The most recent headline in the on-going FTX scandal is that lawyers representing a large group of Plaintiffs have finally served legal proceedings on Shaquille O'Neal, the NBA legend, after five months of trying. In fact, he was the last of a dozen or so high-profile celebrities to be served.
On 11 November 2022 FTX Trading Ltd, a Bahamas-based crypto-currency trading platform, filed for Chapter 11 bankruptcy protection in the US Courts. This followed the resignation of its founder and CEO, Sam Bankman-Fried, after customers tried to withdraw billions of dollars' worth of assets as a result of rumours about FTX's governance and ability to meet its obligations. FTX was unable to meet the demand for customer withdrawals and it has subsequently become apparent that customer funds were not properly segregated and were used to prop up the trading losses of Alameda Research, a hedge fund run by the FTX executives. The house token issued by FTX, called FTT, was also found to be effectively worthless and yet it constituted over $6 Billion of assets on the FTX and Alameda balance sheet.
The insolvency practitioner John J. Ray III, who was appointed as CEO as part of the Chapter 11 process, stated that "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here." Sam Bankman-Fried is facing a criminal trial for wire fraud and conspiracy, amongst other things, while some of his colleagues have already pleaded guilty. We note that Mr Bankman-Fried has pleaded not guilty – he has sought to distance himself from the daily operations of FTX – and has asked the Court to dismiss a large number of the criminal charges against him.
Chapter 11 and recovery of customer losses
One fundamental feature of the Chapter 11 process is that there is a general stay of proceedings brought by creditors (ie customers) against the debtors (ie FTX), which is similar to a moratorium in a UK administration process. This means that customers will be prevented from seeking damages for the losses they have suffered directly from FTX until the insolvency process has been completed, and the full extent of the loss have been crystallised.
In light of this stay, or moratorium, creditors have started proceedings to recover damages against parties other than FTX itself, and who may be outside of the Chapter 11 process.
The most well-known is the claim in the Southern District of Florida, in which a Plaintiff group have sued a dozen or so "celebrity endorsers" of FTX. They include Tom Brady, Gisele Bunden, Larry David, Naomi Osaka, Stephen Curry and Shaquille O'Neal. The complaint is based on the premise that the yield-bearing accounts at FTX are securities, which is the position taken by the Securities and Exchange Commission (SEC). Therefore the celebrities, all of whom were either paid or received shares for endorsing FTX on social or television commercials, may be liable for promoting unregistered securities and inducing consumers to acquire them. The attraction for the plaintiffs, of course, is that these celebrities are all incredibly wealthy and are not subject to the stay, so there is a greater prospect of recovery, if liability can be established.
Another important class action, which was issued in the Delaware Courts, seeks (amongst other things) a declaration that title to the customer's assets (ie ownership) did not pass to FTX when they were transferred to the FTX platform. Somewhat unusually, FTX's Terms and Conditions state expressly that title remains with the customer and "shall not transfer to FTX." This could have great significance in the Chapter 11 process because it may mean that any assets in those accounts are not part of the Debtor's estate, and so should be returned to the customers at an early stage.
A similar case has recently been decided in the Chapter 11 bankruptcy proceedings of Celsius Network, another cryptocurrency company which paused trading in July 2022. Creditors sought a similar declaration about ownership of cryptoassets in its "Earn" accounts, albeit that the Court found in that case that title to over $4 Billion had been transferred to Celsius. This dramatically increased the size of the estate, because the assets were owned by Celsius rather than the customers, with the effect that those customers became unsecured creditors.
Another category of class actions has targeted FTX's professional advisors. For example, there are several conspiracy claims against FTX's accountants, Armanino and Prager Metis, in which it is alleged that they misled potential customers, by signing off FTX's accounts and therefore validating its financial health. Similarly, there was a claim against Silvergate Bank, FTX's bank, relating to its failure to identify the use of FTX customer assets in Alameda Research. However, Silvergate has itself now collapsed, in no small part due to its exposure to FTX.
Finally, Sam Bankman-Fried and other FTX executives are named as Defendants in a number of the claims, for their part in the various fraudulent transactions. Whilst they are obvious targets in terms of liability, it appears that the vast majority of their wealth was tied up with FTX and so actually recovering any damages from them seems difficult.
What are the implications for UK-based customers?
The primary point is that the Chapter 11 process affects creditors in any jurisdiction. Recent filings in the Chapter 11 proceedings indicate that there may be Billions of dollars' worth of distributable assets, so there appears to be a substantial chance of some recovery. Similarly, the declaration sought in the Delaware proceedings should equally apply to all customers – indeed one of the named Plaintiffs is based in the UK.
FTX's most recent Terms and Conditions, for non-US customers, were governed by English law and contained an arbitration clause giving jurisdiction to the Singapore International Arbitration Centre, although the moratorium means that arbitral proceedings are unlikely to be commenced until the Chapter 11 proceedings have been concluded and it is not immediately clear what additional loss they would seek to recover.
The final point is that it is difficult to see a similar "celebrity endorser" claim in the UK. A more likely claim (in the right circumstances) would be against any advisor for negligence in advising a customer to use FTX.
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