The Rise and Fall of FTX - Lessons Learned and What's Next?

Zachary Pyers is joined by Zachary Durant, a professional liability attorney at Reminger Co., LPA, to review the rise and fall of one of the world’s largest cryptocurrency exchanges - FTX. They'll discuss the ripple effects of this billion-dollar scandal, including the impact on future crypto regulations.

Be sure to check out the video version of this interview on our YouTube page.

Visit our website for information about our legal services related to emerging technologies.

Transcript

ZBP     Zachary B. Pyers, Esq.

ZRD    Zachary R. Durant, Esq.

ZBP

            Welcome to another edition of the Reminger Report Podcast on Emerging Technologies.  I am excited today to be presenting to you one of my colleagues out of a different office.  I’m in Columbus, but Zach Durant, who is with us, he’s in our Cleveland, Ohio office.  Zach, I appreciate you taking the time to meet with us today and to talk to us a little bit about what you do and kind of some of the developments in the financial sector that we’ll be talking about today.  If you could, could you just tell us a little bit about yourself and your practice area?

ZRD

Sure, yeah.  Thanks for having me on, Zach, and uh, yeah, I, I work out of Cleveland, Reminger’s Cleveland office.  My practice primarily focuses on professional liability, including financial services, professional liability, securities litigation and arbitration, business and commercial litigation, and then also broker/dealer and investment advisor compliance and enforcement defense.

ZBP

            Now, one of the things I want to make sure that our audience knows before we go any further.  Zach and I did not plan our wardrobes today to match like this, but apparently today this is the Reminger uniform is the navy blue jacket and white shirt.  We were even joking beforehand that both are, have black coffee mugs.  Just like the fact that we’re in different offices, apparently this is the, the mandatory look for today, so.  I know that you recently did a, a written Reminger Report on a company called FTX.  Now I know that it’s hard, it’s been hard to flip through or scroll through your news feed within the last several months and not see a headline involving FTX.  Can you tell us a little bit about what FTX is?

ZRD

            Yeah, sure, so it, it’s definitely been a huge story and one that I, I think a lot of people know a little bit of something about but maybe don’t get the full picture of what’s going on, so FTX was one of the world’s largest cryptocurrency exchanges, which means that folks could go on their virtually and, and buy and sell cryptocurrencies like Bitcoin or Dogecoin or even FTX’s own token called FTT.  FTX was founded fairly recently in 2019 by, by Sam Bankman-Fried, who ran the company as its CEO.  It had a pretty meteoric rise where it was attracting all these big name investors and, and getting a lot of attention initially and became a very popular crypto exchange.

ZBP

            Now, are there other companies that are, that are related to FTX either in, in, as an exchange or maybe as kind of like a ancillary business?

ZRD

            Sure, so the, the big one is, is Alameda Research.  Alameda was founded, was also founded by Sam Bankman-Fried a few years before FTX, and Alameda was a crypto trading firm or hedge fund that Bankman-Fried also ran as CEO, and it would later play a significant role in the downfall of FTX which I’m sure we’ll get into.

ZBP

            Well, so, as we’re talking about, you know, and as you’ve kind of led us in that direction, tell us why has FTX been in the news and what are we kind of seeing as a result of, you know, of that?  What happened to FTX?

ZRD

            Yeah, so, as a lot of listeners will probably remember, in, in around November, early November 2022, there started to be a lot of news reports coming out about this FTX and Sam, Sam Bankman-Fried or as, as some refer to him, SBF, which gets a little confusing with FTX, but there were news reports that it was diverting funds, investor funds that FTX had collected and diverting them to Alameda Research.  There were stories about Bankman-Fried taking loans from Alameda, the money that was transferred from, from FTX, and using it for personal investments, using it to purchase real estate in the Bahamas, throw extravagant parties, purchase real estate for his friends and family including other executives, so there were a lot of questions about, well, what’s going on with this company.  Then further news snowballs where there were reports that, well, Alameda’s balance sheet and financials are looking weird where there’s a bunch of FTT tokens making up its balance sheet which again are the tokens issued by FTX, so there was a lot of questions about this company, and it just kept snowballing and snowballing.  I feel like every other day there were new reports out there and, and Bankman-Fried was very visible and going on, like, Twitter Livestreams and talking to people about it, but giving very wishy-washy answers about these questions that were being raised, so it all, it all came to a head very quickly and he ended up resigning as CEO pretty soon thereafter of FTX, and FTX then filed for bankruptcy, so as you can imagine, the, while this is going on, not just the public but the Justice Department and the SEC are paying attention as well, and they’re seeing all these reports and probably have been doing investigating of their own even before the media got their hands on it.  So in December, so again, only about a month and a half after this stuff starts to come out, Bankman-Fried is arrested in the Bahamas at the request of the U.S. government and about a day after, the SEC filed a civil lawsuit seeking an injunction in federal court against him for his conduct in running FTX and Alameda.

ZBP

            So that’s a lot to kind of digest.  You know, one of the things that I think was, is interesting about this, and, and you’ve kind of alluded to this, is kind of how quickly some of this stuff unfolded which, I, I mean, I’ve watched these stories kind of play out before with other businesses and usually it seems to me at least that you, instead of having this kind of almost daily barrage of, of problems that were being leaked or, or, or put forth in the media, you hear, like, one issue and then there might be quiet.  I mean, there may be, you may still have, hear reporting on that one issue, but this was like a series, at least to me it appeared to be a series of issues, and, and the speed at which there was the SEC and the Justice Department kind of sought those remedies, you know, the arrest was, you know, and I’m not a criminal defense lawyer by any stretch, especially not a, a white collar criminal defense lawyer, but it seemed very quick for me.  To me, it seemed very quick for them to be acting where, you know, sometimes it takes them a year or so to build a care.  Here you’re talking in the span of, you know, a month or two, they’re building a case and they’re seeking the, the arrest of, of SBF.  Can you, so we know right now that, you know, there was an arrest warrant for SBF and you mentioned that FTX was in bankruptcy.  What are kind of some of the legal implications of the bankruptcy and the criminal proceedings and, and the other proceedings that, you know, the civil suit that the SEC is, what are some of these legal implications that these entities and individuals face?

ZRD

            Yeah, so there’s a lot going on.  I mean, with the bankruptcy, I know that they’re, they’re, I believe the Trustee’s gonna sign, so they’re working on trying to recoup certain things in that regard, but they’re also, like we talked about, been the criminal charges against SBF and there are eight charges total, and they include wire fraud as to customers, wire fraud as to lenders, conspiracy including conspiracy to commit securities fraud and, and commodities fraud and, and to defraud the United States and violate campaign finance laws, and so it’s a pretty big laundry list of charges that he’s facing personally, and he’s since been extradited to the United States and, and will eventually stand trial or, you know, cut a deal with prosecutors, but in addition, as I mentioned before, there, there have been these civil charges brought by the SEC against Sam Bankman-Fried and the SEC is alleging that $1.8 billion were raised by FTX and he misled those investors who invested that amount of money while also defrauding customers of the exchange, and the SEC alleges that Bankman-Fried hid from his investors that customer funds and investor funds were being diverted to Alameda, like I said, used, used for his personal investments and real estate purchases and, and campaign donations, and so the problem is, is that he’s taking money from investors and not telling them what it’s gonna be used for and, and, uhm, which is a, which is a big no-no in the financial world.  The SEC is seeking civil fines from him, disgorgement of all of the illegally earned profits and a bar from serving as a, an officer or director of a public company, and it’s, it’s a unique procedure because the SEC is basically citing their jurisdiction conferred on them in the Securities Act and Exchange Act which allowed them to, if they, if they think that an individual has been or is going to commit acts that are violations of those statutes, they can file with a federal court to, to enjoin those individuals or entities from committing those actions, so there’s quite a lot going on in terms of, of the legal ramifications from all of this.

ZBP

            And I, I know that, I mean, from the bankruptcy standpoint, you, you talked about, you know, if they’re trying to, if they’re trying to recover, right, I, at least my understanding ‘cause I’m not a bankruptcy lawyer, like, just like I’m not a criminal defense lawyer, but in the bankruptcy proceeding, the trustees are trying, or the trustee is trying to recover the funds that could be available to pay back the creditors.  Is that, is that fair, so people who would have invested or people who FTX may have owed money to?

ZRD

            Yeah, I, and that’s my understanding, too.  Like you, I’m not a bankruptcy lawyer or a criminal lawyer, but just from, from past examples of these fraud situations where, you know, a trustee or, or someone’s appointed to try to wrangle all of these funds to, to get as much as they can back to investors.  I, I remember the, the Bernie Madoff fallout taking quote a long time for them to do that, so, you know, we might be lookin’ at years where they’re still tryin’ to, to gather up a lot of these losses.

ZBP

            Now, you know, I, I have seen because it’s one of the things, one of the many emerging technologies that I follow is the, the impacts, whether they’re, whether they’re real or perceived, that the collapse of FTX may have on the cryptocurrency, in the crypto industry, in, in kind of in a wider-spread fashion.  Do you have any kind of insight as to what impact FTX’s downfall may have on the crypto industry?

ZRD

            Yeah, so I think one of the big ones that we’re looking at and, you know, keeping our eyes open for is, is increased regulation over the, the, the cyber, excuse me, the crypto industry.  There’s been a lot of, uh, well I should say, there’s been a, an opinion that the cryptocurrency industry is not as widely regulated as traditional securities, other investments, things like that, and it, it makes sense because it’s an emerging technology like you said, and it’s, it’s a new thing that, you know, in these, in these statutes, a lot of them, when regulations were written, just didn’t exist, so, so I think it’s, for some people, it’s confirmed.  They’re concerned over the lack of regulation, I think, you know, there’s even been confusion amongst regulators as to things like whether or not a crypto coin is a security and therefore under the SEC’s jurisdiction.  In more recent times, the SEC Chair, Gary Gensler, said that this, these tokens and coins are securities and that he’s directing the SEC staff to go directly to the issuers and the exchanges for these cryptocurrencies and to try to get them to come into compliance with, with applicable laws and regulations and more appropriate as securities, so, you know, this could certainly be a springboard for regulators like the SEC to get their hands around cryptocurrency and to get more involved in, in regulating it and, and ensuring that it’s safe for investors.

ZBP

            You know, that’s one of the things that I, I mean that I, I’ve watched, you know, well respected and well known individuals in the, in the investment markets talk about cryptocurrency, Bitcoin, Dogecoin, Ethereum, you know, you name it, Ripple, and I, I’ve seen, I’ve seen now where people have, you know, have discounted it or who have, you know, come out and said this is a fraud and then some of those people have flipped and said well, you know, maybe there is some legitimate use for some of this as an investment, and then they, after the FTX, they said this is only confirming what I originally thought, the whole thing is a scam.  What I wonder, though, you know, is whether or not the increased regulation and, and essentially, if the SEC is going as far as to say, this is a security, then all of a sudden, the increased regulation over the industry may actually add some legitimacy to the industry because it’s almost as if the SEC is saying, yes we do recognize this.  I mean, even if there is a speculative nature or even if there is a component of this that is, you know, difficult to understand the intrinsic, you know, value of these coins, the fact that somebody else is recognizing these as a security then lends itself, gives it some credence almost.

ZRD

            Yeah, I think there’s, there’s definitely some truth to that.  That could well be how it plays out, and you know, a lot of this is on the heels of, of, we’ve seen more, uh, traditional institutions embrace cryptocurrency.  I had a Reminger Report a few years ago where the traditional banks are starting to recognize cryptocurrencies as a, as a form of currency and, and, and things like this, so, and you’re seeing a lot of people, like you said, you know, who, confirming their belief that it, it is unstable and, and not a good investment, but you know, there’s people on the other side that say, look, this was a, this was a fraudster, a one-off fraudster who, who did bad things and it doesn’t reflect the, the, the currency as a whole, so we, we do see here both sides of that, and I guess time will tell.

ZBP

            Yeah, absolutely.  Now from an, from a consumer standpoint, you know, somebody who may be looking into investing or who, you know, is already invested, is, is there anything important you think that as consumers we should be taking away from the FTX situation, for lack of a better term?

ZRD

            Yeah, I mean, and, and consumers may be affected by this if they’re already holding cryptocurrencies.  They may have seen a decline in the, in the value of their crypto assets as a result of this.  They might see it from increased regulation.  We don’t know.  Time will tell.  But, but I think it highlights the importance of, of, of knowing whether your investments are made with folks who are in compliance with, with the applicable laws and regulations, and it also shows the crypto issuers and the crypto exchanges that it’s probably a good idea to get under compliance if you’re not already with regard to the cryptocurrency stuff, so yeah, I think, I think this’ll present even more learning lesson, lessons learned over the time that these cases play out and, it’s definitely been an interesting story for sure.

ZBP

            Well, Zach, I really appreciate you taking the time to talk with us today and to come on.  You know, I was thinking as we were talking about this, as you were talking about how this was gonna play out, in the next, I don’t know, six months or so, we may have you back on to discuss how this has played out.  I don’t know that, you know, all of the proceedings will be wrapped up by then, but certainly it will be interesting to see, like you said, kind of the, the bookends to this and see kind of how this, this ends, so.

ZRD

            I, I would love to, and, and I appreciate you having me on, and anybody out there who has any questions on, on this stuff, cryptocurrency regulations like this, can contact Reminger’s professional, the financial services/professional liability group.

ZBP

            I appreciate that, Zach.  Thanks again for joining us today, and we really appreciate it.

ZRD

            Thanks, Zach.