Crypto boss arrested as DoJ, SEC investigate FTX collapse

SEC’s aggressive stance, plus CFTC charges and a federal indictment for FTX, could cause funds to re-think plans for crypto in 2023

The SEC announced this morning that it has charged FTX Trading Ltd. co-founder Samuel Bankman-Fried for fraud, but had barely gotten its own accusation posted before the CFTC filed a similar civil charge and the U.S. Dept. of Justice announced it had indicted Bankman-Fried for conspiracy to commit wire fraud.

All three accuse Bankman Fried of defrauding equity investors who put as much as $1.8 billion into the crypto trading platform he founded by convincing them the financial controls and risk-management tools built into the platform made their investments safe. Almost from the beginning of his efforts to promote FTX trading, however, according to his accusers, Bankman-Fried had been funneling money into a privately held hedge fund at Alameda Research LLC, which he also founded. Bankman-Fried allegedly used the mingled funds to make venture-capital investments, “lavish real estate purchases” and large political donations, according to the SEC complaint.

The diversion was illegal and destabilizing because it gave Alameda special status among the platform’s customers that exempted it from risk-mitigation measures, provided a virtually unlimited line of credit funded by FTX customers and increased the risk to investors by basing many of Alameda’s holdings on “overvalued, Illiquid assets such as FTX-affiliated tokens,” according to the SEC.

“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,” SEC Chair Gary Gensler said in the SEC announcement that it had filed civil charges against Bankman-Fried.

Massive fraud and the eventual bankruptcy of both FTX and Alameda is emblematic of the instability of the crypto market and resistance of many companies to regulation designed to protect investors and customers by preventing fraud on the part of public companies and requiring that investment advisers to keep separate any lines of business that could create conflicts of interest for fund managers, according to Gensler, who promised the SEC would pursue other non-compliant crypto platforms just as vigorously.

FTX is the latest crypto company to run afoul of the SEC’s effort to regulate investments in cryptocurrencies and other digital assets, which led it to accuse executives of BitConnect of bilking investors of $2bn in September 2021 and led to hundreds of millions in penalties during 2022 for market participants it accused of misleading investors by improperly touting crypto schemes, or running Ponzi- or pyramid schemes.

“FTX’s collapse highlights the very real risks that unregistered crypto asset trading platforms can pose for investors and customers alike,” Gurbir S. Grewal, director of the SEC Division of Enforcement, said as part of the announcement.

Bankman-Fried, 30, resigned from his leadership positions at FTX in November after the company, which had a market cap of $32bn, admitted in its bankruptcy filing that it could not account for $8bn in customer funds.

In written testimony filed ahead of his Dec. 13 appearance before the U.S. House Financial Services Committee, current FTX CEO John Jay Ray III blamed the collapse on “the absolute concentration of control in the hands of a very small group of grossly inexperienced and unsophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company that is entrusted with other people’s money or assets.”

Bankman-Fried also submitted written testimony to the House panel ahead of remote testimony scheduled for Dec. 13.  Members of the Senate Banking Committee complained Dec. 12 that Bankman-Fried was avoiding their demands for testimony this week as well.

Bankman-Fried is currently in the custody of the Royal Bahamian Police following his arrest at a resort near Nassau on Dec. 12 and pending extradition, which followed a request from the DoJ, according to a tweet from the U.S. Attorney’s Office, Southern District of New York, which also filed the wire-fraud indictment.