Unpacking the SBF Indictment

Bernie Madoff, Millennial Edition

The spectacular fall of Sam Bankman-Fried (“SBF”) and his crypto-exchange company FTX Trading Ltd. (“FTX”) culminated this week in federal criminal charges. Prosecutors in the Southern District of New York indicted SBF on eight felony counts of fraud, conspiracy, and money laundering. In addition, the Securities Exchange Commission filed a civil suit against SBF and the Commodity Futures Trading Commission filed suit against SBF and his companies. On Monday SBF was arrested in the Bahamas, where he was living and FTX was based.

Given the magnitude of the alleged fraud, the Justice Department has moved with remarkable speed in bringing these charges. This is reflected in the very bare-bones indictment, which provides almost no detail about the alleged crimes. We can expect a superseding indictment in the future that likely will add additional defendants and provide more details. But this millennial version of Bernie Madoff is already facing decades in prison.

Summary of the Allegations

SBF was the CEO and co-founder of FTX, a digital currency exchange where people could buy and sell assets such as bitcoin and other cryptocurrencies. He was also the co-founder of Alameda Research, LLC (“Alameda”), his privately-held crypto asset hedge fund.

The government alleges that SBF repeatedly assured customers that FTX was a responsible company that had adequate controls in place to protect customer assets. The FTX terms of service provided that customer deposits were secure, belonged to the customer, and would never be loaned out or used for any other purpose. Customers sent billions of dollars to FTX expecting their deposits to be safe, as they would be in a bank or brokerage.

In truth, virtually no controls were in place. Customer funds were commingled with other funds. SBF allegedly used FTX as his personal piggy bank, diverting billions of dollars in customer deposits to Alameda. He then used those funds to make other investments, to purchase real estate, to make large political donations, and to make extravagant purchases such as Super Bowl ads and naming rights for the arena for the NBA’s Miami Heat. He provided Alameda with a virtually unlimited “line of credit” at FTX, funded by FTX depositors. He also made “loans” and other payments to himself and other FTX executives totaling more than a billion dollars, using the money to support a lavish lifestyle.

In addition to defrauding FTX customers, the government alleges that SBF defrauded his own investors. He made repeated false statements about FTX’s financial condition and business practices. He also falsely assured investors that Alameda was not receiving any special treatment regarding FTX funds. Venture capital funds and others caught up in the crypto frenzy invested nearly $2 billion, in what can only be regarded as a breathtaking failure of due diligence.

The crypto market experienced a broad collapse in 2022 and SBF’s fraud scheme began to unravel. Depositors tried to withdraw billions from FTX, but the funds had been diverted to Alameda and were not available. Alameda, for its part, was heavily invested in FTX’s own crypto token called FTT. When FTT collapsed along with the rest of the crypto market, it became clear that Alameda was insolvent. Both FTX and Alameda filed for bankruptcy in November. More than a million people have lost their deposits with FTX and it’s unclear whether there will be any assets available to try to make them whole. It’s likely that total losses will be in the billions of dollars.

John Ray III, who handled the restructuring of Enron after its historic collapse, was brought in as the new CEO to handle FTX’s affairs in the wake of its collapse. In testimony before Congress this week, Ray said of FTX: “Never in my career have I seen such an utter failure of corporate controls at every level of an organization.” He went on:

Although our investigation is ongoing and detailed findings will have to await its conclusion, the FTX Group’s collapse appears to stem from 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.

Ouch.  

Why Three Different Cases?

As noted above, in addition to the criminal indictment brought by the Department of Justice, both the SEC and CFTC have filed civil suits based on the same events. The SEC complaint alleges that SBF committed securities fraud against the investors in FTX. The CFTC complaint alleges that some of the transactions on the FTX platform constituted commodities trading and that SBF and his companies defrauded FTX customers in connection with those transactions.

These are examples of parallel proceedings, where different agencies proceed against a defendant at the same time. It’s not uncommon in the white collar world, where the same conduct often can lead to both criminal and civil sanctions. The three different cases are simply the three different agencies pursuing the matters that fall within their respective jurisdictions.

The SEC and CFTC have authority to bring civil suits. Those suits can result in fines and in other penalties such as injunctions against future misconduct and orders prohibiting the defendant from being a corporate officer or engaging in trading in the future.

But the SEC and CFTC don’t do criminal prosecutions. Only the Department of Justice can bring criminal charges. And those are the only charges that can result in a defendant going to prison.

The Criminal Charges

The indictment contains eight counts and is fourteen pages long. SBF is the only defendant. As these cases go, it’s very skimpy. It lays out the charges but provides almost no detail about the alleged crimes and how they were committed. That’s unusual in a white collar case, where prosecutors tend to prefer “speaking indictments” that describe the crimes and how they were carried out in great detail.

This indictment has the feel of a placeholder, pulled together quickly just to get the charges filed. It almost certainly will be superseded with a more detailed indictment down the road. (More on that later.)

Count One: Conspiracy to Commit Wire Fraud - Customers

Count one charges that SBF conspired with others (who are not yet named) to defraud FTX’s customers by misappropriating their deposits and using the money to fund Alemeda and make other purchases and investments.

The charge is wire fraud because the government alleges that the conspirators sent emails or text messages, posted online, made bank wire transfers, and/or made cell phone calls in furtherance of a scheme to defraud. The effect on interstate commerce from such transmissions, many of which would have gone to persons in the United States or through U.S. computer servers, is what gives the U.S. government jurisdiction over a fraud that was largely carried out in the Bahamas and elsewhere.

Due to its breadth and adaptability, wire fraud is one of the most commonly-charged white collar offenses. (The name is a bit misleading, because it also applies to wireless transmissions in furtherance of a fraud.) It’s the charge most prosecutors would expect to be featured in a case like this.

Conspiracy to commit wire fraud is a felony punishable by a maximum of twenty years in prison.

Count Two: Wire Fraud - Customers

Count two is based on the same allegations as count one. It charges that SBF defrauded FTX’s customers by misappropriating their deposits. In other words, count one charges SBF with agreeing with others to defraud the customers, and count two charges SBF alone with actually committing that fraud.

This is a common structure in such indictments. The lead count charges a conspiracy to commit one or more offenses, and then subsequent counts charge the actual commission of those offenses. The conspiracy is a separate crime. It can be charged in addition to the underlying crimes that were the object of the conspiracy. It can even be charged if those crimes were never successfully completed.

Wire fraud is also a twenty-year felony.

Count Three: Conspiracy to Commit Wire Fraud – Lenders

Count three charges that SBF conspired with unnamed co-conspirators to defraud lenders to Alameda by providing false and misleading information to those lenders about Alameda’s financial condition.  This is the same charge as Count one, but the fraud scheme and the victims are different. This time it’s the lenders, rather than FTX’s customers, who are victims of the alleged fraud.

Count Four: Wire Fraud – Lenders

Count four charges SBF alone with actually engaging in the fraud that is the object of the conspiracy in count three. Counts three and four thus have the same structure as counts one and two: the conspiracy count followed by the individual fraud count.

Count Five: Conspiracy to Commit Commodities Fraud

Count five is another conspiracy charge, with SBF’s co-conspirators again unnamed. The government alleges that some of the cryptocurrency transactions FTX customers engaged in amounted to trading in commodities. In connection with those transactions, the conspirators allegedly engaged in fraud by misappropriating client funds and by making false representations to their customers. The client deposits allegedly were used to fund Alameda, pay off Alameda’s loans, and make other investments.

This count is the criminal counterpart to the civil lawsuit filed by the CFTC. This conspiracy charge is a five-year felony.

Count Six: Conspiracy to Commit Securities Fraud

Yet another conspiracy charge, count six is the criminal counterpart to the civil suit filed by the SEC. This charge does not allege that FTX’s own cryptocurrency token FTT or any of the other tokens traded on FTX were “securities” for purposes of federal law. That issue is currently the subject of considerable debate. The securities for purposes of this count are shares in FTX itself. The government alleges that SBF and his co-conspirators defrauded investors in FTX by providing false and misleading information about the company’s financial condition.

This is another five-year felony.

Count Seven: Conspiracy to Commit Money Laundering

Count seven charges that SBF and his co-conspirators engaged in financial transactions involving the proceeds of their fraud and that the transactions were designed to conceal the nature, ownership, source, location, or control of those proceeds. There are no more details about these alleged transactions. This kind of money laundering charge would apply, for example, to taking proceeds of the fraud and trying to conceal them by transferring them to offshore accounts or accounts held by shell companies, using the proceeds to purchase real estate or other assets in the name of different corporate entities, and the like.

In addition to providing almost no details, this count is a bit garbled, at one point using the term “monetary transactions” from 18 U.S.C. §1957 instead of the correct term “financial transactions” for this charge, 18 U.S.C. §1956. This may reflect the haste with which the government was moving. This charge will have to be cleaned up down the road, and prosecutors will have to provide a lot more detail about the alleged laundering transactions.

This conspiracy charge is another twenty-year felony.

Count Eight: Conspiracy to Defraud the U.S. and Violate Campaign Finance Laws

This count alleges that SBF and his co-conspirators made political contributions in the names of other persons or through corporations, in violation of federal campaign finance laws. It alleges that this amounted to a conspiracy to violate those laws and to defraud the United States by impeding and evading the lawful functions of the Federal Elections Commission.

SBF was known for making millions of dollars in campaign contributions, mostly to Democratic candidates and liberal-leaning PACs. He allegedly pumped at least $40 million into the 2022 campaign cycle alone. This will all be sorted out and revealed over the coming months and promises to be quite embarrassing to a number of Democratic candidates and organizations, who are already facing calls to return the money.

This is another five-year conspiracy charge.

Forfeiture

The indictment also seeks forfeiture of any assets derived from the alleged schemes. The government will seek to forfeit any bank accounts or other accounts it can find, as well as real estate and other assets SBF may have purchased with proceeds of the fraud.

The Total Sentence SBF Faces

This indictment charges SBF with five 20-year felonies and three 5-year felonies. If you stacked them all up, the theoretical maximum sentence would be 115 years in prison.

It may be unlikely any judge would give him that much time. On the other hand, with the amount of money allegedly involved in this fraud, the federal sentencing guidelines could easily end up calling for a sentence of 25-30 years or even life in prison.

Suffice it to say that SBF is looking at very serious jail time. This is in addition to criminal fines and forfeiture and any fines and other penalties that may result from the SEC and CFTC suits.

Bernie Madoff, by the way, was sentenced to 150 years -- and died in prison.

Why the Rush?

I was quite surprised that this indictment was returned as quickly as it was. FTX crashed and filed for bankruptcy just last month. Bringing an indictment now qualifies as lightning speed by DOJ.

In a complex financial case like this it takes many months to subpoena and assemble all the various financial records, emails, and other documents. Those records must then be reviewed, organized, and understood. Witnesses must be put in the grand jury. Normally I’d expect this to take six months to a year or more. There is no way the government currently has all of the evidence that it wants to prosecute this case.

The speed is reflected in the skimpy indictment. These are very minimal allegations, stating the alleged offenses but providing almost no detail. Presumably this is because the government doesn’t yet know all of those details.

No doubt the investigation will continue. The government likely will be looking to add co-conspirator defendants or additional charges. There will almost certainly be a superseding indictment, perhaps many months from now, adding additional defendants and charges. That will allow prosecutors to continue to use the grand jury to investigate.

But why the rush to charge now? The government doesn’t really gain any legal benefit from indicting early in a case like this. In fact, it arguably deprived itself of potentially valuable evidence: SBF was set to testify before Congress this week. Having the defendant testify under oath about these events would almost certainly have helped the prosecution, in addition to informing the public. His indictment prevented that testimony from happening.

It's possible the government was worried SBF was about to flee to a country with no extradition treaty with the United States. But even if that’s true, they could have simply arrested him on a warrant rather than returning an indictment. That would at least have given prosecutors a bit more time to continue the work in the grand jury and gather a few more details before indicting.

There must be something going on we don’t know about, because on its face indicting the case this quickly doesn’t make much sense.

What Happens Next

SBF was arrested in the Bahamas, so he will have to be extradited to the U.S.  If he agrees to waive formal extradition proceedings, he could be brought to the U.S. relatively quickly. If he fights extradition, as he appears to be doing so far, it could take months or even longer. But ultimately he should be brought to the U.S. for trial.

SBF and FTX reportedly are also under criminal investigation by the government of the Bahamas. Charges could potentially be filed there and in other affected countries as well.

SBF’s Defense

Based on his public statements since FTX’s collapse, it appears SBF’s defense will be a lack of fraudulent intent. He will claim he just got in over his head, that the company was growing too fast, and that he wasn’t aware of all that was happening. He will try to shift the blame to others in and outside the company. He will say his actions were the result of some combination of inexperience, carelessness, and incompetence, but he never meant to defraud anyone.

This is a potentially legitimate defense. Incompetence is not a crime. It’s not criminal to mismanage your company, have it go bankrupt, and have your investors get wiped out — that happens all the time. To prove fraud, prosecutors are going to have to prove that SBF (and presumably his future co-conspirators) deliberately deceived their customers and investors with the intent to harm them.

Based on the evidence already known, claiming a lack of fraudulent intent is going to be a tough sell. The sheer number of false statements and shady transactions alleged in these filings, and the staggering amounts of money involved, make it hard to believe it was just carelessness or inexperience.

Since FTX’s collapse SBF has given multiple interviews, made numerous public statements, and has been active on social media. He claims that he screwed up and wants to make it right but that he never meant to defraud anyone. This is an unusual approach for a potential criminal defendant. Any competent defense lawyer would almost certainly tell him to shut up yesterday. Every statement is simply more potential evidence for prosecutors to use against him.

Perhaps SBF believes that his openness and willingness to discuss what happened will be seen as evidence that he really is just a wide-eyed, well-intentioned kid and it was all just a big mistake. If so, that’s a very high-risk strategy that I think is likely to fail.