair, the SEC complaint, as I mentioned, also victimized FTX customers, albeit in parentheses.

I’m literal: the second sentence of the SEC’s complaint reads, “Unbeknownst to these investors (and FTX’s trading clients), Bankman-Fried orchestrated a massive, years-long fraud, diverting billions of dollars from fund trading platform client for his personal benefit and to help grow his crypto empire.”

What I mean is that the SEC’s advocacy strategy in Tuesday’s lawsuit shows that crypto remains a big challenge for US regulators. An alleged fraudster is accused of embezzling billions of dollars from clients who wanted to buy and sell crypto, but the top US investor protection agency is not claiming securities fraud on behalf of those clients.

Securities law professor Ann Lipton of Tulane University School of Law said this was likely due to regulatory uncertainty about which crypto assets meet the definition of a security. (As you know, this issue, in turn, is the subject of intense litigation between the SEC and Ripple Labs)

“The SEC is limited to prosecuting securities fraud — and that requires title to exist,” Lipton said via email. “At the very least, each crypto asset should be analyzed individually to determine if it was a security, which is likely not feasible for clients who have traded many different types of assets.”

Focusing instead on the individuals and funds that have acquired a stake in FTX, Lipton said, “The SEC is avoiding this issue – these investors have certainly purchased securities in the form of stocks.”

Former Manhattan federal prosecutor Timothy Howard of Freshfields Bruckhaus Deringer agreed, “It’s easier and simpler for the SEC to focus on equity investors.”

Unlike private shareholders who sue for securities fraud, the SEC does not have to prove that investors relied on alleged misrepresentations. (The U.S. Department of Justice, which has accused Bankman-Fried of defrauding FTX stock investors in addition to FTX clients, also doesn’t have to prove it relies on the securities fraud. movables.)

“It makes SEC and DOJ lawsuits much easier, because it eliminates all questions about the adequacy of investor due diligence,” Joseph Grundfest, a professor at Stanford Law School, said by email.

Many of the SEC’s allegations involve allegations that FTX lied in statements and reports publicly posted on its websites. But, perhaps anticipating Bankman-Fried’s arguments that he cannot be held responsible for the company’s general statements, the SEC complaint cited two instances in which FTX investors were allegedly misled by Bankman. – Fried himself.

He gave a U.S. investor who bought $35 million worth of FTX stock in July 2021 a document promising that FTX and Alameda were not mixing funds, according to the SEC. And in late summer 2021, according to the complaint, Bankman-Fried told a potential US investor who ultimately acquired a $30 million stake that FTX did not hold its native cryptocurrency, tokens known as FTT’s name.

According to the SEC, Bankman-Fried knew or should have known that his statement to the investor was false.

These specific allegations, Freshfield’s Howard said, appear intended to show Bankman-Fried that FTX investors are cooperating with the government — and that he can’t escape responsibility simply by saying he wasn’t. unaware of FTX’s public statements.

Looking far down the road at the potential fallout from FTX’s collapse, I’d be interested to see if any clients or creditors of FTX try to pin the blame on the equity investors who are considered victims in the lawsuit. SEC on Tuesday, arguing that their due diligence failures enabled the platform’s subsequent alleged misconduct.

If that happens, it will be even more interesting to see if FTX stock investors point to their description in the SEC complaint as evidence that they too were victimized by Sam Bankman-Fried.

© Thomson Reuters 2022

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