US Prosecutors Investigate FTX Months Before Collapse

Key points:

• Long before Sam Bankman-Fried’s FTX cryptocurrency empire collapsed this month, it had already caught the attention of Manhattan federal prosecutors.
• Authorities have used laws requiring financial institutions to take steps to prevent money laundering and terrorism financing.
• Prosecutors and regulators, including the SEC and the CFTC, are now seeking the help of FTX's new CEO, John J. Ray III.
• Ray told the bankruptcy court in a filing that his team found that Alameda had lent more than $1 billion to Bankman-Fried and other executives.
• The loss of FTX client funds means authorities will investigate whether the exchange misled clients about how their assets were held.

The U.S. Attorney's Office for the Southern District of New York, led by Damian Williams, has been conducting a wide-ranging investigation into cryptocurrency platforms with U.S. and offshore arms for months and has begun an in-depth investigation into FTX's massive involvement, according to the people familiar with the investigation.

It said the focus was on compliance with bank secrecy. Authorities have used laws requiring financial institutions to take steps to prevent money laundering and terrorism financing to go after crypto platforms that allegedly falsely claimed to not serve U.S. customers. Bahamas-based FTX operates one of the world's largest international cryptocurrency exchanges, as well as a separate and much more restricted venue called FTX US, which says it complies with the law.

It's unclear whether Manhattan prosecutors reached any conclusions in their probe ahead of the collapse of FTX, which raised funds worth nearly $32 billion in January, sending cryptocurrency markets into a tailspin and sparking questions about the accuracy of its pledges to protect customer assets. That put the federal investigation on a new track, the people said.

U.S. prosecutors and FTX officials declined to comment.

The month-long sweep revealed that FTX’s sprawling activity was being called into question even before the revelation of multibillion-dollar financial ties between the exchange operator and investment arm Alameda Research Ltd. Bankman-Fried wowed investors, and his empire fell apart.

Prosecutors and regulators, including the SEC and the Commodity Futures Trading Commission, are now seeking the help of FTX's new CEO, John J. Ray III, who has taken over his bankruptcy proceedings and is navigating what he calls "a complete absence of trustworthy financial information." 

Last week, Ray told the bankruptcy court in a filing that his team found that Alameda had lent more than $1 billion to Bankman-Fried and other executives. The software was also allegedly used to disguise the use of client funds, according to the filing. It is up to prosecutors to decide whether such conduct is illegal. So far, they have not accused anyone of wrongdoing.

The Manhattan-based U.S. Attorney’s Office, long known for its ability to fight complex financial crimes, has handled the majority of government cryptocurrency cases since digital assets became fashionable a decade ago. That included six in the year through October, roughly double the number of other Justice Department offices during that period, an analysis of federal documents showed.

The office benefits from long-standing working relationships between prosecutors and investigators at the FBI and SEC, as well as its location in the largest financial center in the United States. Money flowing to Wall Street or an email exchange with one of the city's many companies can give local prosecutors an edge in exercising jurisdiction.

Much of the securities law was enacted in the 1930s, well before digital currencies, and forced investigators to structure cases with extra care, said Samson Enzer, a former prosecutor with the SDNY’s Securities and Commodities Fraud Task Force. He was handling the first lawsuits related to initial coin offerings when prosecutors began questioning whether securities laws applied to the asset class.

"We had to think about a lot of these issues, and you're dealing with a very well-armed defendant," he said. "You have to think about what arguments they can make. How do we convince the court?"

Wire fraud

Federal investigators use various laws to go after crypto platforms.

Southern District Attorneys in 2020 invoked the Bank Secrecy Act against senior executives of Seychelles-based cryptocurrency platform BitMEX, which allegedly allowed more than $209 million worth of transactions with known darknet markets. BitMEX argued that it does not need anti-money laundering or know-your-customer policies, in part because it has no U.S. customers and is not registered in the United States. But customers bypassed the platform's attempts to block IP addresses in the United States, according to a government conviction letter filed in federal court.

The loss of FTX client funds means authorities will investigate whether the exchange misled clients about how their assets were held, former prosecutors said. To prove wire fraud, investigators would need to prove that someone at FTX used wire transfers (such as phone calls, emails, or text messages) to make money.

The FTX bankruptcy case will help prosecutors determine which documents are available for subpoenas. Now Anand Sithian, a former federal prosecutor at Crowell & Moring, says investigators will also seek communications between employees, whether by email, Slack, Signal, or WhatsApp, as well as testimony from witnesses.

“What is going to be hard when you issue a subpoena to financial institutions as it can take 30, 60, 90, days to process,” Sithian said. "Here if you send a subpoena, I don’t know that the company, FTX, would have that ready. They might need to recreate that.”