Conflict of Interests in the FTX Bankruptcy
R Tamara de Silva
In the 16 months before its spectacular fall, FTX paid the law firm, Sullivan & Cromwell, LLP (S&C), in excess of $20 million dollars in legal fees and retainers ($15.4 million of this was paid in the last 90 days before bankruptcy). On December 21, 2022, Sullivan & Cromwell submitted an application to be the FTX's (and all its 130 affiliated entities) bankruptcy counsel. This is a prima facie conflict of interest because S&C was one of FTX's main external law firms during the time the alleged wrongdoings and fraud at FTX and its affiliated entities, took place..
One of FTX creditor's, Warren Winter, submitted an amended objection to the appointment of Sullivan & Cromwell stating that it would undermine the integrity of the bankruptcy process, and "create a rigged game" as Sullivan & Cromwell may itself be "a target for investigation with its own potential liability." 1
Four Senators from across the aisle, (John Hickenlooper, D-Colo., Elizabeth Warren, D-Mass., Thom Tillis, R-N.C., and Cynthia Lummis, R-Wyo.), wrote to the bankruptcy judge, Judge John Dorsey, opposing the appointment of Sullivan & Cromwell as FTX's bankruptcy firm. They asked for the appointment of an Independent Examiner to conduct a thorough and objective review of the activities that led to the fall of FTX one that Sullivan & Cromwell may not be able to do, "[G]iven their longstanding legal work for FTX, they may well bear a measure of responsibility for the damage wrecked on the company’s victims,” the senators said.
U.S. District Judge John Dorsey brushed aside the Senators' letter as an inappropriate ex parte communication.
This is unfortunate because the two lawyers at the top of FTX's legal structure were from Sullivan & Cromwell. FTX US's General Counsel, Ryne Miller, was a former Sullivan & Cromwell partner, as was FTX Ventures' General Counsel, Tim Wilson. Mr. Wilson was General Counsel of the FTX entity (presumably at all relevant times) when according to the Securities & Exchange complaint, FTX Ventures made $200 million in venture investments using customer funds funneled through Alameda Research.1
S&C advised FTX on regulatory and compliance matters. FTX's principals would have relied on their legal advisors and counsel- during critical times in the criminal conduct alleged, and according to Sam Bankman-Fried and another principal S&C advised FTX almost on a daily basis.
FTX founder and former CEO, Sam Bankman-Fried wrote both in planned congressional testimony and a blog post today, that when Sullivan & Cromwell represented FTX, it pressured him to seek chapter 11 bankruptcy protection for FTX. Sullivan & Cromwell then selected FTX's new CEO, John J. Ray III. John J. Ray, III in turn wrote a declaration of support for the appointment of Sullivan & Cromwell to be counsel to the Debtors in the FTX bankruptcy.
Sullivan & Cromwell's lawyers would earn up to $2,000 and hour for their work on the FTX bankruptcy, which may amount in tens of millions of dollars in legal fees. When questioned about a possible and perceived conflict of interest, they downplayed their role at FTX.
Warren Winter's amended objection to the appointment of Sullivan & Cromwell enumerates instances of conflicts of interest of S&C including the activities of former employees during times when allegedly fraudulent activity took place. It also points out that the $15.4 million S&C received for legal work may itself be recoverable under the Bankruptcy Code's scrutiny of transfers made within 90 days prior to the filing of a bankruptcy petition. The latter is an astonishing conflict of interest.,
Now that FTX is bankrupt, and several of its principals were criminally charged, it is not outrageous to question the role Sullivan & Cromwell and its partners played in advising FTX. Were the principals of FTX adequately made aware of basic tenets in the law involving the safeguarding and segregation of customer funds? Did the law firm adequately educate its clients? Or as in the case of so many other conflicts on Wall Street, like credits ratings agencies before before 2008- did the monetary value of the client affect or perhaps dissuade an effective representation?
If S&C are appointed to also be FTX's bankruptcy law firm, then how objectively will they be able to look at the events at FTX from a forensic standpoint when doing so would also mean looking at the actions or non-actions of their current and former partners?
Conflict of interest is one of the most common reasons for an attorney to turn down, or be turned down from a representation. The idea being that the representation of one client may adversely affect another. A conflict of interest matters because it raises the question whether an entity's vested interests may affect their professional judgment and actions.
But beyond the conflict of interest, the appointment of Sullivan & Cromwell, LLP as Debtor's Counsel does not prevent actual or perceived self-dealing. There is the possibility, that as the bankruptcy firm, Sullivan & Cromwell could clean up any deficiencies in Sullivan & Cromwell's pre-bankruptcy advice as FTX's law firm. It would arguably be tantamount to one entity investigating itself while simultaneously donning the hats of investigator, judge and jury.
If there is fault on the part of FTX's legal advisors, along with the actions of FTX's principals that led to the bankruptcy, the creditors, stakeholders and retail investors of FTX deserve answers from an unconflicted investigation.
R Tamara de Silva
Endnotes:
1. 22-11068-JTD Doc.459
2. Securities & Exchange Commission v. Bankman-Fried, Case No. 22-cv-10501 (S.D.N.Y. 2022), ¶ 74