FTX Does Not Want an Independent Investigation
R Tamara de Silva
On February 15, 2023, Judge John T. Dorsey, presiding over the bankruptcy proceedings of FTX, denied the United States Trustee’s motion-along with motions from two creditors of FTX, and a letter from four sitting U.S. Senators to have an independent examiner appointed in the FTX bankruptcy proceedings. Apparently, it boiled down to a matter of money-Judge Dorsey reckoning that he had the authority to deny the request, and that spending what may be $100 million to have an independent examiner look over what forensically could have gone wrong at FTX in the fourth largest corporate bankruptcy in U.S. history, would not be worth it. In addition, Judge Dorsey ruled that it would be duplicative of the work of FTX’s counsel. The problem with this ruling is that the public, the customers, and FTX’s creditors will just have to take the word of parties, some of whom will not only wind up investigating themselves, but whose hands are not clean of conflicts of interest.
But first some context for all of this in case you have not read my prior complaints on this matter here and here. Similar to those previous comments, Commodity Futures and Trading Commission, Commissioner Christy Goldsmith Romero recently emphasized the important role that law firms and lawyers associated with FTX International and its related entities played in the downfall of FTX.
Although Ms. Romero did not mention them by name in the context of FTX, she asserted that attorneys within the futures industry and the broader securities industry should serve as gatekeepers, prioritizing the protection of customers and the integrity of financial markets. This view is entirely accurate.
It will take courage for gatekeepers to speak truth to power or leave companies that fail to prioritize their clients' well-being. As a former Inspector General, I understand how difficult this can be. Nonetheless, it is necessary if the industry, and those who serve as gatekeepers, hope to regain any semblance of trust. Most importantly, it is essential for safeguarding customers and promoting market integrity.
Commissioner Romero's speech, page 11
Sullivan & Cromwell (S&C) battled to be, and succeeded in being appointed Debtor’s Counsel despite also having represented all three FTX entities, along with Sam Bankman-Fried and Nishad Singh, pre bankruptcy petition, and during the time when the alleged fraud and wrongful activities by FTX, its principals and affiliated entities is thought to have taken place.
One hates to be cynical, but it makes sense to want to be Debtors’ Counsel as it represents hundreds of millions of dollars in legal fees-S&C submitted a bill for $9.7 million a few days ago just for its first month or so of work. Bankruptcies of the size of FTX are a windfall for lawyers.
According to a declaration of FTX’s former chief compliance and chief regulatory officer (admittedly this is somewhat like being chief risk manager at Lehman Brothers), and a customer of FTX.US, Daniel Friedberg- S&C purposefully understated the extent of their representation of FTX entities in the bankruptcy proceedings leading up to the appointment of Debtors' Counsel.[i]
The conflicts of interest alleged by Mr. Friedberg on the part of former partners of S&C and S&C, raise many questions about the integrity of any forensic examination of the activities, and advisors at FTX at all relevant times during and leading up to the alleged criminal activities. Questions that without the appointment of an independent examiner will go unanswered.
Mr. Friedberg’s declaration enumerates several conflicts of interest and potentially less than ethical behavior, among them:
- Former S&C partner, Ryne Miller is said to have insisted that FTX.US be part of the proceedings principally because “FTX.US had the cash to pay S&C its retainer."
- Friedberg mentions relating to Miller, that FTX.US had no obligation to pay for the legal expenses or bankruptcy expenses of FTX International Group or Alameda. But Miller had insisted on it.
- S&C represented Blockfi. Alameda Group made a $200 million loan to Blockfi, which included an option for Alameda to purchase Blockfi. S&C acted as counsel to Blockfi while it was also advising Alameda on whether the latter should exercise its option to purchase Blockfi.
- Friedberg states that he repeatedly attempted to impress on partners of S&C that it could not combine all the entities of FTX into the bankruptcy proceedings because there were unwaivable conflicts of interest-each entity had different customers and creditors. S&C saw no conflicts of interest.
- Ryne Miller, according to Friedberg, is also said to have directed $200 million in cash from U.S. based LedgerX to be sent as fees to S&C for bankruptcy costs.
- According to Friedberg, Mr. Miller is alleged to have stated that S&C would install "their guy"-presumably, John Ray III. (John Ray III in turn filed an affidavit in support of the appointment of S&C. And though Mr. Ray stated in testimony before Congress that FTX/Debtors were left, "more closely resembling a crime scene than an operating business," pointing to inadequate governance, lack of controls and naivety-in a hearing to appoint S&C as counsel later on Mr. Ray states "the advisors are not the villains," dismissing objections to the appointment of S&C.[ii]
Judge Dorsey in his bench opinion denying the appointment of an independent examiner, states that after all, Sam Bankman-Fried appointed John Ray III. But did he? We will most likely now never know. Like much in the law, the party or court that gets to have the last word on a matter becomes its narrator and Herodotus-and not always because it also happens to be right or tells what actually happened.
We will never know the entire role the former partner of S&C, and S&C itself played in the fall of FTX.
We can be assured that all the law firms will be found to have clean hands because their roles will not be questioned. It is axiomatic in the law, like life, that an entity cannot investigate itself. No one expects it to. What rational entity would even entertain the exercise? And then there is that saying by George Carlin about it being like a club, it may be so.
Tens of millions of dollars of legal advice later, the world discovered that FTX was established without basic safeguards in place towards customer funds, or any meaningful checks and balances whatsoever on corporate governance. How did this happen?
My securities law professor in law school, (an embarrassingly long time ago), remarked that a good securities lawyer should have ulcers. They should always be worried. Worried about potentialities that have not materialized and worried that they can protect and advise their corporate client in the most fulsome manner. Worried about any possibility of anything overlooked that may cause their clients to run afoul of the securities laws or forget the purpose of the Securities Act, which has always been to protect the public. Over the years, this advice has proven truer and truer. Because lawyers are also counselors and advisors.
But here is the thing about clients that are worth millions of dollars to law firms. Their large impact on a firm’s bottom line can sometimes make conflict of interests go down smoother. We saw this in the case of the credit ratings agencies before the Credit Crisis. Who wants to alienate or say something that a client worth millions of dollars a year simply does not want to hear?
Speaking of questions, without an independent examiner, there are many in regards to the lawyers and law firms of FTX we will likely now never know the answers to. Was there any question about including FTX.US in the bankruptcy proceedings? Was the use of U.S. customer funds to pay for the bankruptcy proceedings, when these same customers, may possibly have otherwise been able to withdraw their funds-months ago the correct determination? Was there any conflict of interest on the part of all parties who made this determination? To what extent did the principals of the FTX entities reasonably rely on the advice of their counsels? If their counsels gave them improper or less than fulsome advice-how would they have been able to know this at the time? What responsibility does the law firm, and the lawyers have in establishing and allowing a corporate structure without any safeguards, knowing that customer money would be involved? Would have been interesting to find out the answers. It seems reasonable to have conducted an inquiry along many of the aforementioned lines just to get to the truth. Why? Because it all seems odd in retrospect.
Most of all, the customers and creditors of FTX, who suffered as a result, deserved to know the entire truth, through an investigation as thorough as possible-one unfettered by significant conflicts of interest. It is a shallow ruling most of all for them.
R Tamara de Silva