Bahamian regulators froze accounts belonging to FTX, one of the world’s largest centralized cryptocurrency exchanges, on November 10. Shortly thereafter, and amid large-scale customer withdrawals, the founder and chief executive officer of FTX, Sam Bankman-Fried, announced that FTX.com, FTX.us, Alameda Research, and more than 100 of its corporate affiliates were filing for bankruptcy.
FTX began a decline in the days leading up to the bankruptcy announcement, as various industry players questioned its balance sheet as well as the relationship between FTX and Alameda Research, a crypto-focused investment fund also founded by Bankman-Fried. It was alleged, for example, that Alameda drew customer funds from FTX. The reports triggered an estimated $6 billion in withdrawal requests amid questions on whether FTX possessed liquid assets sufficient to fund the withdrawals.
While the full story surrounding FTX’s apparent insolvency is still developing, and neither FTX nor its executives have been charged with any wrongdoing, the fallout has led to publicly reported criminal and regulatory investigations.
It was reported on November 14 that the US Attorney’s Office for the Southern District of New York is investigating FTX and Bankman-Fried; and as is typical, the US Securities and Exchange Commission (SEC) is likely conducting a parallel investigation. Given the intense public interest in Bankman-Fried and the pronounced prioritization of cryptocurrency-related crime by the US Department of Justice (DOJ), DOJ is likely to pursue a criminal prosecution should the evidence support one. Such a prosecution, if initiated, is likely to be the subject of significant scrutiny, but may offer opportunities for individuals and entities which have lost money in the FTX wipeout to have their voices heard.
In recent months, DOJ has reemphasized its commitment to protecting victims in white-collar cases. Assistant Attorney General Kenneth A. Polite, Jr., who leads DOJ’s Criminal Division, said earlier this year that “considering victims must be at the center of our white-collar cases.” Polite specifically called out digital asset fraud as a key area for victim identification and assistance, notwithstanding the complexity of the space.
Recent DOJ measures include appointing a victim coordinator to the Criminal Division’s front office and the decision that DOJ, where appropriate and necessary, will bifurcate corporate plea hearings from sentencings to allow time for victims to come forward. Even apart from the criminal proceedings themselves, this change in approach is likely to amplify the risk of follow-on civil litigation by victims of alleged financial fraud.
Even more recently, Attorney General Merrick Garland released comprehensive guidelines related to victims’ rights in criminal investigations. See The Attorney General Guidelines for Victim and Witness Assistance (effective March 31, 2023). Depending on the facts and statutes at issue, “victim” may have a broad definition. Under the Victims’ Rights and Restitution Act (VRRA), a victim is “a person that has suffered direct physical, emotional, or pecuniary harm as a result of the commission of a crime.” 34 USC § 20141(e)(2). Under the Crime Victims’ Rights Act (CVRA), a victim is “a person directly and proximately harmed as a result of the commission of a Federal offense.” 18 USC § 3771(e)(2)(A). Victims generally can include corporations and other business entities. Under the new guidelines, a “strong presumption exists in favor of providing, rather than withholding, assistance and services, including assistance from Department personnel, to victims of crime.” See Attorney General Guidelines at 4.
Under the VRRA and CVRA, alleged victims are afforded various rights to participate in criminal proceedings. With some limitations, victims are entitled to information about the status of the government’s investigation and an arrest or declination. Under the CVRA, victims have a right to be reasonably heard at any public proceeding in the district court involving release, plea, sentencing, or any parole proceeding. 18 USC § 3771(a)(4).
Finally, under the CVRA, restitution is mandatory for most federal crimes, regardless of the defendant’s ability to pay, when the statutory criteria are met. Even if not mandatory, restitution may be imposed by the district court in connection with sentencing, probation, and supervised release.
Given DOJ’s enhanced emphasis on victim identification and assistance, any prosecution of alleged cryptocurrency fraud will likely present both expanded opportunities for victims to participate and enhanced risks for defendants of liability to victims.
FTX’s remaining assets will be redistributed to claimants following bankruptcy proceedings. FTX boasted a high-profile list of investors that gave the company $1.8 billion in funding. As for its customers, it has been reported that an average of around $840 million worth of cryptoassets were exchanged on FTX’s platform daily by more than 1.2 million registered users. Even after claims against FTX are settled in bankruptcy court, there will likely be an influx of litigation between victims of the FTX fallout regarding priority to settlements.
Additionally, affected investors may pursue litigation against FTX advisors, institutional investors, and executives. Lawsuits may address which other actors’ conduct may have contributed to FTX’s downfall and likely will focus attention on what due diligence was conducted in the past. Given the breadth of entities affected by the insolvency and the regulatory uncertainty surrounding digital assets, the failure of FTX is likely to lead to protracted investigations and litigation.
The digital asset working group at Morgan Lewis will continue to closely monitor developments surrounding FTX’s fallout. If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following: