Top FTX Execs Flip: CEO Caroline Ellison and Co-Founder Gary Wang Plead Guilty

Caroline Ellison and FTX Co-Founder Gary Wang Plead Guilty to Fraud

Two former top executives of Sam Bankman-Fried’s crypto trading empire have pleaded guilty to federal criminal fraud charges and are cooperating in the prosecution of the disgraced crypto entrepreneur, the U.S. attorney for the Southern District of New York said on Wednesday night.

The two are Caroline Ellison, 28, who was the chief executive of the cryptocurrency hedge fund Alameda Research, and Gary Wang, 29, a founder of FTX, the crypto exchange. They were key lieutenants in Mr. Bankman-Fried’s vast business empire, an international web of investments and enterprises that began with the founding of Alameda and FTX.

SEC Charges Caroline Ellison and Gary Wang with Defrauding Investors in Crypto Asset Trading Platform FTX

According to the SEC’s complaint, between 2019 and 2022, Ellison, at the direction of Bankman-Fried, furthered the scheme by manipulating the price of FTT, an FTX-issued exchange crypto security token, by purchasing large quantities on the open market to prop up its price. FTT served as collateral for undisclosed loans by FTX of its customers’ assets to Alameda, a crypto hedge fund owned by Wang and Bankman-Fried and run by Ellison. The complaint alleges that, by manipulating the price of FTT, Bankman-Fried and Ellison caused the valuation of Alameda’s FTT holdings to be inflated, which in turn caused the value of collateral on Alameda’s balance sheet to be overstated, and misled investors about FTX’s risk exposure.

In addition, the complaint alleges that, from at least May 2019 until November 2022, Bankman-Fried raised billions of dollars from investors by falsely touting FTX as a safe crypto asset trading platform with sophisticated risk mitigation measures to protect customer assets and by telling investors that Alameda was just another customer with no special privileges; meanwhile, Bankman-Fried and Wang improperly diverted FTX customer assets to Alameda. The complaint alleges that Ellison and Wang knew or should have known that such statements were false and misleading.

SEC Calls FTT Exchange Token a Security

FTX’s exchange token FTT was sold as an investment contract, and is a “security,” the U.S. Securities and Exchange Commission said in a complaint filed late Wednesday, in a move that is sure to have a wide-ranging impact on the industry.

“If demand for trading on the FTX platform increased, demand for the FTT token could increase, such that any price increase in FTT would benefit holders of FTT equally and in direct proportion to their FTT holdings,” the SEC wrote in its complaint. “The large allocation of tokens to FTX incentivized the FTX management team to take steps to attract more users onto the trading platform and, therefore, increase demand for, and increase the trading price of, the FTT token.”

The SEC made the claim in a complaint filed against FTX co-founder Gary Wang and former Alameda Research CEO Caroline Ellison.

SEC Heightening Scrutiny of Auditors’ Crypto WorkThe Securities and Exchange Commission is stepping up scrutiny of the work that audit firms are doing for cryptocurrency companies, concerned that investors may be getting a false sense of reassurance from the firms’ reports, a senior official at the regulator said.

“We’re warning investors to be very wary of some of the claims that are being made by crypto companies,” Paul Munter, the SEC’s acting chief accountant, said in an interview.

Increased scrutiny has led at least one audit firm to drop crypto clients, in some cases soon after producing reports on the companies’ assets and liabilities. Crypto companies are eager to get the blessing of an auditor to reassure their skittish clients.

The Wall Street watchdog is looking closely at how crypto companies are portraying their reports from audit firms, according to Mr. Munter….

Recent Rulings Can Help Securities Defendants Avoid Industry Bans

Federal district courts increasingly are expressing concerns about the effect being barred from the securities industry as part of a settlement will have on defendants’ livelihoods, even in cases where they acted with knowledge of wrongdoing.

In three recent litigated Securities and Exchange Commission enforcement actions involving violations of the Investment Advisers Act, courts have denied the SEC’s request for an injunction that would provide a jurisdictional basis for an administrative proceeding seeking a bar from future work in the securities industry. Meanwhile, constitutional challenges have constrained the SEC’s use of contested administrative proceedings where the SEC could seek a bar directly.

But the SEC appears routinely to require bars in settled actions involving scienter-based violations of the Act. There is tension between the SEC’s regular imposition of bars in a settled context and the SEC’s narrowing ability to obtain those bars through litigation.

New York Flags Climate Risks for Banks

Banks both big and small should pore over how climate change could impact their business, New York’s influential state banking regulator said in a proposal that would heighten risk management expectations for financial institutions.

Financial institutions of all sizes—including foreign-based banks with operations in New York—would be expected to evaluate climate risks throughout their business under guidance released Wednesday by the New York State Department of Financial Services. Banks would be called upon to look at climate-related risks when bringing on new clients and when extending credit.

Crypto Giant Binance Offers Little Transparency After FTX Collapse

Like FTX, Binance discloses limited financial information. It doesn’t say where the company is based. And its founder, Changpeng Zhao, is affiliated with market makers providing liquidity on its own platform, an arrangement some market observers say leads to a potential conflict of interest.

“Does the exchange give preferential treatment to an affiliate? Is the exchange supporting an affiliate with customer money? These questions concern customers and the regulators who try to protect them,” said Larry Harris, a finance professor at the University of Southern California’s Marshall School of Business and former Securities and Exchange Commission chief economist.

“When a business is not transparent and not regulated, we have no true understanding of what is happening inside,” Prof. Harris said.

Regulating Crypto: How we move forward as an industry from here

Perhaps the most complex point that needs clarity is around which crypto assets are commodities and which are securities. The CFTC and SEC have been debating this issue in the U.S. for several years now, but unfortunately they haven’t provided any clarity to the market.

At this point, it seems clear that Congress needs to step in and pass legislation. This can be done with an updated version of the Howey test that applies to crypto tokens that may fall under the definition of an investment contract.

A modern day Howey Test for cryptocurrency might look something like this:Was there an investment of money?  If the crypto asset issuer hasn’t sold the asset for money for the purpose of building a project, it’s not a security.Is the investment in a common enterprise?  For a crypto asset to be a security, it must be controlled and operated by a centralized organization like a company. If a project has become sufficiently decentralized, it’s not a security.Is there an expectation of profit?  If the primary purpose of the crypto asset is some other form of utility (voting, governance, incentivizing actions of a community, etc) then it is very unlikely to be considered a security.Are the profits to be derived primarily from the efforts of others?  If the expectation of profit primarily comes from participants who are unaffiliated with the issuance of the asset, then the project is sufficiently decentralized and would not be considered a security.It’s important to note that all four of these prongs need to be satisfied for the asset to be considered a security….

Not Now, CoinbaseAfter the collapse of FTX, what is the path forward for crypto regulation? I have no idea! The basic situation in the US is that regulators — mainly, the US Securities and Exchange Commission — are pretty hostile to crypto, and if a crypto exchange comes to the regulators and says “how can I set up a full-service, innovative, but regulatorily compliant crypto exchange for US customers” the regulators will say “I’m so glad you came in, welcome,” and then throw them in a dungeon. After FTX, you could have two views of that approach:

1) If US regulators had been more accommodating, more crypto trading would have moved to US-regulated exchanges that were transparent, audited, and carefully supervised by US regulators, and the result would have been that FTX would not have lost billions of dollars of customer money. Or:

2) If US regulators had been more accommodating, crypto exchanges like FTX would have had a lot more access to US customers, and would have lost a lot more of their money.

I think both of those views probably have some merits, but the overall tone of the discussion these days favors the second….