‘Fraud in shorts and T-shirts’: the case against the FTX founder

The wheels of American justice do not turn nearly so fast as the cryptocurrency markets. But in the last 48 hours they have caught up to Sam Bankman-Fried, the boy king of the shattered FTX empire, who now stands accused of perpetrating one of the largest financial frauds in US history.

A series of overlapping events unfolding in the Bahamas, Washington and Manhattan left 30-year-old Bankman-Fried in police custody, while offering fresh insights into how one of the digital token market’s dominant trading platforms suddenly collapsed into bankruptcy a month ago with $8 billion (€7.5 billion) in customer funds missing.

For Bankman-Fried the reckoning began on Monday, when he was arrested by local police just after 6pm at his apartment in Nassau, the Bahamas, after the US Department of Justice sought his extradition. It was in the same time of year when, 14 years earlier, Bernie Madoff, mastermind of Wall Street’s biggest Ponzi scheme, was arrested on a US securities fraud charge.

Tuesday brought the unsealing of an eight-count criminal indictment in which Bankman-Fried was accused of pilfering customers’ funds practically since FTX’s inception in 2019. These were allegedly transferred to a proprietary hedge fund controlled by Bankman-Fried called Alameda Research, according to authorities, and then deployed for his own venture investments, real estate purchases and political donations.

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“This is one of the biggest financial frauds in American history,” said Damian Williams, US attorney for the Southern District of New York, wearing the starched demeanour of a federal prosecutor.

Williams was flanked by counterparts from the FBI, the Securities and Exchange Commission and the Commodity Futures Trading Commission. Behind them were shelves of legal tomes that reeked of the adult world, and adult consequences, and served as a marked contrast to the callow insouciance of Bankman-Fried and his posse.

The fact that so far he is the only person charged in the affair has added to speculation that his business associates may be co-operating with prosecutors.

Bankman-Fried’s lawyer said he was “reviewing the charges with his legal team and considering all of his legal options”.

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Meanwhile, in Washington, John Ray, FTX’s new court-appointed chief executive, was describing for gobsmacked members of the House of Representatives’ financial services committee the depths of mismanagement and negligence that had preceded the company’s collapse.

“It’s really unprecedented, in terms of lack of documentation,” said Ray, who gained stature two decades ago in untangling the financial wreckage of Enron, the bankrupt energy trader. “Literally, there’s no record-keeping whatsoever.”

In spite of their claims of rigorous risk controls, FTX staff recorded transactions on Slack, the office chat software, and did the accounts on QuickBooks, a piece of software widely used by freelancers and small businesses. There was no board of directors to exercise oversight, there were large gaps in insurance, and payments were made to Bankman-Fried’s family, the new chief executive told politicians.

“This isn’t sophisticated whatsoever,” Ray concluded of the alleged fraud. “This is just plain old embezzlement. Old-school.”

Committee members took turns raging against Bankman-Fried, with California Democrat Brad Sherman calling him “a big snake in a crypto garden of Eden”.

While Bankman-Fried was broadly condemned, some of them refrained from attacking the wider crypto industry. The inconvenient truth is that several had accepted campaign contributions from a nascent industry determined to stave off onerous regulation. Bankman-Fried had emerged from obscurity to become the second-largest donor to Democratic-leaning groups in the recent midterm elections, doling out $36 million.

He had been expected to testify at Tuesday’s hearing, but then he was arrested. Representatives were treated instead to prepared remarks in which he trampled on the institution’s formalities.

“I would like to start by formally stating, under oath: I f**ked up,” he began.

The statement that followed toggled between a fuzzy reconstruction of FTX’s last days, based on “memory and extrapolation”, and passages that read more like the excuses of a university student who had failed to turn in an assignment.

“I bit off more than I could chew, and ended up failing to focus on risk management,” his statement read. Bankman-Fried also blamed a busy schedule this year that meant he was “less grounded in operational details than I had been before”.

Throughout the statement, he reiterated his contention that FTX could have been rescued by outside investors if he had not been pressured into declaring bankruptcy on November 11th. At 4.30am the preceding morning, he had clicked on a DocuSign tab, nominating Ray to take charge. Ten minutes later, according to Bankman-Fried, he received a potential funding offer for billions of dollars.

Mark Kasten, an attorney at Buchanan Ingersoll & Rooney who specialises in cryptocurrencies, found Ray’s testimony particularly damning. “[Bankman-Fried] was setting himself up to argue that he was merely inept, not criminal. But Mr Ray’s statements today that there were simply no compliance controls certainly makes it more difficult,” he said.

In some cases, trading customers who thought they were sending dollars to FTX to back their crypto trades were, in fact, depositing those funds directly into Alameda’s bank accounts

It is not clear when – or if – Bankman-Fried will arrive in New York to answer the US charges. His lawyer has contested his extradition. A Bahamas judge denied his request for bail on Tuesday.

In legal terms, the indictment represents the most serious threat to him, alleging misconduct including wire fraud, conspiracy to commit money laundering and campaign finance violations. But it was scant on details.

A richer portrayal of FTX’s rise and fall came in a related SEC civil complaint. It explained in detail, for example, how Bankman-Fried allegedly moved money from FTX to Alameda, including $1.8 billion raised from equity investors who had been sold on the platform’s rigorous risk management.

In some cases, trading customers who thought they were sending dollars to FTX to back their crypto trades were, in fact, depositing those funds directly into Alameda’s bank accounts, according to the SEC. Funds were also shifted by allowing Alameda to draw down on a virtually limitless credit line from FTX, the SEC added. In a quarterly balance sheet provided to outside lenders, Alameda then listed this as a “loan” without specifying that it came from FTX.

When crypto prices dropped in May, lenders began to demand repayment and FTX wobbled. Bankman-Fried, according to the SEC, diverted billions of dollars more in customer assets to keep pace with the payments. Throughout the summer, as the situation became more precarious, Bankman-Fried diverted hundreds of millions of dollars more to Alameda, they said – some of which was “loaned” to him and other FTX executives.

On Tuesday afternoon, as those and other allegations were made public, one reporter asked if the youthful Bankman-Fried, known for his shaggy hair and uniform of T-shirt and shorts, fit the profile of a typical financial fraudster.

“You can commit fraud in shorts and T-shirts in the sun,” Williams replied. “It is possible.” – Copyright The Financial Times Limited 2022