On December 12, 2022, billionaire Sam Bankman-Fried was arrested at his apartment complex in Nassau, Bahamas, after criminal charges were filed in New York. It was a dramatic fall for the founder and CEO of the FTX cryptocurrency exchange that saw his $32 billion company plunge into bankruptcy. The day after his arrest federal prosecutors and regulators unsealed an indictment and two civil complaints alleging that the King of Crypto not only perpetrated a fraud, it was a swindle from the start. Although the FTX collapse stunned the crypto world some industry players had been wary that the dizzying ascent of FTX had exceeded his grasp.

1. Introduction

On December 9, 2022, a federal grand jury returned an indictment in the U.S. District Court, Southern District of New York, charging Mr. Bankman-Fried with conspiracy to commit wire fraud, conspiracy to commit commodities fraud and conspiracy to commit securities fraud. He was arrested three days later and extradited to the United States. The core of the allegations is that he, and others, devised a scheme to use deposits made by FTX customers to pay the expenses and debts of Alameda Research, his proprietary crypto hedge fund. In an article titled Prosecutors Say FTX Was Engaged in a ‘Massive, Yearslong Fraud’ published in The New York Times edition of December 13, 2022, David Yaffe-Bellamy, Matthew Goldstein and Emily Flitter reported that “[t]he strategy of taking money from FTX to keep Alameda afloat imploded when customers of the crypto exchange started demanding their money this fall. The financial hole was $8 billion, so big that the whole enterprise collapsed.” (here)

2. Who is Sam Bankman-Fried?

The son of Joseph Bankman and Barbara Fried, both law professors at Stanford Law School, Mr. Bankman-Fried received a bachelor’s degree in physics and mathematics from the Massachusetts Institute of Technology in 2014. His career path developed from Jane Street Capital, a proprietary trading firm, to the founding of Alameda Research in 2017 and the FTX cryptocurrency exchange in 2019 where he was the CEO. He has been reported to be a supporter of the moral crusade called “effective altruism” which encourages people to maximize their positive social impact. (here) He went into finance “hoping to make a fortune so he could give it away to charity.” Under his tutelage in the wheelhouse, FTX gained “a reputation for creating new markets at a frenetic pace.” (here) At one time he was ranked as the forty-first richest American and the sixtieth richest person in the world. But by November 8, 2022, his net worth plummeted ninety-four per cent from $10.5 billion to $991.5 million in one day. On November 11, 2022, the Bloomberg Billionaires Index considered Mr. Bankman-Fried to have no material wealth.

3. What is FTX Trading Ltd.?

FTX Trading Ltd., commonly known as “FTX”, specialized in derivatives and leveraged products and was the world’s third largest centralized cryptocurrency exchange in 2021. It also offered a range of other products including options and volatility products. Incorporated in Antigua and Barbuda, and headquartered in the Bahamas, FTX filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the District of Delaware on November 11, 2022, and Mr. Bankman-Fried resigned as CEO. Once valued at $32 billion, FTX has $8 billion of liabilities it can’t pay to one million creditors according to the bankruptcy filing. The new court-appointed CEO, John J. Ray III, told a U.S. House of Representatives Committee on December 13, 2022, that FTX appeared to be a case of “old-fashioned embezzlement” and it is unlikely that investors and creditors will get all their money back. (here) In his Declaration In Support of Chapter 11 Petitions, Mr. Ray said he has never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” (here)

4. The Fall

Suspicions about the financial stability of FTX began circulating during the crypto winter of 2022. On November 2, 2022, Ian Allison reported in an article published by CoinDesk that “[…] Alameda rests on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto.” (here) On November 11, 2022, The Wall Street Journal and other international news agencies reported that “FTX lent billions of dollars of customer assets to fund risky bets by its affiliated trading firm, Alameda Research, setting the stage for the exchange’s implosion […].” (here and here) The slide accelerated when Binance, FTX’s main competitor, sold its crypto tokens linked to FTX. Binance CEO, Changpeng Zhao, announced that his company would be selling off the holdings “in light of recent revelations.” Binance said reports of “mishandled customer funds and alleged US agency investigations” had swayed its decision. Panicked FTX customers then began withdrawing billions of dollars from the exchange. FTX was bankrupt. (here and here)

5. The Indictment

On December 13, 2022, the U.S. Attorney’s Office for the Southern District of New York announced the unsealing if the eight count indictment charging Mr. Bankman-Fried with a total of five conspiracies as well as other offences arising from the alleged scheme to misappropriate customer funds deposited with FTX. (here) I will give you the following four key allegations from the indictment:

• From at least in or about 2019, up to and including in or about November 2022 […] BANKMAN-FRIED, along with others, engaged in a scheme to defraud customers of FTX.com by misappropriating […] customers’ deposits, and using those deposits to pay expenses and debts of Alameda Research, BANKMAN-FRIED’s proprietary crypto hedge fund, and to make investments. (count 1)
• It was a part and object of the conspiracy that […] BANKMAN-FRIED agreed with others to defraud lenders to Alameda Research, BANKMAN-FRIED’s proprietary crypto hedge fund, by providing false and misleading information to those lenders regarding Alameda Research’s financial condition. (count 3)
• It was a part and an object of the conspiracy to commit commodities fraud that the defendant and others agreed to use customers’ deposits, “in connection with a swap, a contract of sale of a commodity in interstate commerce” to pay expenses and debts of Alameda Research. (count 5)
• From at least in or about May 2022, up to and including in or about November 2022, the defendants and others conspired to commit securities fraud […] by providing false and misleading information to […] investors regarding FTX.com’s financial condition. (count 6)

The indictment also alleges that Mr. Bankman-Fried conspired with others to engage in violations of federal law regarding “contributions to candidates for federal office”. The United States seeks forfeiture of all property that constitutes or is derived from proceeds traceable to the commission of the offences. (here)

6. Two Civil Complaints

Civil complaints have been initiated by the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission. The SEC alleges that Mr. Bankman-Fried concealed the diversion of customers’ funds from FTX to Alamada Research while raising more than $1.8 billion from investors. (here) The CFTC alleges that Mr. Bankman-Fried made material misrepresentations in connection with the sale of digital commodities in interstate commerce. The CFTC asserts that his actions caused the loss of over $8 billion in customer deposits. (here) Both complaints have been filed in the U.S. District Court, Southern District of New York.

(a) The SEC Complaint

The SEC asserts that Mr. Bankman-Fried solicited equity investors by “touting FTX’s controls and risk management” ultimately raising $1.8 billion from investors in exchange for various classes of stock in FTX through multiple fundraising rounds. He claimed in public forums and directly to investors that: (a) FTX was a safe crypto asset trading platform; (b) FTX had a comparative advantage due to its automated risk mitigation procedures; and, (c) FTX and its customers were protected from other customers’ losses due to FTX’s automated liquidation process. These statements were misleading, the SEC claims, in light of Mr. Bankman-Fried’s failure to disclose to FTX investors the diversion of FTX customer funds to Alameda which he used for his own purposes including loans to himself. He also did not disclose “the special treatment afforded to Alameda on FTX, including its virtually unlimited ‘line of credit’ at FTX.” (here)

(b) The CFTC Complaint

The CFTC complaint alleges that, at its peak, the daily trading volume on the FTX platform was over $20 billion and it had garnered a $32 billion valuation. FTX had prominent paid sponsorships and celebrity endorsements. A Super Bowl commercial in 2022 touted FTX as “the safest and easiest way to buy and sell crypto.” The CFTC claims that, known only by a small circle of insiders, FTX customer deposits intended to be used for trading or custodies on FTX were regularly “accepted, held by, and/or appropriated by Alameda for its own use.” At Mr. Bankman-Fried’s direction “FTX executives created features in the underlying code for FTX that allowed Alameda to maintain an essentially unlimited line of credit on FTX.” The executives, including Mr. Bankman-Fried, also took “hundreds of millions of dollars in poorly-documented ‘loans’ from Alameda” which they used to purchase luxury real estate and to make political donations. (here)

7. Conclusion

Once a darling of Silicon Valley investors and a prolific contributor to political campaigns, Mr. Bankman-Fried is now caught in the crosshairs of a criminal indictment and two regulatory complaints painting him in the mould of Bernie Madoff who orchestrated a notorious pyramid scheme. On January 3, 2023, Shayna Jacobs reported for The Washington Post that two of Mr. Bankman-Fried’s close associates have entered into agreements with prosecutors. In addition to pleading guilty to similar charges, former FTX chief technology officer Gary Wang and former Alameda Research CEO Caroline Ellison agreed to cooperate with the Department of Justice. They may be critical in helping prosecutors to follow the money. (here) At Mr. Bankman-Fried’s arraignment last month, Assistant U.S. Attorney Danielle Sasson had described the relationship between FTX and Alameda as “unique and concealed”. On February 7, 2023, prosecutors filed applications to stay the SEC and CFTC complaints “until the conclusion of the parallel criminal case” that will likely impact the issues in the civil cases. Two days ago Mr. Bankman-Fried did not contest the applications. (here) The trial is scheduled to begin on October 2, 2023.