By Pam Martens and Russ Martens: January 12, 2023 ~
To grasp the severity of the miscarriage of justice that occurred yesterday at the hands of Judge John Dorsey in the bankruptcy hearing for collapsed crypto exchange, FTX, one first needs a brief bit of background.
The FTX companies that the bankruptcy lawyers are attempting to resuscitate or sell off to other crypto outfits (while the law firms collect millions of dollars in billable hours for their work) are peddling a product – crypto – that is created out of thin air and has no legitimate productive purpose. (See Over 1,600 of the Brightest Scientific Minds in Technology Have Signed a Letter Calling Both Crypto and Blockchain a Sham.)
The hundreds of billions of dollars that American investors have been dumped into crypto exchanges, crypto lenders, crypto miners, and crypto banks are not only threatening the safety and soundness of the U.S. financial system, they are threatening the global competitiveness of U.S. innovation. These failing enterprises raise capital in public markets, crowding out real companies with real innovations.
In July 2019, NYU Professor and economist Nouriel Roubini said this in a Bloomberg News interview:
“Crypto currencies are not even currencies. They’re a joke…The price of Bitcoin has fallen in a week by how much – 30 percent. It goes up 20 percent one day, collapses the next. It is not a means of payment, nobody, not even this blockchain conference, accepts Bitcoin for paying for conference fees cause you can do only five transactions per second with Bitcoin. With the Visa system you can do 25,000 transactions per second…Crypto’s nonsense. It’s a failure. Nobody’s using it for any transactions. It’s trading one sh*tcoin for another sh*tcoin. That’s the entire trading or currency in the space where’s there’s price manipulation, spoofing, wash trading, pump and dumping, frontrunning. It’s just a big criminal scam and nothing else.”
The law firm that Judge Dorsey is allowing to pull a coup d’etat in his courtroom is Sullivan & Cromwell – the go-to law firm for Wall Street for more than a century — which has bestowed on itself the role of lead law firm in the FTX bankruptcy. For reasons that appear to rest firmly on just two words – “billable hours” – Sullivan & Cromwell has immersed itself in all things crypto. In a recent FTX bankruptcy court filing, Sullivan & Cromwell acknowledged that not only has it collected legal fees and expenses of $8,564,487.50 from FTX and its related companies over the prior 16 months, plus a $12 million retainer for bankruptcy work, but it is simultaneously outside counsel to four of FTX’s major competitors: BlockFi, Coinbase, Gemini, and Kraken.
The quick take on the status of those five clients of Sullivan & Cromwell is as follows: the FTX group of companies has been described by federal prosecutor Damian Williams as “one of the biggest financial frauds in American history” with three of its top executives now indicted on a combined 19 criminal counts; BlockFi is also in bankruptcy; Coinbase, a publicly-traded crypto exchange, has lost more than 80 percent of its market value over the past 12 months; Gemini has had more than $900 million of client funds frozen at another crypto firm, Genesis; and Kraken has fired 30 percent of its staff.
But instead of bringing some sunshine to this murky mess that exists between Sullivan & Cromwell and the crypto cabal, Judge Dorsey has opted for more darkness. FTX filed for Chapter 11 bankruptcy on November 11 – two months ago. The U.S. Trustee, which represents the Department of Justice in bankruptcy cases, together with major media outlets (Bloomberg News, Dow Jones, New York Times and Financial Times), had filed motions asking the court to release the names of the customers and creditors so that the public and the press could have transparency in the matter.
There have been multiple academic studies showing that the vast majority of trading on unregulated crypto exchanges is fake with an unsavory agenda of attempting to legitimize an otherwise illegitimate enterprise. Just last month, a paper released by the National Bureau of Economic Research found that “wash trading volume, on average, is as high as 77.5% of the total trading volume on unregulated exchanges, with a median of 79.1%….” The researchers define wash trading as “investors simultaneously selling and buying the same financial assets to create artificial activity in the marketplace….”
Judge Dorsey releasing the names of the customers would allow the academic community and the press to conduct an analysis into the nature of traders that used FTX as well as its interrelationships with the megabanks and hedge funds on Wall Street. A document filed with the bankruptcy court by Sullivan & Cromwell has indicated that megabanks JPMorgan Chase, Bank of America, Morgan Stanley and Wells Fargo had existing relationships with FTX and/or its affiliated companies. Details of these relationships have yet to find their way into the sunshine.
Attorneys for FTX argue that the customer lists have resale value and that the customers might be poached by crypto competitors if their names are released.
The reality is that any real FTX customers (outside of the potential bots, algorithms and fake traders that might be doing the trading) are very angry customers. Their accounts at FTX have been frozen for more than two months with no ability to access their cash or securities. New FTX management has testified that $8 billion of customers’ money is missing. And as each day of financial distress grows among FTX customers, there is a new breaking story about the opulent life that the alleged fraudsters were living with the looted funds from customer accounts.
In short, it is highly unlikely that these defrauded customers are going to beat a path to the door of another crypto exchange or remain at that crypto firm if their account is sold and moved to another crypto firm. These are now very hostile, out-for-revenge customers and for good reason. So, who in their right-mind would want to pay good money for pitchfork-yielding clients who have had a life-altering taste of crypto investing?
Where these defrauded and abused customers would likely want to run is into the arms of a traditional, federally-insured bank. But what federally-insured bank would want to get within 10 miles of this mess – given the recent warning from federal regulators to consider rubbing elbows with crypto a threat to a bank’s safety and soundness.
The attorney for the U.S. Trustee, Juliet Sarkessian, has already agreed to accept making public just the customers’ names, without addresses or other identifying information. But despite that concession, yesterday Judge Dorsey yielded yet again to Sullivan & Cromwell and extended the blackout on the names of customers and creditors for another 3 months.
Then there is the issue of such brazen conflicts of interest with Sullivan & Cromwell that four U.S. Senators had to resort to sticking the glaring conflicts under the nose of Judge Dorsey by releasing a public letter to him on Monday. (The letter struck us as symbolic of an open cry for help from fellow Americans to save a failing democracy, its court system and its financial system.)
The bi-partisan group of Senators (Elizabeth Warren (D-MA), John Hickenlooper (D-CO), Thom Tillis (R-NC) and Cynthia Lummis (R-WY) got to the core of the conflicts in this paragraph:
“To name just one challenge: will the firm’s lawyers be able to effectively investigate their current and former partners who were central in FTX’s conduct? Additionally, given their longstanding legal work for FTX, they may well bear a measure of responsibility for the damage wrecked on the company’s victims. Put bluntly, the firm is simply not in a position to uncover the information needed to ensure confidence in any investigation or findings.”
An FTX customer, Warren Winter, was even more blunt in the objection his attorneys filed with the Court. His assessment was as follows:
“Sullivan & Cromwell was one of the FTX Group’s ‘primary external law firms’ before the FTX Group collapsed. To date, the FTX Group has paid the firm more than $20.5 million in fees and retainers. Now, in the most flagrant attempt by a fox to guard a henhouse in recent memory, Sullivan & Cromwell has applied to be appointed the FTX Group’s bankruptcy counsel with duties that would include ‘investigating all potential estate causes of action.’ But it has revealed almost nothing about its prepetition work for Sam Bankman-Fried’s fraudulent enterprise — and failed to disclose or elided glaring conflicts of interest.”
Winter goes on to reveal the following to Judge Dorsey:
“Two former Sullivan & Cromwell lawyers are General Counsel to FTX Group entities. Sullivan & Cromwell did not disclose these connections in its Application and therefore violated Federal Rule of Bankruptcy Procedure 2014, which requires a statement ‘all of [the firm’s] connections with the debtor … [and the debtor’s] attorneys.’ What’s more, disclosed or not, these connections create a conflict of interest and are disqualifying. FTX US General Counsel Ryne Miller is a former partner at Sullivan & Cromwell…Miller is alleged to have played a key role— perhaps the key role—in wresting control of the FTX Group from Sam BankmanFried and directing this extremely valuable bankruptcy matter to his former firm. According to Bankman-Fried, and supported by what appears to be genuine evidence, Miller proclaimed to have usurped control of the FTX Group by November 8th. He immediately secured a $12 million retainer for his former firm and allegedly mounted an ‘extreme pressure’ campaign to put the FTX Group into bankruptcy with Sullivan & Cromwell and its hand-picked CEO at the helm.
“FTX Ventures General Counsel Tim Wilson is another former Sullivan & Cromwell lawyer. The Securities and Exchange Commission has alleged that FTX Ventures made at least $200 million in venture-capital investments using customer funds that had been misappropriated through Alameda Research….”
Despite all of these startling conflicts of interest, Judge Dorsey has been allowing Sullivan & Cromwell to run the show since the FTX bankruptcy petition was filed on November 11. Sullivan & Cromwell has overseen the hiring of a multitude of advisors, including investment bank Perella Weinberg Partners, which is engaged in seeking buyers for some of the FTX businesses.
In addition, Judge Dorsey has stalled on hearing a motion filed more than 40 days ago by the U.S. Trustee for an independent examiner to be appointed in the case. The U.S. Trustee wrote in the motion:
“An examiner could—and should—investigate the substantial and serious allegations of fraud, dishonesty, incompetence, misconduct, and mismanagement by the Debtors, the circumstances surrounding the Debtors’ collapse, the apparent conversion of exchange customers’ property, and whether colorable claims and causes of action exist to remedy losses. The appointment of an examiner is mandatory under 11 U.S.C. § 1104(c)(2) because the Debtors’ fixed, liquidated, unsecured debts to its customers alone far exceed section 1104(c)(2)’s $5 million threshold.
“An examination is preferable to an internal investigation under the facts of these cases because the findings and conclusions of the examination will be public and transparent, which is especially important because of the wider implications that FTX’s collapse may have for the crypto industry….”
Yesterday, Judge Dorsey cancelled the hearing on that motion that had been scheduled for January 20 and pushed the hearing forward to February 6 at 9:30 a.m. (We would anticipate that the objection to Sullivan & Cromwell filed by customer Warren Winter would be heard on the same date.)
This raises the obvious question as to whether all of the myriad actions and hirings and expenditures of money that Sullivan & Cromwell has already engaged in will have to be unraveled if the court determines that the law firm was too conflicted to have functioned as the lead law firm on the FTX bankruptcy.