Written by Allison Frankel

(Reuters) – Federal prosecutors and regulators from the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission told a similar story on Tuesday about Sam Bankman Fred’s scheme to funnel billions of dollars in client funds from cryptocurrency exchange FTX to Alameda Research LLC.

They all accused Bankman-Fried of fraud, asserting that he had repeatedly lied when he insisted that FTX clients’ funds were safe, secure and completely separate from Alameda’s affiliate but purportedly independent.

According to the indictment unsealed Tuesday in Manhattan federal court and separate complaints filed Tuesday by the Securities and Exchange Commission and the Commodity Futures Trading Commission, Bankman-Fried knew or should have known that funds were stolen from FTX clients’ accounts to fund Alameda speculatively traded and that, despite its repeated protests to the contrary, FTX granted Alameda special trading concessions which ultimately proved disastrous for the platform and its customers.

Who are the victims of this alleged fraud?

The CFTC complaint highlighted how FTX users were tricked, the regulator said, into believing their funds were safe. The Manhattan district attorney’s indictment also cited the FTX clients as victims of the wire fraud and commodity fraud charges against Bankman-Fried.

But the SEC’s lawsuit focused on a different set of alleged victims: investors who invested $1.8 billion in FTX in a series of stock purchases between 2019 and 2022.)

Reuters reported that equity investors in FTX included companies like Sequoia Capital, SoftBank Group Corp, BlackRock (NYSE:) Inc, and Temasek — not exactly small crypto clients who wanted to trade on the FTX platform and trusted their Bankman-Fried promises. The money will be safe.

An important note here: Bankman Fried’s attorney, Mark Cohen of Cohen & Gresser, told Reuters on Tuesday that his client is “reviewing the charges with his legal team and considering all of his legal options.” Meanwhile, the SEC has not responded to my inquiry about the wording of its lawsuit.

And to be fair, the SEC complaint, as you mentioned, made FTX clients victims as well, albeit in a parental fashion.

I’m being verbatim: The second sentence of the SEC’s complaint reads, “Unbeknownst to these investors (and to FTX trading clients), Bankman-Fried has been orchestrating a massive, years-long scam, diverting billions of dollars from clients of the trading platform’s money for his own personal benefit and to help grow his crypto empire.” “.

My point is that the SEC’s pleading strategy in Tuesday’s lawsuit shows that crypto remains a significant challenge for US regulators. An alleged fraudster is accused of misappropriating billions of dollars from clients who wanted to buy and sell cryptocurrency, yet the first US Investor Protection Agency is not soliciting securities fraud on behalf of those clients.

This may be due to regulatory uncertainty about what crypto assets meet the definition of security, said Anne Lipton, a professor of securities law at Tulane University School of Law. (As you know, this question, in turn, is the subject of intense litigation between the SEC and Labs Inc.)

“The SEC is limited to suing for securities fraud — that requires a security,” Lipton said by email. “At the very least, each crypto-asset needs to be analyzed individually to determine if it is a security, which is probably not possible for clients who have traded different types of assets.”

Focusing instead on the individuals and funds that have taken a stake in FTX, Lipton said, “The SEC is ditching this issue — these investors definitely bought the securities in the form of shares.”

“It’s easier and more direct for the SEC to focus on equity investors,” agreed former Manhattan federal prosecutor Timothy Howard of Freshfields Bruckhaus Deringer.

Unlike private shareholders who are sued for securities fraud, the SEC does not have to prove that investors relied on alleged misrepresentations. (The US Department of Justice, which has charged Bankman-Fried with defrauding FTX stock investors as well as FTX clients, similarly does not have to show reliance on proof of securities fraud.)

“This greatly mitigates prosecutions in the SEC and DOJ because it removes all questions associated with the adequacy of investor due diligence,” Stanford Law School professor Joseph Grundqvist said by email.

Many of the SEC’s allegations include allegations that FTX lied in publicly released statements and reports on its websites. But, perhaps anticipating arguments from Bankman-Fried that it could not be held responsible for the company’s public statements, the SEC complaint cited two instances in which FTX investors were allegedly misled by Bankman-Fried himself.

According to the Securities and Exchange Commission, an American investor who bought $35 million in FTX shares in July 2021 gave a document promising that FTX and Alameda did not link up the funds. And in late summer 2021, the complaint alleges, Bankman-Fried told a potential US investor who eventually acquired a $30 million stake that FTX does not hold its native cryptocurrency, known as FTT.

According to the SEC, Bankman Fried knew or should have known that its statement to the investor was false.

These specific allegations appear to be intended to show Bankman-Fried that FTX investors are cooperating with the government, said Howard of Freshfield – and that he could not evade responsibility simply by claiming he was unaware of FTX’s public statements.

Given the potential repercussions of FTX’s collapse, I’ll be interested to know if any of FTX’s clients or creditors try to blame the equity investors deemed victims in Tuesday’s complaint from the SEC, arguing that they failed to do the due diligence that later enabled the platform. of alleged misconduct.

If that happens, it will be interesting to see if FTX equity investors point to their portrayal in the SEC complaint as evidence that they, too, were victimized by Sam Bankman-Fried.