The following is a lightly edited excerpt from our December 1st conference call for Inner Circle subscribers, Puck’s highest tier of membership, featuring Eriq Gardner and Teddy Schleifer in discussion with executive editor Ben Landy. We hold these calls for Inner Circle members every other week, among other benefits; to join our next live off-the-record session, upgrade your membership here.
Ben Landy: Let’s start with one of the central questions about this FTX disaster: What happens to all of the money that Sam Bankman-Fried distributed? Even if it didn’t come directly out of customer accounts, in practical terms it seems to have had the same effect—customer deposits were used against bets at Sam’s associated hedge fund, Alameda Research. What happens to those funds? Can they be recovered in bankruptcy court?
Teddy Schleifer: A lot of money has gone out the door, right? I mean, political contributions have been made, super PACs have spent money on ads, grantees have used the money for salaries or for office spaces… So I think we should acknowledge that it’s not as if there’s $500 million or a billion dollars just sitting in a bank account somewhere, ready for creditors to show up with a wheelbarrow. A lot of grantees are expecting the possibility of clawbacks, meaning the money may not be theirs. And frankly, it depends on how savvy the litigants are, and whether or not they can persuasively make the claim that this money was fraudulently made and fraudulently distributed. That’s a long way of saying we’ll see, but everyone expects there to be at least attempts to claw back the money. Eriq, I’m curious how you think of the legal questions here?
Eriq Gardner: Yeah for those who are not familiar with the clawback mechanisms, basically the law keeps insiders at failing corporations from hiding assets from creditors by transferring them outwards. So there are always attempts to claw back funds, and at some point in the bankruptcy case a litigation trustee will be appointed—and that litigation trustee will start filing litigation against the beneficiaries of S.B.F.’s largesse.
Consider the Bernie Madoff case—and I’m not pointing to Madoff because I’m saying that what S.B.F. did was a Ponzi scheme, although it might be—but mainly just to show what happens in these instances. When Madoff’s investment firm declared bankruptcy, there was very little in the estates, and eventually a trustee named Irving Picard was appointed. He went around suing, attempting to void fraudulent transfers, and was pretty successful. He still has cases active to this day, and by now he’s recovered more than 70 percent of the $20 billion that was lost. With S.B.F., we might see something similar to that, although we’re still assessing what type of event this was—whether it was a Ponzi scheme or something closer to the collapse of MF Global.
Regardless, there’s $9 billion dollars in liabilities and there’s going to be efforts to recover whatever he took and whatever he spent. Some of that money was received in good faith and might not have to be returned, but there’ll be examinations into the circumstances in which money was received, and if people who received the money were willfully blind to fraud.
Ben: Among those funds there is the pretty sizable investment that S.B.F. made in Semafor. We don’t know exactly what that number is, but what is, or isn’t, happening with that money? With the caveat, of course, that this is an evolving story.
Teddy: In terms of the size of the investment, $5 million or so is my guess. I previously reported that his team spent about $10 million on its media investments overall. I’m speculating here, but I would say five million sounds right. And the money has not been returned. Semafor says they don’t expect any changes, and C.E.O. Justin Smith put out a note on Friday that they’re monitoring the situation.
I’ve reported that there is a clawback provision in the Semafor-S.B.F. deal—which Smith confirmed in his note to staff—essentially allowing Semafor to buy out its investors if they chose to do so. So there is an escape hatch here. If Semafor feels like one of their biggest investors is ethically compromised in a way that makes staff or leadership uncomfortable, could they buy the shares back? They could, but here’s no sign that’s going to happen here. And you would think if they were going to do that, they probably already would have.
Ben: Eriq, do the creditors themselves have any kind of claim on the money that Sam invested in Semafor?
Eriq: I expect the litigation trustee to target wherever Bankman-Fried transferred money. But even if Semafor doesn’t have to give back money, I think there’ll be a question over what S.B.F. actually owns of Semafor, and whether that is really owned by the bankruptcy estate. So, if S.B.F. owns say, 10 percent of Semafor, I would imagine that the debtor wants that 10 percent, perhaps so they could sell it and give the proceeds to creditors. Although, as I understand it, Ben Smith and Justin Smith raised money with a SAFE convertible instrument, so Bankman-Fried doesn’t yet have equity. Regardless, one way or another, I expect the Semafor investment to come up in court.
Ben: Regarding the people and organizations that were promised Sam’s money, which is in some very real ways customers’ money, what has been the response so far to the vaporization of cash?
Teddy: I mean, these can be divided into two categories. There’s essentially Sam Inc., which were the entities that were funded by Sam already, and then there’s the broader political and philanthropic establishments that were expecting Sam’s money that had dreams of getting their hands in the candy bowl.
To address the second group first, there were tens of millions of dollars that had been promised, or were in the process of being spent, and that money is gone. It was always just a promise, and as we’ve seen, money can vanish in an instant. Say you had part one of your grant—now you won’t get part two. Or you may have been in the closing stages of getting money, and now you’re not going to get it. For specific stories, there’s a message board—now community grieving platform—called the EA Forum. EA stands for Effective Altruism, the philanthropic credo that Sam and his followers subscribe to. The forum is now littered with sort of sob stories about entities that thought were gonna get money that suddenly are panicking and trying to make this all work out.
The other category are the entities that Sam personally was standing up, whether it was his super PAC, or his nonprofit lobbying group called Guarding Against Pandemics. Those things are dying, if not dead already. I don’t know if anyone wants to admit they’re dying, but they’re dying. And that’s the state of play in Sam Inc.—everything he touched is unraveling.
Ben: We have a listener question: What about the politicians who took Sam’s money? Is there a mechanism to recover funds from political candidates or campaigns?
Teddy: That’s a good question. I mean, the focus on $5,000 contributions to random senators is kind of missing the point. Sam was spending tens of millions of dollars on campaigns, on super PACs, on (c)(4) groups and committees. So in terms of suing the candidates, there’s not much juice in that lemon. Committees, I don’t know whether or not they even have the money to get back. Eriq, do you have any thoughts on that?
Eriq: Yeah, I mean, you’re right, it’s low-level amounts to specific politicians. Nevertheless, we could see some litigation over that as well.
Ben: Speaking of litigation, Eriq, there are three investigations underway in the United States that we know about—from the S.E.C., the D.O.J., and the Commodities Future Trading Commission. Will one of these agencies ultimately pull rak? Do the regulatory commissions defer to the D.O.J. if this ends up being a bigger case?
Eriq: Well, I think they can happen concurrently. To the extent that that one agency is going to take the lead, it’s probably going to be the Cybercrime Unit at the Southern District of New York, which is part of the Department of Justice. The S.E.C. usually just handles civil cases, the feds in New York would handle any criminal charges. If there is a criminal matter, that will certainly take priority over everything else. I also expect that the I.R.S. will look into it, and it wouldn’t surprise me if there are other agencies too.
I think that the criminal stuff could complicate the recovery efforts and complicate the bankruptcy. I think there are a lot of people who are going to be tempted to stay quiet and not incriminate themselves—although apparently that does not include S.B.F. himself, who doesn’t seem willing to shut up, probably to his own lawyers’ horror. I’m sure the feds are going to be particularly interested in trying to figure out where the money went, and, to the extent that they can, to ascertain the criminal leverage in that regard, to figure out where this money is hiding. In a way, it’s a little bit strange to me. I mean, part of the benefits of the blockchain was that it was supposed to be transparent, and that there was more security in the system. It’s hard for me to imagine that some of this can’t be traced, but we’ll see. It’s definitely gonna be very fascinating to watch.
Ben: We have another apropos listener question here, which is, how does being located in the Bahamas affect recovery of funds or the prosecution? Obviously there are jurisdictional issues at play. The Bahamas Attorney General has gotten involved, and he’s been trying to reassure investors that, actually, the Bahamas is still a nation of laws, and so on; the Securities Commission of the Bahamas suspended FTX’s license and appointed their own liquidator. Eriq, what kind of potential issues do you foresee here in terms of multiple competing jurisdictional claims?
Eriq: Yeah, in fact I think that’s going to be the very first big issue that will be decided. The Bahama liquidators brought a Chapter 15 case in New York, and it’s already been transferred down to Delaware, so I expect that one of the big questions is going to be whether this should take place in Delaware or should take place in the Bahamas. But I expect Delaware to win out. That being said, the Bahamas people are going to have a very real role in this going forward—that’s where a lot of the operations were, that’s where S.B.F. is currently. They’re going to have leverage on their side.
I don’t know if anyone saw this because it kind of came out while S.B.F. was being interviewed by Andrew Ross Sorkin on Wednesday. But apparently he opened up withdrawals for local Bahamian citizens, even though he supposedly didn’t have authorization to do so. And there was an interview he gave where he said, basically, that he didn’t want to be in a country with a lot of angry people in it, which is an amazing quote. In other words, he’s paying the locals for protection. And he’s already voiced the opinion that he regrets the Chapter 11 and he wishes that he just let the Bahamian regulators deal with this. So he’s thrown himself in bed with them. So I expect them to be a very real presence as this goes forward in the next year or two.
Ben: Fair enough, if I were Sam Bankman-Fried and I’d lost hundreds if not billions of dollars of crypto deposits globally, there’s all kinds of unsavory elements that would potentially concern me, beyond the local populace.
Eriq, you also reported the other day that when the U.S. bankruptcy proceedings begin, there’s essentially a freeze on other types of civil litigation, which I suppose explains why David Boies has gotten involved in a lawsuit targeting FTX spokespeople, but not anyone at FTX. Is this some sort of ironclad protection around the company, and we won’t be seeing any other sort of outside lawsuits until it’s resolved?
Eriq: Well, we won’t see lawsuits against FTX immediately. Eventually, there’ll be an orderly process where claims can be made, particularly in the bankruptcy process. But there’s still going to be lots of litigation around FTX. Anyone who touched Sam Bankman-Fried should be talking to a lawyer right now. Let me apologize in advance for this metaphor, but S.B.F. is like the most contagious thing to come along since Covid, he’s like the Bernie Madoff Omicron. There’s gonna be a lot of litigation.
For instance, those who invested in S.B.F., who invested in FTX, where was their due diligence? We might see claims against those who were entrusting assets to FTX and not performing adequate oversight. There’s gonna be all sorts of unusual, interesting cases that are brought, and eventually, as I said, there’ll be a litigation trustee appointed in the bankruptcy court, who’ll be going after everyone too.
We’re gonna see hundreds, maybe thousands of cases stretching into a decade from now. So just stay tuned. This is really the first inning of the ballgame.
Ben: Teddy, another listener question for you. With FTX filing for bankruptcy, how much is the relationship going to change between the cryptocurrency industry and federal regulators?
Teddy: Look, Sam was the spokesman for the entire industry. It was a role he embraced that went beyond just being the crypto guy running his company in the Bahamas. I think he actually genuinely liked being the center of attention in Washington; he got energy out of it.
The irony now, of course, is that because he was so visible and so public, he is an absolute punching bag. Republicans are whacking him left and right because they see him as a liberal and are tar-and-feathering him daily. Democrats, though, who were sort of embracing Sam, also feel the need to look tough. And you’re seeing lots of Democrats who were associated with Sam over the last couple of years, saying “I barely know this guy,” and, you know, “what he thinks about crypto has no influence over my thinking about crypto.” He basically has no friends now, and he is going to be an albatross to the causes that he wanted to push, from pandemic preparedness to crypto regulation, including the bill that was moving in Congress that Sam was helping to craft that would have given a lot more regulatory power to the C.F.T.C., as opposed to the S.E.C.
Sam, in fact, has shown that the industry is under-regulated. So in practice, what matters more is not what Sam was saying, it is what he was doing. I think this scandal is going to be his lasting impact on crypto regulation, not any of the dinners he held at BLT Steak.
Ben: The biggest question, of course, is whether Sam Bankman-Fried is going to jail. Obviously, there’s chatter about wire fraud charges, which carry a potential 20 year prison sentence. But Sam has also made a point of emphasizing repeatedly in the press that he was incompetent, that he lost track of where the money was, that it was mislabeled and he isn’t sure what happened… Even assuming that anyone buys his explanation that he lost track of some $10 billion, is incompetence a good defense against wire fraud? I’ll toss that to you, Eriq.
Eriq: Originally, I thought that there’s no way that he’s going to jail—white collar crimes are tough to prosecute. But let me tell you, I’ve changed my mind. I think he will wind up in jail, especially the more he speaks. Even if he wasn’t doing this purposefully, we’re getting very close to the time when prosecutors can make a criminal negligence case against him. I don’t think incompetence is going to work as an excuse. Like I said, I think that there are other reasons why prosecutors may go after him, both as part of the recovery efforts to get money back, and I think he just makes a big, juicy target for politically ambitious folks.
Part of the calculus that goes into whether crimes get charged is whether it can make a difference in deterring others. And I think that to the extent that people learn who S.B.F. is, I think prosecutors are going to take a shot at this. There are still lots of details about this whole thing that still have to be sussed out, and it’s still not clear to me whether people were exactly lied to, and I think that’s a very important note in all of this. But at the end of the day, I think he very well may end up in jail.
Ben: Reading between the lines of some of Sam’s commentary over the last few days, he has seemed to point the finger at Alameda Research, his associated hedge fund where these bets with customer deposits were being made. That hedge fund was run by Caroline Ellison, who is the young C.E.O. there, and reportedly a girlfriend or former girlfriend of S.B.F. It will be interesting to see whether he or his team are sort of setting her up to take the fall.
Teddy, last thoughts from you on how people in Sam’s concentric circles are responding to all this?
Teddy: That’s the big question: how many people knew what was going on and when did they know it? Sam is clearly pointing the finger at Alameda, yes. And there’s other reports of executives not at FTX not knowing about Sam’s decisions. And to some extent this is all normal, right? Rats jump ship. There’s also those in the concentric circles around Sam—his friends who did not work for FTX—who are claiming they had no idea that Sam was doing any of this. Everyone is pleading ignorance. Who knows what’s true? But it’s easy to understand why they’re doing it—everyone is trying to shift blame. And is it possible, truly, that no one really knew exactly what was going on? Sure. But it’s also very convenient legally, to claim this was all a system error.