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3 US agencies throw the fraud book at FTX’s Bankman-Fried

The legal hits just keep on coming for Sam Bankman-Fried (SBF), who has been criminally charged by no less than three different U.S. government agencies for his role in the collapse of the FTX digital asset exchange.

Following Monday’s news that SBF had been arrested at his home in the Bahamas at the request of U.S. law enforcement, Tuesday brought his first court appearance, where his request to be released on $250,000 bail was denied. SBF will spend at least one night in a Bahamas jail, where the reality of his situation may finally pierce his thick, Adderall-addled skull.

Ahead of his inevitable extradition to the U.S., Tuesday saw the Department of Justice (DOJ) unseal its eight-count indictment against SBF. The charges are: conspiracy to commit wire fraud on customers and lenders, wire fraud on lenders, conspiracy to commit commodities fraud, conspiracy to commit securities fraud, conspiracy to commit money laundering, and conspiracy to defraud the United States and commit campaign finance violations. If convicted on all counts, SBF could be sentenced to 115 years in prison.

The DOJ also seeks the forfeiture of “any and all property, real and personal” derived via the above offenses. If any of this property has been transferred, sold, or placed beyond the U.S. court’s jurisdiction, or if the value of the sought property has “substantially diminished in value,” the DOJ seeks the forfeiture of “any other property” that SBF might possess.

The DOJ accuses SBF of defrauding FTX.com customers “by misappropriating those customers’ deposits and using those deposits to pay expenses and debts of Alameda Research, [SBF’s] proprietary crypto hedge fund, and to make investments.” Lenders were defrauded by SBF by “providing false and misleading information … regarding Alameda’s financial condition.”

The commodity securities fraud involved lying to users looking to trade swaps on FTX.com and using customer deposits to “among other things, satisfy loan obligations owed by Alameda.” The plain old securities fraud involved SBF “providing false and misleading information to those investors regarding FTX.com’s financial condition,” including (for the purposes of the Southern District’s action) investors based in New York City.

The money laundering occurred when SBF engaged in financial transactions involving “the proceeds of specified unlawful activity” that were designed to “conceal and disguise the nature, the location, the source, the ownership, and the control” of said proceeds.

The campaign finance charge involves SBF and other FTX principals making donations that violated federal election laws regarding “source and amount restrictions.” In addition to exceeding $25,000 caps, these contributions were made to New York candidates and committees and “reported in the name of another person.”

At a press conference announcing the indictment, Williams suggested that SBF’s downfall will be recognized as “one of the biggest financial frauds in American history.” Williams credited the cooperation of the Federal Bureau of Investigation, the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC), all of which “have been working around the clock to figure out what happened and to begin the process of seeking justice.”

A massive, years-long fraud

Gurbir Grewal, the SEC’s Director of Enforcement, said Tuesday that FTX “operated behind a veneer of legitimacy” that “wasn’t just thin, it was illegitimate.” The SEC’s complaint against SBF alleges violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

The SEC is demanding a jury trial and seeks disgorgement of SBF’s ill-gotten gains plus civil monetary penalties. The SEC also wants a permanent ban on SBF having anything to do with any securities, “except for his own personal account,” and to prevent SBF from ever again acting as a corporate officer or director, otherwise “he will continue to engage” in criminality.

The SEC notes that SBF raised “more than $1.8 billion” from investors, of which $1.1 billion came from Americans, without bothering to inform them that he was “orchestrating a massive, years-long fraud, diverting billions of dollars of the trading platform’s customer funds for his own personal benefit and to help grow his crypto empire.”

SBF portrayed himself as “a responsible leader of the crypto community” and “touted the importance of regulation and accountability.” Customers “believed his lies” and sent “billions” to FTX in the belief that “their assets were secure on the FTX trading platform.”

Instead, these billions were used as SBF’s “personal piggy bank” and squandered on “speculative venture investments” while crypto’s former boy-wonder “spent lavishly on office space and condominiums in the Bahamas.”

The ultimate decision-maker

In addition to calling the shots at FTX, the SEC details how SBF “remained the ultimate decision-maker at Alameda, even after [Caroline] Ellison and [Sam] Trabucco became co-CEOs in or around October 2021.” SBF “gave Alameda carte blanche to use FTX customer assets for its own trading operations and for whatever other purposes [SBF] saw fit.”

Alameda enjoyed undisclosed “special treatment,” including a “virtually unlimited ‘line of credit’ at FTX, an ability to carry a negative balance in its FTX account, and an exemption from FTX’s automated liquidation process.” SBF also failed to tell investors that “the collateral Alameda deposited on FTX consisted largely of illiquid, FTX-affiliated tokens, including FTT.”

The SEC reveals that SBF directed FTX customers to deposit into bank accounts controlled by Alameda but not always listed under Alameda’s name. These accounts included Alameda subsidiary North Dimension Inc, whose website didn’t disclose any Alameda connection.

The deposited funds were commingled with other Alameda assets and grouped under an internal account in the FTX database called “[email protected]” In quarterly balance sheets provided to lenders, Alameda referred to this liability as a “loan” without disclosing that the funds were loaned by FTX.

When FTX’s liquidity crunch began in 2022, the exchange belatedly tried to separate the [email protected] account’s customer deposits sent to Alameda-controlled bank accounts from those sent to accounts controlled by FTX. The resulting $8 billion liability imposed on Alameda accidentally triggered FTX’s internal systems to start charging Alameda interest on this sum, payments Alameda had not previously been required to make. In response, SBF shifted Alameda’s liability to an account “associated with an individual that had no apparent connection to Alameda” that wouldn’t be subject to interest charges.

In 2021, SBF directed Alameda to borrow billions of dollars from third-party crypto lending firms “to fund [SBF’s] venture investments and for his personal use.” As token prices crashed in May 2022, these lenders demanded repayment. Alameda didn’t have the cash, so SBF directed Alameda to claim billions in FTX customer funds via Alameda’s line of credit and to hide this line of credit on Alameda’s balance sheet.

SBF directed Alameda to go on robbing customer funds in this fashion through the summer “to pay hundreds of millions of dollars in ‘loans’ to [SBF] and other FTX executives, as well as hundreds of millions more to fund additional venture investments.”

All this time, FTX’s terms of services assured customers that their funds were properly segregated from operating capital and that FTX held sufficient liquid reserves to meet all withdrawal requests. Investors were shown “materially misleading” financial statements that supposedly had been audited, but FTX’s court-appointed CEO John J. Ray III has expressed “substantial concern as to the information presented” in these audits.

Out of control

The SEC alleges that “from its inception, FTX had poor controls and fundamentally deficient risk management procedures.” Despite these deficiencies, SBF told the U.S. House of Representatives’ Financial Services Committee in December 2021 that FTX offered “complete transparency about the full open interest. There is complete transparency about the positions that are held. There is a robust, consistent risk framework applied.”

In a submission to the CFTC, FTX claimed that its ‘automated risk engine’ calculated customer margin levels every 30 seconds, and if collateral sunk beneath the required margin, FTX’s system would automatically sell customers’ assets to restore the margin level. FTX notably failed to mention Alameda’s exemption from this process.

Alameda’s collateral consisted largely of FTT and other “illiquid crypto assets issued by FTX and [SBF],” the sale of which “would not have generated sufficient funds to cover the amount Alameda borrowed from FTX.” SBF “knew, or was reckless in not knowing” that Alameda had no business holding an unlimited line of credit “collateralized by a large illiquid position.”

Also, as late as September 2021, SBF “falsely told certain investors that FTX had no exposure to FTT at all.” One U.S. investor assured that he wouldn’t have any exposure to FTT, and subsequently invested $30 million.

I’d gladly pay you Tuesday for a condominium today

Between March 2020 and September 2022, SBF “executed promissory notes for loans from Alameda totaling more than $1.338 billion, including two instances in which [SBF] was both the borrower in his individual capacity and the lender in his capacity as CEO of Alameda.”

Alameda co-founders Gary Wang and Nishad Singh received loans of $224.7 million and $554 million, respectively, over the same period. These loans “were poorly documented and at times not documented at all.” Records for the real estate purchased with these loans “was poorly organized and documented.” None of this was disclosed to investors.

Some of these loans were made even as the FTX/Alameda roof was crashing down on SBF’s head, including third-party lending platforms calling in loans made to FTX/Alameda. Thus, SBF’s actions during this period “further imperiled FTX’s financial condition.” Throughout, SBF continued to lie to investors regarding the severity of the problem.

When Alameda’s wonky balance sheet was leaked in early November, SBF “sought emergency funding from other investors” to cover the $8 billion hole in FTX’s books. A balance sheet SBF circulated to investors listed a negative $8 billion entry labeled as a “hidden, poorly internally labeled ‘[email protected] account.'”

Two days before FTX declared bankruptcy, Ellison admitted to Alameda staff that she, SBF, Wang, and Singh “were aware that FTX customer funds had been used by Alameda.”

Alameda puts the ‘front’ in ‘front-run’

The CFTC, on whose behalf SBF had lobbied hard to assume the primary role in overseeing digital assets, filed its own complaint in the Southern District on Tuesday. SBF, FTX, and Alameda are all charged with “fraud and material misrepresentations in connection with the sale of digital commodities in interstate commerce.”

There’s a lot of overlap here with the other two complaints but there are a few juicy bits, including the claim that Alameda enjoyed “quicker execution times” on FTX. This ability to “bypass certain portions of the system and gain faster access to the API” allowed it to front-run lesser customers, even high-frequency traders. Similar speed advantages came via FTX exempting Alameda from the “automated review process” that, among other things, verified account balances.

Alameda also enjoyed a “special designation” in the FTX Trading code, an “allow negative flag” that permitted Alameda to execute a transaction even if it did not have the necessary funds in its account. When Alameda exceeded its credit limit, SBF directed staff to boost Alameda’s borrowing limit to “many tens of billions of dollars,” effectively eliminating all constraints on Alameda.

To hide the $8 billion hole in Alameda’s balance sheet, SBF directed FTX staff to reallocate the liabilities to a customer account he later described as “our Korean friend’s account” and/or “the weird Korean account.” This ‘Korean’ account was granted the same negative-balance/liquidation-exempt privileges as Alameda.

In September 2022, SBF circulated a document in which he proposed shutting down Alameda, something he suggested probably should have been done “a year ago.” SBF revealed that, because “we didn’t hedge as much as we should have,” the expected downside could cost more “than all the money Alameda has ever made or will ever make.”

At the same time, an apparently conflicted SBF acknowledged that, due to the interdependence of FTX/Alameda, “we can’t really shut [Alameda] down.” SBF went as far as to draft a Twitter thread asking the FTX community for “thoughts” on shutting down Alameda, but never published these tweets.

It’ll all come out in the wash

Following the early-November revelation of Alameda’s wonky accounting and Binance CEO’s Changpeng ‘C.Z.’ Zhao’s public pledge to dump his half-billion worth of FTT, a chat group involving SBF and some Alameda execs featured the following exchange:

[former Alameda executive 1]: “I’m surprised BTC isnt down more”

[former Alameda executive 2]: “me too”

Bankman-Fried: “yea me 3”

(While the BTC token did subsequently suffer a decline, SBF well understood the volume of BTC-Tether wash trading that occurs on exchanges such as Binance that are specifically intended to keep the value of BTC and other tokens from cratering in times of crisis.)

As FTX customers flooded the exchange with withdrawal requests, SBF gave approval to a plan to “close everything down to generate capital, maximally aggressive,” with instructions to “liquidate all positions.” SBF pressed his traders on how quickly they could raise “at least $2b of USD.”

On November 7, when FTX execs were asked to evaluate the solvency of the allegedly arms-length FTX US exchange, they were “readily able” to do so and discovered “a shortfall they did not understand and were unable to quantify.” The following day, an Alameda exec revealed that “apparently part of what’s going on is that Alameda actually has a long USDT/short USD margin position on FTX US that we aren’t tracking?” This same exec explained that this “is why FTX US has less USD than we thought it should.”

That same day, SBF directed Alameda traders to prioritize meeting FTX US capital requirements and to send any excess capital to the U.S. exchange. Around $185 million was duly transferred to FTX US.

Around the same time, SBF prepared a balance sheet to show to prospective bailout investors that claimed the $8 billion hole was due to the aforementioned “hidden, poorly internally labeled ‘[email protected]’ SBF made this claim despite his having directly managed and directed the use of this account for nefarious purposes.

Bahama drama

SBF’s troubles aren’t limited to ‘Murica. When he was arrested Monday in the Bahamas, local authorities insisted that their own probe into FTX/Alameda was ongoing. Attorney General Ryan Pinder saw the need to insist that neither he nor any other local government official had given SBF the okay to restart withdrawals for the exchange’s Bahamian clients the day before FTX et al. filed for Chapter 11 bankruptcy protection in Delaware.

Documents filed with the Delaware court on Monday included an email exchange between SBF and Pinder in the wee hours of Thursday, November 10. In this 2:27 am email, SBF offered his now standard apologies and vowed to do whatever it took to make customers whole.

But SBF also declared that “we have segregated funds for all Bahamian customers on FTX.” FTX had suspended all transactions on November 8, but SBF told Pinder that he would be “more than happy to open up withdrawals for all Bahamian customers” in the morning. SBF told Pinder that “it’s your call whether you want to do this” but then stated that “if we don’t hear back from you, we are going to go ahead and do it tomorrow.”

The court filings don’t include any response from Pinder before that morning, upon which FTX did indeed begin processing withdrawals for customers who allegedly called the Bahamas home. Court filings indicate that around 1,500 individuals withdrew “nearly $100 million” in the 25.5 hours that FTX granted these customers access to their funds.

At the time, social media was abuzz with claims that some Bahamas-based FTX customers had concocted a scheme in which other customers could transfer their FTX assets to the Bahamian customers, who would then withdraw the non-Bahamian customer funds for a commission.

On Tuesday, Bahamian media outlet Tribune242 quoted Pinder saying “no authorization was given by any party” for FTX to permit withdrawals by Bahamian customers. Speculation is rife that some ‘politically exposed persons’ may have been among the 1,500 Bahamian customers who were able to get their funds off FTX before the bankruptcy filing.

We pause here to note that Pinder formerly served as an executive at Deltec Bank & Trust, the Bahamas financial institution whose clients included not only FTX/Alameda but also Tether, the company behind the controversial stablecoin of the same name. Alameda was among the largest recipients of Tether, which, given SBF’s shoddy financial record, has sparked skepticism that his companies sent anywhere near $40 billion to Tether, which in turn is sparking questions as to what arrangement the two parties really had.

While SBF didn’t make his scheduled appearance at Tuesday’s House Financial Services Committee hearing, Forbes obtained the statement that SBF purportedly planned to read into the record. In keeping with his previous tweets and his ill-advised media apology tour, SBF apparently planned to start his address “by formally stating, under oath: I fucked up.” Dude, read the room…

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of groups—from BitMEX to Binance, Bitcoin.com, Blockstream, ShapeShift, Coinbase, Ripple,
Ethereum, FTX and Tether—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.

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