FTX Fraud Investigation: What Is The FTX Scandal All About?

FTX Fraudulent Use of Customer Funds Explained

FTX was a cryptocurrency exchange founded by Sam Bankman-Fried in 2019, which quickly rose to become one of the largest crypto trading exchanges in the world, handling around 11% of the $2.4 trillion in derivatives traded each month.

However, FTX’s collapse was a shock to the cryptocurrency industry. The exchange giant was once estimated at $32 billion and serviced millions of users, but it suddenly filed for Chapter 11 bankruptcy in November 2022, after experiencing a liquidity crisis that was caused by an illegal use of customer funds.

Federal investigations have revealed that FTX CEO Sam Bankman-Fried and his executives were funneling customer funds paid for the platform’s native FTT token into Alameda Research, a hedge fund that was also owned by Bankman-Fried.

Investigators have now revealed that Bankman-Fried essentially used billions of dollars of customer funds paid into FTX as an “open line of credit” for Alameda Research to partake in risky investments for Bankman-Fried’s personal gain and lavish lifestyle habits.

The collapse of FTX has mainly been attributed to hubris, incompetence, and greed on the part of the former leadership, which investigators say lost at least $8 billion in client funds. Prosecutors have referred to the catastrophic turn of events as one of the “biggest financial fraud cases” in history.

FTX Deceived Customers About The Safety of Investments

While cryptocurrency is still a relatively new and volatile asset class, many investors prefer trading with cryptocurrency due to its decentralization and the ability for individuals to have full control over their assets without the need for central banks or intermediaries. Additionally, some investors see cryptocurrency as a way to diversify their investment portfolios and potentially earn high returns.

In the case of FTX many investors were drawn to the platform over the company’s assurances offered to customers in the terms of service agreement. Several of these assurances offered to customers included that;

• Customers control the Digital Assets held in Accounts
• Customers Digital Assets shall at all times remain with you and shall not transfer to FTX
• None of the digital assets in your account are the property of, or shall or may be loaned to, FTX Trading
• You may redeem all or part of any E-Money held in your Account at any time

However, it would become apparent by November 2022, that these terms outlined in the FTX customer service agreement were not being upheld.

FTX Used Celebrities and Athletes to Deceptively Promote Their Platform

Doubling down on the deceit of customers, many FTX lawsuits claimed that the exchange used aggressive marketing campaigns to promote its platform, including Super Bowl ads, celebrity endorsements, and naming rights to the Miami Heat’s arena.

These campaigns promised people higher yields than the average bank account and included aggressive advertisements by top tier athletes promoting the company’s platform using the slogan “#NotAnExpert”, to draw in consumers.

Several celebrities, athletes and influencers that were paid handsomely by FTX to promote the platform included;

• NFL star Tom Brady
• Supermodel Gisele Bundchen
• NBA star Steph Curry
• Tennis star Naomi Osaka
• “Shark Tank” TV show star Kevin O’Leary

However, these endorsements would soon backfire on the celebrities and athletes, as many FTX class action lawsuits were filed raising allegations that the endorsers engaged in deceptive marketing by promoting the company.

While companies have long used celebrity endorsements to market their products and services, FTX was accused of selling unregistered securities in the form of yield-bearing accounts. The Securities and Exchange Commission (SEC) classified FTX’s cryptocurrency, FTT, as a security because it was sold as an investment contract, but was not registered properly.

In the U.S. it is illegal to advertise the sale of unregistered securities. Any security without a registration statement on file with the SEC is considered “unregistered,” and selling such securities constitutes a violation of federal securities laws.

Therefore, the celebrities who were paid to promote FTX are now being accused of actively participating in the “offer and sale of unregistered securities”. As a result, individuals are pursuing lawsuits against celebrities and athletes claiming they promoted unregistered securities in the form of yield-bearing accounts.

CoinDesk Report Reveals FTX Mismanagement of Customer Funds

Despite FTX’s “smoke and mirror show” portraying FTX as a safe way for new and savvy investors to trade cryptocurrency, investors would soon learn that FTX was not handling their funds as contractually obligated, or in their best interest.

Popular cryptocurrency news source, CoinDesk issued a report in November of 2022, revealing serious financial dislocation and security issues at Alameda Research. The report revealed that Alameda lacked diversification and was too closely tied to FTX, with Alameda holding more than $5.8 billion “worth” of FTX’s FTT token among its purported $14 billion in assets.

The report prompted Binance, a rival exchange, to announce that it would sell around $530 million worth of FTT tokens, causing a significant drop in FTT token prices. The report also prompted investors to withdraw their funds from FTX, exacerbating the company’s liquidity concerns.

When FTX would not cover the $8 billion gap in customer demand, the company collapsed, starting on November 2 and ending with a bankruptcy filing on November 11, 2022.

Just one month after the report’s release, the U.S. Department of Justice and the U.S. The Securities and Exchange Commission launched investigations into FTX’s actions, which ultimately resulted in an indictment of Sam Bankman-Fried and other top executives.

U.S. Department of Justice FTX Investigation

In a press release issued by the United States Attorney General, and the Federal Bureau of Investigation (FBI) on December 13, 2022, officials stated that Bankman-Fried and his co-conspirators defrauded customers of FTX by misappropriating billions of dollars of customers’ funds for his personal use. The report also states that Sam Bankman-Fried used customer funds to repay billions of dollars in loans owed by his investment company, Alameda Research.

The findings led to an indictment of Sam Bankman-Fried, and the U.S. Department of Justice has charged the FTX owner with;

• Conspiracy to commit wire fraud
  Wire fraud
• Conspiracy to commit commodities fraud
• Conspiracy to commit securities fraud
• Conspiracy to commit money laundering, and
• Conspiracy to defraud the Federal Election Commission and commit campaign finance violations

In a press release issued by the U.S. Department of Justice, the United States Attorney for the Southern District of New York Damian Williams stated;

“One month ago, FTX collapsed, causing billions of dollars in losses to its customers, lenders, and investors. Now, a federal grand jury in New York has indicted the former founder and chief executive officer of FTX and charged him with crimes related to the phenomenal downfall of that one-time cryptocurrency exchange, including fraud on customers, investors, lenders, and our campaign finance system.

As today’s charges make clear, this was not a case of mismanagement or poor oversight, but of intentional fraud, plain and simple.”

How much jail time is Sam Bankman-Fried facing?

Based on the charges against Bankman-Fried in the DOJ press release, if found guilty, he could face up to 115 years in prison, although the actual length of his sentence will depend on various factors, including the severity of the charges, his criminal history, and any mitigating circumstances.

When will Sam Bankman-Fried’s criminal hearing begin?

Sam Bankman-Fried’s criminal trial with the Department of Justice is scheduled to begin on October 2, 2023. Bankman-Fried has pleaded not guilty to the original charges and is currently free on $250 million bond.

SEC Investigation into FTX Securities Fraud

The Securities and Exchange Commission issued a press release on January  19, 2023, charging Samuel Bankman-Fried with orchestrating a scheme to defraud equity investors in FTX Trading Ltd. In the SEC complaint filed on December 13, 2022, investigators found that Bankman-Fried orchestrated a years-long fraud to conceal from FTX’s investors the following;

• The undisclosed diversion of FTX customers’ funds to Alameda Research LLC, his 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 complaint further alleges that Bankman-Fried used commingled FTX customers’ funds at Alameda to make undisclosed venture investments, lavish real estate purchases, and large political donations.

According to the SEC, Bankman-Fried committed fraud by misleading investors and misappropriating funds while raising $1.8 billion from them. He is accused of using investors’ funds for personal expenses, such as purchasing hundreds of millions of dollars worth of luxury real estate, and for risky trades that resulted in massive losses.

In the press release announcing the indictment, SEC Chair Gary Gensler stated;

Bankman-Fried has pleaded not guilty to all charges, including a recently introduced charge that he authorized bribes of $40 million in crypto to Chinese officials.

While the SEC itself cannot bring criminal charges, it often partners with law enforcement agencies like the FBI in criminal investigations. The penalties for Bankman-Fried’s charges could range from hefty fines to several years in prison.