By Mark S. Nelson, J.D.
According to civil complaints filed by the SEC and CFTC, and a now-unsealed 8-count federal criminal indictment, Samuel Bankman-Fried, the founder and one-time CEO of FTX Trading Ltd. d/b/a FTX.com allegedly sought to prop up a years-long fraudulent scheme by using a related hedge fund he owned or controlled to divert investors’ funds to his personal use. FTX had been touted as a safe place to invest in crypto assets and became almost a household name beginning in early 2022 just before prices of crypto assets in the wider crypto marketplace began to plummet and FTX and its related hedge fund began to falter. The criminal indictment is also significant for its allegations of money laundering and campaign finance law violations in addition to repeating many of the same securities and commodities charges brought by the SEC and CFTC (SEC v. Bankman-Fried, December 13, 2022; CFTC v. Bankman-Fried, December 13, 2022; U.S. v. Bankman-Fried, December 13, 2022).
U.S. Attorney General Merrick B. Garland recited in a press release the basic facts underlying the criminal charges and commented on the federal government’s efforts to police financial markets. “As this indictment demonstrates, the U.S. Department of Justice will aggressively investigate and prosecute alleged criminal wrongdoing in the financial system and violations of federal elections laws,” said Garland. “We will continue to work to ensure U.S. capital markets operate honestly and with the integrity that investors, lenders, and the American people are entitled to.”
“[P]ersonal piggy bank.” The SEC’s complaint alleged that Bankman-Fried engaged in a multi-year scheme to defraud equity investors in FTX Trading Ltd. According to the SEC, Bankman-Fried raised $1.8 billion in investor funds between May 2019 and November 2022.
The SEC further alleged that despite Bankman-Fried’s claims that FTX was a responsible crypto platform that took the safety of customer funds seriously by having, among other things, automated risk mitigation procedures, Bankman-Fried was actually using FTX, and a related hedge fund, Alameda Research LLC, as his “personal piggy bank.”
The SEC’s complaint explained that Bankman-Fried’s scheme began to fall apart when crypto prices nosedived in early 2022 and Alameda’s lenders began to demand payment. The SEC said Bankman-Fried engaged in ever-larger diversions of FTX customer funds to prop up Alameda, which diversions took several forms, including: (1) telling FTX customers to deposit fiat currency in bank accounts under Alameda’s control; and (2) permitting Alameda to draw from a “virtually limitless ‘line of credit’” at FTX.
According to SEC Chair Gary Gensler, commenting via press release, “[t]he alleged fraud committed by Mr. Bankman-Fried is a clarion call to crypto platforms that they need to come into compliance with our laws.” Gensler added: “Compliance protects both those who invest on and those who invest in crypto platforms with time-tested safeguards, such as properly protecting customer funds and separating conflicting lines of business.”
The CFTC’s complaint against Bankman-Fried, FTX and Alameda, traces much of the same ground as the SEC’s complaint, including that FTX engaged in major public displays of its supposedly safer way for investors to trade crypto, which was exemplified by FTX’s “2022 Super Bowl commercial that touted FTX as ‘the safest and easiest way to buy and sell crypto.’”
The CFTC’s complaint also outlined some of the ways in which Alameda was treated differently than other users of FTX. For one, Bankman-Fried owned or controlled Alameda, which also was the primary market maker on FTX. Moreover, the CFTC said that Alameda used computer code to step ahead of other FTX investors and secure “an unfair advantage” on the platform. For example, Alameda was able to obtain faster trade execution and it was able to avoid FTX’s “auto-liquidation risk management process.”
“Digital commodity asset markets continue to present risks for investors due to the lack of basic protections,” said CFTC Chairman Rostin Behnam in a press release. “The CFTC continues to be fully committed to using all available enforcement tools and authorities to protect investors and root out those who seek to profit through fraud and misappropriation.”
Civil and criminal charges. The SEC, the CFTC, and the United States Attorney for the Southern District of New York each brought interrelated civil and criminal charges against Bankman-Fried and several related entities in the Southern District of New York, which encompasses Manhattan. The SEC and the related criminal indictment charged only Bankman-Fried, while the CFTC charged Bankman-Fried and two related entities.
According to the SEC, Bankman-Fried allegedly violated Securities Act Sections 17(a)(1), 17(a)(2), and 17(a)(3), which prohibit fraudulent devices, obtaining property or money via untrue statements of material facts or material omissions, and engaging in practices that operate as fraud or deceit upon a purchaser. The SEC also alleged that Bankman-Fried violated Exchange Act Section 10(b) and Rule 10b-5. The CFTC’s complaint makes similar allegations under CFTC Regulation 180.1(a)(1), 180.1(a)(2), and 180.1(a)(3).
The SEC and CFTC both seek permanent injunctions against Bankman-Fried, disgorgement, and civil monetary penalties. The SEC seeks an officer and director bar plus a bar on Bankman-Fried participating securities (including crypto) offerings other than for his own account. The CFTC also seeks various trading bans, restitution, and the payment of costs.
The criminal indictment integrates securities and commodities charges that are similar to the civil charges brought by the SEC and CFTC, while also adding counts for wire fraud, money laundering, and for violations of federal campaign finance laws. The wire fraud charges include conspiracy to commit wire fraud and wire fraud against customers and lenders. The securities, commodities, money laundering, and campaign finance charges are all conspiracy counts.
With respect to the campaign finance law count, the DOJ’s press release alleged that Bankman-Fried sought to hide the fact that the donations were made by a corporation while also seeking to evade limits on political contributions and to evade reporting requirements. Bankman-Fried, the DOJ said, achieved this by having donations made by unnamed co-conspirators instead of by the true source of the donations.
U.S. Attorney Damian Williams, remarking on the collapse of FTX said: “[a]s today’s charges make clear, this was not a case of mismanagement or poor oversight, but of intentional fraud, plain and simple.”
The DOJ, for informational purposes, noted that the wire fraud and money laundering charges each carry a potential maximum sentence of 20 years. The securities, commodities, and campaign finance charges, by contrast, each carry a potential maximum sentence of 5 years.
The cases are Nos. 1:22-cv-10501 (SEC); 1:22-cv-10503 (CFTC); 22 Crim 673 (DOJ).