On Dec. 11, Bankman-Fried was arrested in the Bahamas on federal criminal charges at the direction of the U.S. Attorney for the Southern District of New York, just one day before preparing to testify before the House Committee on Financial Services about why FTX, once valued at $32 billion, collapsed and filed for Chapter 11 bankruptcy protection in November.
In testimony at that same hearing, John Ray, FTX’s new chief executive who was brought in to clean up the mess, commented, “I don’t trust a single piece of paper in this organization.” He went on to say the case isn’t as complex as some are making out, but rather, “old-fashioned embezzlement.”
“This is just taking money from customers and using it for your own purpose,” Ray said. “Not sophisticated at all,” he continued, explaining that what might have been sophisticated about the scheme was hiding it in plain sight.
Ray has been tasked with implementing a restructuring plan that will serve as the roadmap for navigating the FTX debtor entities through Chapter 11 and to a final resolution with its customers and creditors. He previously served as chairman of Enron Creditors Recovery Corp., a company tasked with recovering creditor funds from Enron in the wake of its accounting scandal and subsequent collapse.
In his testimony, Ray described a long list of what he called “unacceptable management practices” at the FTX Group, including the following:
- The use of computer infrastructure that gave individuals in senior management access to systems that stored customer assets, without security controls to prevent them from redirecting those assets;
- The storing of certain private keys to access hundreds of millions of dollars in crypto assets without effective security controls or encryption;
- The ability of Bankman-Freid controlled hedge fund Alameda to borrow funds held at FTX.com to be utilized for its own trading or investments without any effective limits;
- The commingling of assets;
- The lack of complete documentation for transactions involving nearly 500 investments made with FTX Group funds and assets;
- The absence of audited or reliable financial statements;
- The lack of personnel in financial and risk management functions; and
- The absence of independent governance throughout the FTX Group.
Details of the Fraud
In an eight-count indictment, unsealed Dec. 13, the Department of Justice charged Bankman-Fried with wire fraud, commodities fraud, securities fraud, money laundering, and a scheme to defraud the Federal Election Commission and commit campaign finance violations. The DoJ did not go into any further detail in its indictment. Five of the charges each carry a maximum sentence of 20 years in prison; three others carry a maximum sentence of five years each.
The Securities and Exchange Commission Dec. 12 separately filed securities fraud charges in the Southern District of New York against Bankman-Fried. According to the SEC’s complaint, since at least May 2019, Bahamas-based FTX raised more than $1.8 billion from equity investors, including approximately $1.1 billion from 90 U.S.-based investors.
“In his representations to investors, Bankman-Fried promoted FTX as a safe, responsible crypto asset trading platform, specifically touting FTX’s sophisticated, automated risk measures to protect customer assets,” the SEC said. In reality, according to the SEC complaint, Bankman-Fried orchestrated a years-long fraud to conceal from FTX’s investors:
- The undisclosed diversion of FTX customers’ funds to Alameda Research, Bankman-Fried’s privately held crypto hedge fund;
- The undisclosed special treatment afforded to Alameda on the FTX platform, including providing Alameda with a virtually unlimited “line of credit” funded by the platform’s customers and exempting Alameda from certain key FTX risk mitigation measures; and
- The undisclosed risk stemming from FTX’s exposure to Alameda’s significant holdings of overvalued, illiquid assets such as FTX-affiliated tokens.
The SEC complaint further alleged Bankman-Fried “used commingled FTX customers’ funds at Alameda to make undisclosed venture investments, lavish real estate purchases, and large political donations.”
“We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto,” said SEC Chair Gary Gensler. “The alleged fraud committed by Mr. Bankman-Fried is a clarion call to crypto platforms that they need to come into compliance with our laws.”
“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,” Gensler added. “It also shines a light into trading platform conduct for both investors through disclosure and regulators through examination authority. To those platforms that don’t comply with our securities laws, the SEC’s Enforcement Division is ready to take action.”
“FTX operated behind a veneer of legitimacy Mr. Bankman-Fried created by, among other things, touting its best-in-class controls, including a proprietary ‘risk engine,’ and FTX’s adherence to specific investor protection principles and detailed terms of service—but as we allege in our complaint, that veneer wasn’t just thin, it was fraudulent,” said Gurbir Grewal, Director of the SEC’s Division of Enforcement. “FTX’s collapse highlights the very real risks that unregistered crypto asset trading platforms can pose for investors and customers alike.”
The SEC’s complaint charges Bankman-Fried with violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. It seeks injunctions against future securities law violations; an injunction that prohibits Bankman-Fried from participating in the issuance, purchase, offer, or sale of any securities, except for his own personal account; disgorgement of his ill-gotten gains; a civil penalty; and an officer and director bar. Investigations into other securities law violations and into other entities and individuals relating to the alleged misconduct are ongoing, the SEC said.
CFTC Action
In a third parallel enforcement action, the Commodity Futures Trading Commission (CFTC) filed a complaint in the U.S. District Court for the Southern District of New York against Bankman-Fried, FTX Trading, and Alameda. All three were charged with fraud and material misrepresentations in connection with the sale of digital commodities in interstate commerce. The CFTC complaint further asserts that the scheme resulted in the loss of over $8 billion in FTX customer deposits.
According to the CFTC complaint, from at least May 2019 through Nov. 11, 2022, Bankman-Fried controlled both FTX.com and Alameda. As charged, FTX held itself out as “the safest and easiest way to buy and sell crypto” and represented that customers’ assets, including both fiat and digital assets including bitcoin and ether, were held in “custody” by FTX and segregated from FTX’s own assets.
“To the contrary, FTX customer assets were routinely accepted and held by Alameda and commingled with Alameda’s funds,” the CFTC said. “Alameda, Bankman-Fried, and others also appropriated customer funds for their own operations and activities, including luxury real estate purchases, political contributions, and high-risk, illiquid digital asset industry investments.”
The CFTC complaint further alleges that, at Bankman-Fried’s direction, FTX employees created features in the FTX code that favored Alameda and allowed it to execute transactions even when it did not have sufficient funds available, including an “allow negative flag” and effectively limitless line of credit that allowed Alameda to withdraw billions of dollars in customer assets from FTX. These features were not disclosed to the public.
In its continuing litigation, the CFTC seeks restitution, disgorgement, civil monetary penalties, permanent trading and registration bans, and a permanent injunction against further violations of the Commodity Exchange Act and CFTC regulations.
Compliance Overhaul
Ray described the restructuring plan for FTX as having five core objectives, as described below:
Implementation of risk management, compliance, and security controls: This objective, which he said is already underway, “involves building accounting, audit, cash management, cybersecurity, human resources, risk management and other systems that did not exist, or did not exist to an appropriate degree, prior to my appointment.”
As part of this objective, a new management team will be brought on board. Among the company’s new appointments include the hiring of a new chief financial officer; a new head of human resources and administration; and a new head of information-technology, “all of whom have deep experience in their areas of core competency and have also managed other, large-scale corporate failures,” Ray said.
A team of independent third-party professionals has also been engaged in the “necessary areas of restructuring, forensic accounting, tax disciplines, and cybersecurity, including Alvarez & Marsal, Alix Partners, Ernst & Young, respectively, along with a cybersecurity firm,” he said.
Asset protection and recovery: We are working around the clock to locate and secure the property of the estate, a substantial portion of which may be missing, misappropriated, or not readily traceable due to the lack of proper record keeping. “We are working with Nardello & Company, Chainalysis, BitGo, Alvarez & Marsal and our cybersecurity firm on these recovery efforts,” Ray said. Thus far, more than $1 billion of digital assets to protect against the risk of theft or unauthorized transfers have been secured.
Transparency and investigation: Our investigative and cyber security teams, led by the law firm Sullivan & Cromwell, are already well into the process of gathering the evidence that will provide us with an understanding of what led to this collapse. They are working in close coordination with U.S. and foreign regulatory and law enforcement authorities. In addition, the entire process is being overseen by a newly appointed independent board of directors, chaired by former U.S. Attorney and Chief Judge for the U.S. District Court for the District of Delaware, the Honorable Joseph Farnan.
Efficiency and coordination: This objective requires cooperation and coordination with insolvency proceedings of subsidiary companies in other jurisdictions.
Maximization of value for stakeholders: “A fundamental, overarching challenge with each of these objectives is that we are, in many respects, starting from near-zero in terms of the corporate infrastructure and record-keeping that one would expect to find in a multi-billion-dollar international business,” Ray said. “Still, in just over four weeks since assuming control of FTX, we have instituted meaningful steps to gain command and control and are well on our way to achieve the goals outlined above.”
The scope of the investigation is “enormous,” Ray said, and involves “detailed tracing of money flows and asset transfers from the time of FTX’s founding and highly complex technological efforts to identify and trace crypto assets.” Currently, “dozens of terabytes of documents and data, including records of billions of individual transactions,” are being collected and reviewed, he added, “and we are leveraging sophisticated technology and expertise to identify and trace additional transactions and assets.”
All information gained will be summarized in a manner useful not only to the bankruptcy estate, but also to governmental and regulatory stakeholders, Ray said. “We know that our investigative record will be the foundation for work done by many others, and we are committed to building a reliable foundation.” 
Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.