The Other FTX Case

The allegations at the heart of the trial of Sam Bankman-Fried, or “SBF” as he has come to be known, paint a picture of a large-scale fraud — sweeping in scope, but limited to the misadventures of a particular corporate family at FTX and Alameda Trading. Misuse of customer funds, neglect or abuse of basic accounting responsibilities and lavish personal and political spending are surely serious and garner headlines.

But the allegations are not particularly relevant for the vast majority of the people in crypto or fintech. The government’s case does not represent a systemic threat to the core business model of most firms in this space, assuming those firms don’t act as SBF is alleged to have done.

Andrew C. Adams is a partner in the New York office of Steptoe & Johnson LLP, and a member of the firm’s Blockchain & Cryptocurrency team. Kane Smith is an associate based in Steptoe’s Washington, D.C. office.

But it’s worth considering charges that prosecutors have not yet had the opportunity to pursue in this first SBF trial, because they are of potentially broader relevance to anyone operating in crypto. Charges of bank fraud and illegal money transmission will not be put to the jury in the current SBF trial, and may never be aired at a future SBF trial. But digital asset companies continue to face a regulatory and prosecutorial environment, where the threat of such charges hangs over good-faith actors seeking to participate in global markets through traditional banking rails.

The charges the government did not pursue in the current SBF case are of systemic importance to the industry, reflecting the specter of regulatory and prosecutorial pressure that dissuades traditional financial institutions from engaging with lawful, ethical and viable digital asset projects. The mere potential for such charges place crypto and other blockchain projects between a commercial rock and a regulatory hard place.

The current fraud charges

In the immediate wake of FTX’s spectacular collapse in November 2022, prosecutors at the United States Attorney’s Office for the Southern District of New York (SDNY) rapidly proceeded to file charges alleging FTX’s misappropriation of customer funds.

On Dec. 9, 2022, a SDNY grand jury returned an eight-count indictment, charging Bankman-Fried with multiple counts of wire fraud and wire fraud conspiracy, securities and commodities fraud, campaign finance violations and one count of money laundering conspiracy tied to the alleged concealment of fraud proceeds and the transfer of those proceeds through the U.S. financial system. Each of these charges relate directly to the core fraudulent activity that allegedly allowed FTX to attract victim-investors and customers to the platform, while undermining its financial stability, according to prosecutors.

When the government unveiled these charges in December 2022, Bankman-Fried resided in the Bahamas, where FTX had most recently operated prior to its downfall. The United States moved swiftly after the original indictment to request Bankman-Fried’s arrest there and to move for his extradition. By Dec. 12, Bankman-Fried was in Bahamian custody and those proceedings were under way; and by Dec. 22, 2022, SBF appeared in a Manhattan federal courthouse. (Steptoe represents eight former FTX executives in connection with this case).

‘Rule of specialty’ blocks additional charges – for now

The timing and circumstances of that extradition would later frustrate the government’s effort to move forward on additional charges. When Bankman-Fried consented to, and the Bahamas ordered, his extradition to the United States, the United States was constrained to move forward to trial only on charges subject to that consent and approval by its foreign partner.

The government did proceed to charge Bankman-Fried with additional crimes beyond those included in the original indictment and approved by its Bahamian counterparts.Those new counts included two of particular importance to the crypto industry – including exchanges, token-issuers and payment platforms diligently seeking to avoid regulatory or criminal pitfalls while also seeking to participate in global financial markets.

First, the new indictment included a variant of bank fraud that prosecutors have advanced as requiring mere proof of a scheme to obtain funds under the custody or control of a bank through false or fraudulent “pretenses, representations or promises,” without a related intent to defraud the affected bank. In its most simple form, prosecutors have used this charge to pursue fraudsters making false statements on checks provided to a merchant, which are then presented to a bank by the merchant rather than the fraudster. But in recent years prosecutors have looked to this charge — in essence, a “no loss” bank fraud under 18 U.S.C. § 1344(2) – in both the cryptocurrency space and the traditional correspondent banking space.

With respect to such cases predicated on the now-defunct “right to control” theory, the Supreme Court’s long-anticipated rejection of that theory of fraud – the argument that an entity’s loss of the right to control its resources is a substitute for an actual deprivation of a property interest – forecloses prosecutors’ use of bank fraud charges in crypto cases where no loss occurred But digital asset companies should be alert to the possibility that prosecutors may nevertheless pursue § 1344(2) charges, or other charges, particularly where there are tangible losses.

Second, the superseding indictment included a charge of operating a money transmission business without proper registration by the Financial Crimes Enforcement Network (FinCEN) or state-level authorities as proscribed by 18 U.S.C. § 1960 – an offense with no element of fraud or misstatement required, but rather a charge that elevates a failure to register with a regulator into the realm of criminal prosecution.

Prosecutors have been using this charge in crypto cases for years but not, as yet, in a forum as prominent as the current FTX trial. Nevertheless, a § 1960 charge carries felony penalties and significant exposure under the federal asset forfeiture laws, all without reference to fraud and, importantly, without any concern for whether the transmission of value is in the form of a “security,” “commodity” or “currency.”

Uncharged offenses offer critical lessons

In the case of Bankman-Fried and these late-filed charges, the superseding indictment includes certain key allegations that stand apart from those concerning fraud on investors, lenders or customers. Certain of those allegations describe precisely the dynamic that vexes legitimate companies seeking to do business through the U.S. banking system. As alleged, because many banks, at the time, “were reluctant to do business with cryptocurrency companies,” FTX instead “instructed customers to wire dollar deposits to bank accounts that were owned or controlled by Alameda” to avoid registering as a money service business and comply with know-your-customer (KYC) obligations.

The indictment alleged that a new entity would “function as an account to receive and transmit FTX customer deposits” and misstated in response to due diligence inquiries that the account would be for that entity’s own trading, falsely claiming that the entity was not a money services business. Once funds were deposited, Alameda personnel, “who maintained control” over that intermediate entity, “manually credited or subtracted [a] customer’s FTX account with the corresponding amount” of currency. These facts describe an attempt to utilize a third-party company and bank account for the ultimate purpose of operating a business touching the United States financial system and consumer base, in an attempt to navigate the type of hurdles that exist for many crypto companies at U.S. banks.

The banking environment for crypto companies had changed significantly over the past several years, with many banks that had previously expressed skepticism about dealing with crypto businesses jumping into the digital asset space with both feet prior to 2023. But over the course of the past year – fueled in part by the collapse of FTX and other prominent crypto companies in 2022 – U.S. banking regulators have moved aggressively to constrain traditional financial institution’s interactions with crypto markets. Many digital asset companies are struggling to address the commercial risks posed by a possible loss of banking services in a way that does not create regulatory or even criminal risks.

The criminal litigation that led to the evisceration of prosecutors’ “right to control” theory illustrates the importance of the adversary process in uncertain areas of the law. Similarly, the outer limits of the federal bribery and “honest services” criminal statutes came into focus through vigorous litigation arising from contentious and high-profile prosecutions resulting in convictions that were subsequently overturned by the Supreme Court. The Ripple case reflects a similar effort to push back against SEC “regulation by enforcement” in the digital asset space.

The reality is that U.S. prosecutors will continue to be drawn to investigate cases that appear to involve complex financial flows and structures, reflexively assuming that these structures must have been designed to evade applicable regulations or for some other improper purpose. As long as this dynamic is in play, and as long as the limits of prosecutorial authority are untested, the digital asset industry needs to pay close attention to the issues raised by these untried FTX charges.

Digital asset companies should be careful to ensure that steps they take to mitigate banking risks do not lead to regulatory or criminal exposure. In this environment, even unobjectionable use of financial intermediaries to conduct legitimate transactions may draw the attention of regulators or prosecutors. Digital asset companies should consult with counsel on structuring businesses that must contend with the commercial reality that access to these institutions brings significant benefits, efficiencies, and opportunities for scaling, while also contending with the prosecutorial pressure applied to their platforms and traditional institutions.

In the event of a conviction at SBF’s first trial, the prospect of the United States spending diplomatic and political capital with the Bahamas to obtain consent to try yet more charges tied to FTX may dwindle significantly. Nevertheless, crypto companies should still be attentive to the lessons of the charges that the government is not pursuing.

Be wary of the dog that didn’t bark – it could still bite.