American court hearing recordings and interviews - Season 2. Episode 11. December 13, 2023. In re FTX Trading Ltd., et al., chapter 11 bankruptcy case number 22-11068, audio of hearing held in the FTX/Alameda et al. bankruptcy proceedings pending in Delaware, USA #crypto

Episode Date: December 16, 2023

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Attention, Zoom, participants, please turn off your cameras. Thank you. What answer? Good afternoon, Your Honor, and may it please the court. Adam Landis from Landis Raffey and Cobb on behalf of FPX Trading Limited and its affiliated debtors. Your Honor, we filed our agenda at docket 4601 on December 11, although there's a number of items on the agenda. Item 1 through 5 have been adjourned. Item six through 13 and 15 have been resolved with orders entered or orders pending and we're grateful to your honor for entering those orders.

That leaves us with one matter going forward today. Agenda item 14, which is the debtor's motion to establish the schedule and procedures for the estimation of the Department of Treasury IRS claims. In connection with that matter, Mr. Bromley will make the presentation on behalf of the debtors. Okay, thank you. Good afternoon, Your Honor. James Bromley of Sullivan Cromwell on behalf of the NPX debtors. Nice to be before you again. Your Honor, this is an important issue that we're bringing before you today.

We have a dispute. We have a dispute with the Internal Revenue Service that is potentially the most material dispute that the debtors have. We have the Internal Revenue Service having filed against the F.TX debtors claims in the amount of $24 billion. The filing of those claims, Your Honor, creates an obstacle, a potentially insurmountable obstacle with respect to the resolution of these cases. And if I can start with a little bit of background to lead you to where we are today, I think that might be helpful.

Your Honor may recall that these cases filed very abruptly on November 11, 2022. What we found when these cases filed was quite remarkable, and a lot has been written and spoken about the circumstances of the filing and the condition of the books and records of the debtors at the time of the file. One of the things that hasn't been focused on as much though is that when these cases filed, we effectively had a financial services firm that had a community of customers all around the world that found all of their deposits, their claims, their accounts frozen. In a bank insolvency or broker-dealer insolvency, even an insurance company insolvency,

which would be dealt with in state court, there are a bank insolvency or broker-dealer insolvency, There are very specific provisions in the laws that deal with customer and depositor claims. Indeed, in most financial services insolvencies, customers have their claims addressed immediately and don't find themselves subject to reconciliation in a court proceeding. I am handling the Chapter 11 proceedings for Silicon Valley Bank Financial Group, the holding company for Silicon Valley Bank and all the customers were taken care of by the FDIC and through the sale of SVB to First Citizens Bank. So all those customers of the bank and that was the case in Washington Mutual and Lehman

Brothers, those customers were all taken care of. So why is it different here? Well this is a new type of company, it's a new world. crypto customers, the depositors, who have filed in these cases claims amounting to $16 billion have been held in limbo. There's been no institutional or statutory regime that allows them to be paid out early. There's no statutory regime that provides them with particular protections. What we have is a system that we have been using through the Chapter 11 process to come to a resolution as quickly as humanly possible to be able to compensate and repay the victims of the fraud that occurred

here. And we have been trying to do this at lightning speed. One year ago today, John Ray, the CEO of the FTX entities, was sitting in front of the House Financial Services Committee testifying on Capitol Hill. One year ago yesterday, Sam Bankman-Fried was arrested in the Bahamas, subject to extradition to the United States. Just one year ago today, we were standing in front of and sitting in Congress with Mr. Ray testify. And yet, just one year later, Mr. Bankman-Feed has been convicted after a long trial. The federal government, through the efficient offices of the Southern District of New York were able to put together a massive case, investigate and prosecute not only Mr. Banking Fried, but obtain guilty pleas from several

other leaders of the organization. We are on the precipice of filing a plan of reorganization a disclosure statement and a motion for the approval of solicitation procedures, a set of three extraordinarily complex documents that are the result of an enormous amount of work that has been put in by the debtors, by the creditors committee, by the ad hoc committee, and by the joint provisional liquidators, where we are coming to the court, literally this weekend, with papers that represent an enormous amount of consensual work and a process that will be able to be implemented in the new year that will lead to the delivery of recoveries to the victims of Mr. Bankenfried's crimes.

There is, however, an enormous obstacle to that, and it is the claim that's been filed or the claims that have been filed by the Internal Revenue. And it is impossible, Your Honor, to really disconnect the two. In order for us, as the debtors, together with our creditor constituencies, and working hand-in-glove, and Your Honor knows that wasn't easy, with the joint, now the joint official liquidators, I should say, of the Bahamas entity, we are in a position to implement a comprehensive plan of reorganization that will provide for distributions to victims. And it's important in our view because when you're looking at typical Chapter 11 proceedings,

large liquidations that take place over a period of years, whether it was Lehman Brothers or residential capital or Nortel, proceedings that were largely about institutional claims, There wasn't a universe of victims, of customers that literally were depending on the recoveries to come out the door and into their pockets so that they can restart their economic lives, which had been held simply frozen since the first week of November in 2022. And the team of professionals that has been running this exercise has received an enormous amount of criticism. in the press, in Congress, in papers that have been filed by different parts of the United States government for the amount of money and the time that has been spent on trying to bring all of this information together. One of the things that we needed to do was to create the financial system, to understand the information that had been left by Mr. Bankin-Fried and his cohorts,

and to be able to implement a plan of reorganization, and a path forward. It's cost a lot of money, there's no doubt. But it has worked. And so all the Internal Revenue Service in the paper says, Mr. Ray said that a year ago, that he's never seen anything as bad as this, and he's been seen some bad things.

He has said, this is a dumpster fire. It's a crime scene. These are comments that were made a year ago. In the time since then, enormous efforts have been made. Substantial reports have been filed about malfeasance that has taken place. Enormous claims have been brought, and many successfully resolved, in terms of bringing cash into these estates. The billions of dollars that have been recovered in the one-year period is really unprecedented.

One of the things that the debtors have done over that period of time is work with the most sophisticated financial advisors in the world. There aren't many cases that you can say we have hired both Alex partners and Alvarez and Marselle. But not only have we hired both of them, we also have Ernst & Young, who have worked tirelessly with respect to tax returns. The issues that we're facing today, Your Honor, and the relief that we're seeking isn't something that we just stumbled upon in the last couple. couple of months. From the very early stages of these cases, it was Mr. Ray's instruction that

we needed to be on top of getting a handle on the taxes, filing tax returns, and making sure that those tax returns were credible, bullet-proof, and able to be defended because we expected that the Internal Revenue Service would want to take a look at it. It's also important, Your Honor, to understand the nature of these cases. these entities. The vast majority of the business that was conducted by the FtX.com exchange, as your honor will recall from many hearings, but in particular the first day hearing and we had the structures put up on the law, took place outside of the United States.

The FtX.com exchange was an international exchange. You couldn't operate on the FtX.com exchange if you were an American citizen. of the things that the company did do correctly, generally, was KYC. Because if you were an American citizen or sitting in the United States, you couldn't operate on the FTX.com exchange. There was the FTXUS.com exchange. That was for American citizens. The vast majority of the activity that took place in these debtors, also only took place in the last three years. And that's important to keep in mind because when you look at Mr. Mosley's declaration, and we will talk about that a little bit more,

he makes it clear that FTCS Trading Limited, Antigan entity that operated the International Exchange was really the only entity in the entire group that actually earned any revenue taxable income. But it's an Antiguan entity not subject to tax in the United States. And even taking that into account, it had one year, one year where it earned taxable revenue in Antigua over $300 million. The tax returns that we have filed for the U.S. taxpayers make it clear that there was never any taxable income in the United States. Instead, there were $11 billion of losses, $11 billion of losses, because, as we know, as Mr. Bankland-Fried and his cohort, stole money from clients and used it to make investments.

They were also using it to trade, and they were doing a terrible job at it. And they were losing lots of money on the trades. And the losses on those trades generated the $11 billion of losses that are represented in the tax returns that have been filed and prepared by Ernst & Young. What we're talking about, Your Honor, is the need at this point in terms at this point in time to recognize that if we are going to need to sit down and litigate to a point of certainty, counting the sands in the Sahara desert and boiling the ocean like the IRS would suggest,

the only result that we're going to end up with is being able to say that instead of an $11 billion loss, There's a $10.5 billion loss. Or maybe it's a $13 billion loss. There's simply no credible set of facts or circumstances that the IRS has put forth that could, in a million years, and I use that excessive phrase carefully here, that could ever generate taxable income that would justify a $24 billion plane.

If we have a $24 billion claim in these cases, all of the work that has been done put together the plan of reorganization, put together the disclosure statement, structure the compensation of the tens of thousands, the millions of victims here, all of that is going to have to be put on a shelf until we deal with the issues that have been raised by the sheer magnitude of the claim of the IRS. And that's why we're here today, Your Honor. So what about the IRS claim? I think what we need to do is to start with just form 410.

It's a proof of claim. What has the IRS done? The IRS, like every other creditor, must submit a proof of claim. And we can't lose sight of the fact of the title of that. It is an official form. At the top, it says proof of claim. It doesn't take a lawyer to understand that when you submit the claim, you must supply proof. The Internal Revenue Service has not done that. There is not a single bit of proof attached to any of the claims that they have filed. There are line items with numbers, and every one of those numbers has a footnote that says, estimated, subject to review, every single one.

I understand that the United States government, and in particular the IRS, is given the benefit of the doubt in many circumstances. In terms of the timing with which they file pleadings and the amount of work that is put into them, I understand that they are overworked and underpaid. But the Internal Revenue Service is an enormous institution, and it is part of the Department of the Treasury. And what we are talking about here is not particularly complicated things. The bankruptcy system is put in place to compel creditors to actually come to the court with proof.

The bankruptcy system provides government claimants with more time than regular claims. What we have here is a case that was filed in November of 2022. The Internal Revenue Service has been in contact with the debtors, their professionals and Ernst & Young, throughout the course of 2023. As the declaration of Mr. Shea from Ernst & Young makes clear, thousands of information discovery requests have been submitted by the IRS and responded to and processed by Ernst & Young on behalf of the debtors. We have had extensive correspondence with the Department of Justice on behalf of the Internal Revenue Service.

We have continually asked for a credible, not just credible, any explanation of why the claims, the numbers that are submitted with the claims are, how does any support for this? If you are on Zoom, leave your camera off, please. If you turn your camera on, I'm going to remove you from the Zoom call. It's becoming very distracting. Thank you. I'm sorry, I'm just following. Go ahead. And so, Your Honor, this has been an ongoing exercise, right?

But we have not here looking as the Internal Revenue Service intamates in their objection for some extraordinary relief that, is outrageous in light of all of the unanswered discovery requests that have been outstanding from the Internal Revenue Service. We have been engaged in a constant dialogue. Now, notwithstanding that dialogue, we have not gotten any answers. The way the system is supposed to work is that creditors are supposed to file a claim. When I'm representing a creditor, and indeed I just worked last last year, I just worked last week on a proof of claim submitted by my own firm in a bankruptcy in the District of New Jersey where we have a claim because we have represented the company and hadn't been paid.

I am focusing on making sure that I am complying with the basic instructions that are encompassed by the title of the document, which is proof of claim. I am providing the information, the retention agreement, the document, the time records, the invoices that we submitted that support our approval claim. Now, why is it, is it different with respect to the Internal Revenue Service, and Your Honor, I submit that it's not? We're all taxpayers here in the United States, right? We file tax returns. And until the tax return is objected to by the taxing authority, that's the evidence of prima facie evidence of the amount of tax that's owed. It is incumbent on the taxing authority to tell the taxpayer what's wrong with the tax return, if anything.

This is a circumstance, Your Honor, where we have submitted all of the tax returns for 21, 21, 22. The Internal Revenue Service, that's what they do. They review tax returns and they decide whether or not there's anything to challenge. I understand that in large corporate situations, the strategy and the policy might be, well, we're going to take our time. We're going to conduct an audit. We're going to look at this information. We're going to ask for things. Well, in many respects that process has taken place. We've had thousands of information requests that have been responded to. There are a few that are outstanding and they will be satisfied by January 15th and just so your honor can get a sense of what's

outstanding. The outstanding requests relate to issues like travel and food reimbursement expenses. So Your Honor, the type of information that is being sought and remains outstanding is things like, did they really have Tbili and hummus for dinner and charge for a steak dinner? It's that type of backup that is the subject of the requests that are outstanding, and we will have that information for them no later than January 15th. Now, the IRS has submitted in connection with this after we filed our motion a list of discovery requests. And those discovery requests give the impression that there's another enormous

world of information. Well, let's look at that because it relates to two different worlds. The first world is we've filed tax returns. The way the proof of claim process works is if you think our tax returns are wrong, tell us why you think that they're wrong and file some proof. The proofs of claim that have been filed in these cases have no words other, no words, they have numbers, no words other than estimates. And we're looking at it. It doesn't say what we're looking at or why we're looking at it, why we think it could be this or why we think it could be that. Your Honor, one of the proofs of claim that was filed by the IRS is with respect to Alameda Research LLC.

And it's really interesting to look at it. Because if you look at the tax that is alleged with respect to the year 2022, it simply takes the number from 2021 and it multiplies it by 1.5 to the penny. And when you look at the numbers for 2023, the claim that's a lot, They simply take the number from 22 and they multiply that by 1.5 to the penny. This doesn't show the type of work or thoughtfulness that allows the debtors to have any basis to object. We don't know what the claim is other than the dollar or no.

And so, Your Honor, when we're sitting here today, we're looking at that from the perspective of all of the momentum that is moving forward to bring these cases to conclusion, to be able to distribute dollars and cents to victims, individuals, many of whom are on our line now and have been online for so many hearings throughout the course of this case. The only way that we're going to be able to implement the plan of reorganization and to start putting money into the hands of these individuals is that we deal with the IRS claim. How big is the IRS claim in respect of our claims pool? It's over 50% of the claims pool.

When you take our customer claims and our non-customer claims and you add them together and divide it by two, it's the Internal Revenue Service with zero support. Without a word that tells us why anything that they've, any number that they've alleged, has a basis in fact. All of our proofs that we have submitted to the Internal Revenue Service says that we have $11 billion of losses. So what the Internal Revenue Service has to do is zero out every one of those $11 billion of losses and on top of that prove up $24 billion of cash obligation.

Now in their objection, the Internal Revenue Service largely says, look, we need more information, And it could be zero, it could be 24 billion, it could be some other number. We don't have the ability within the system to accommodate that kind of approach. It's not justified by the law, and the facts here compel a substantially different answer. And so what we're looking at, Your Honor, is we're looking for an estimation schedule. We believe that these claims are ripe, perfect for estimation. They are unliquidated. Quite incredibly, the Internal Revenue Service in the first sentence of their objection says that

these claims are liquidated because we have the information somewhere in the debtor's records that would allow them to calculate the number with specificity. They completely ignore the fact that we have filed tax returns which say we have $11 billion billion of losses. They've already given them the information. The way this tennis game is played, we hit the ball over the net to them by filing a tax return. They hit the ball over the net back to us by saying, we've looked at your tax return and we disagree with it for these reasons. Then we look at that and we hit the ball back over and say, these reasons don't count for these reasons and so on. We have filed the tax returns. It is now their time

to tell us what is wrong with them. And the idea that they don't have sufficient information and they haven't had sufficient time is simply not credible. Now, Your Honor, what are we looking for? Well, we're looking for something that is a timeline that's set forth in our motion. We believe that by mid-January,

they should be able to tell us, with specificity, we should be able to have a process that leads us to an estimation hearing, in mid to late February. We believe that that is appropriate under the circumstances, and we completely dispute any allegation that the IRS has made that there's information that they need in order to take the first step. It's simply not the case.

The way this works is we file tax returns, they object to those tax returns by telling us what's wrong, and then we respond to those objections. to those objections. We cannot bear a double burden of both filing tax returns and then looking at these completely naked proofs of claim, which have infinity numbers attached to it, and then somehow try to credibly object to things that we don't even know we're being alleged. Now, I understand. that these are big cases and complicated cases.

And I understand that the Internal Revenue Service is a large organization. We happen to be dealing with the regional office in Nebraska for some reason. I don't know why and I'm not criticizing it, but that's who we're dealing with. This is such an enormous number. It is such an obstacle to the implementation of a plan of reorganization and the delivery of recovery to victims that we need the attention of more than just the office in Nebraska. We have made inquiries of the Internal Revenue Service

about their willingness to resolve these issues in different ways. If the Internal Revenue Service would agree that they would subordinate their claim to the creditor claims, the other creditor claims, that we could have a conversation about that and we've been willing to do it. They have been unwilling to have that conversation.

We'd be willing to have a conversation with the Internal Revenue Service about trying to deal with something that is more rational, national than a $24 billion claim. I will note it started out as a $44 billion claim, and it is now down to $24. That's progress, but it's still a number that is a complete obstacle to moving forward

with the plans of reorganization. So what we need the Internal Revenue Service to do is to fit in to the system that everyone else has to comply with. If we were dealing with commercial creditors who were filing unsupported, unsubstantiated claims of this magnitude, we would be compelled to not only move to dismiss but to seek sanctions, because the obstacles that are being created by filing unsubstantiated, unsupported, outlandish claims is that we are going to create additional administrative expense to fight them. That's all this is.

We're not asking for any of that with respect to the internal revenues. We understand their role, their obligations, but that doesn't mean that they don't have to play by the rules. They have to play by the rules. They have to realize that this is a case that everything that they think and breathe has an impact on tens of thousands, millions of creditor claims, and they have to stop acting as if what they do

has no impact on anyone else. Right now, the single largest obstacle to moving forward with distributions to creditors is the internal revenue service. And so we need a process here in this court, Your Honor, with all due respect, that forces them to actually engage And the way to force them to engage is to put them on a tight leash and a short schedule that forces the issue to be addressed.

Perhaps the way that gets addressed is once that schedule is set, we can have discussions in Washington to see if there's a way to settle this. But without that sort of schedule and without that sort of compulsion, we're simply going to be stuck in Nebraska. And we can't afford to be stuck in Nebraska anymore, Your Honor. Our creditors can't. The victims of Sam Bankman breeds fraud cannot afford to be stuck in Nebraska. So Your Honor, that's where we are from the debtor's perspective.

We have submitted two declarations in support of the motion, one of Mr. Edgar Mosley, who you've seen before in court and who has testified, he's sitting here, and is ready to testify if there's any concerns, but we'd like to move Mr. Mosley's declaration into evidence. in court is Mr. Thomas Shea of Ernst & Young. He has not been before, Your Honor, but he is similarly here and ready to be questioned if there are any concerns, but we would like to move his declaration into evidence as well. And as you see, the declarations are each for very limited evidentiary purposes, but consistent with our obligations to the court, we have them here, they're ready to testify if necessary.

And with that, Your Honor, I would take any questions the court may have, and if not, I would see the podium to my co-counsel from the creditors. Let me see if anybody has an objection to the introduction of the declarations. Yeah, we do object to the declarations being entered into evidence, Your Honor, at least ask for an opportunity to cross them. I'm sorry? At least ask for an opportunity to cross the way. Oh, you'll have the opportunity to cross if you want, yeah.

But, I mean, I can take the declarations as a proffer, and then you can ask for an opportunity And then I can open up to you to cross-examine the witnesses if you'd like. Okay, that's a separate. Okay, so the declarations are admitted, and we'll finish up with openings here. I'll hear from the committee, and then I'll hear from the government, and then we'll go from there. Thank you. Good afternoon, Your Honor. Excuse me.

Ken Pascuali, Paul Hastings, for the Official Creditors Committee. I'll be very brief. We filed a joinder. I couldn't agree more with what Mr. Bromley represented with respect to getting distributions to creditors. Your Honor, you've heard me at the last number of hearings saying that the committee's primary responsibility, given the status of the case these days,

is to expedite confirmation and expedite that distribution process. the IRS claim is as Mr. Bromley explained, an impediment to the timeline that's been set, that again the committee is looking to move even faster than it has been set forth. I don't want to belabor the record in that regard, especially with respect to an opening, Your Honor, but I will mention, Mr. Bromley quickly mentioned this as well, in the plan support agreement in the term sheet attached, It's at docket number 3291. The proposed plan, and again, as you'll see this weekend when the plan is filed,

does provide for subordination of government claims, such as the Internal Revenue Service claim. There is not a mention in the IRS's opposition to this motion about that issue, which is, needless to say, significant in the context of the plan that will be processed. So I think that is a telling omission in the IRS's papers. But from here I'll just ask the court if has any questions and reserve. No questions at this time, thank you. Thank you, Your Honor.

Good afternoon, Your Honor. Elizabeth was on behalf of the Department of Justice and the IRS. What the debtors are asking here today is essentially to circumvent the bankruptcy process in the code and what it sets out in terms of what's required to challenge the proof of claim. They would like to invent additional requirements that the IRS has when it files a proof of claim, additional things it should have submitted. So things are made up. Those are not actual requirements.

What the code sets forth is what we put out in our brief that when the IRS files its proof of claim is presumptively correct and the burden is on the debtors to challenge that presumption. It's also very clear in case law that a tax return alone is not enough to challenge an assessment by the IRS. A tax return is nothing but a shell. It's a piece of paper with numbers on it, and the debtors have the burden to provide support

for that tax return. That is what they would use to challenge the IRS's numbers. They don't have that, and that's why they're here today on that motion. Now, that being said with their burden, I do think it would be helpful to explain to your honor how the IRS came up with their numbers. So I'd like to just explain that quickly.

Okay. Do you have a witness to support this? We did not bring an IRS witness here today, Your Honor. I'm happy to explain it to you myself, or if we could at a later date bring an IRS witness, but given the short deadline with their motion. Mr. Brombe? Your Honor, we object to any explanation of what the IRS did or considered unless the witness.

I think that's right. I've got to have evidence. I can't, you can't testify. Okay. Understood, Your Honor. So the debtors have now provided the support or substantiation to challenge the IRS's claim. They have claimed that E&Y has been working on this and that they have provided provided thousands of responses to the IRS.

Those responses have included such things as saying we don't have support. So they said we've responded, but they have not provided support. That the debtors are trying to distance themselves from all of their prior filings in this case, from John Raid's reports, and saying, oh, it was a year ago that they said there were no books and records, that there was no corporate controls.

And they're now asking us to somehow believe that John Ray's group has completely reorganized the company such that even prior information is now reliable. We noted in our brief, even EY doesn't believe the prior year tax returns. They noted in their, when they filed 2022, that essentially they couldn't have signed 2022 tax returns if they were relying on the price returns. if they were relying on the prior year tax returns at all. So E&Y wants to stay arm's length away from the prior returns, but wants the IRS to accept them at face value and just take the numbers as they are with no substantiation behind them whatsoever. I think it's also very telling in Mr. Shea's declaration

that the responses they list, not one of them include anything for the 2022 tax returns. Now, the IRS has not issued official IDRs for those, but they have been in contact with E&Y. I personally spoke with Mr. Shea and asked him to provide support for that, given the emphasis from both the debtors and us on speed, and to prioritize providing that information. The IRS has not received any support whatsoever for those 2022 tax returns, which EY filed, in August. They knew very well in August that the IRS was auditing them

and that information would be necessary. It has not yet been provided. The timeline that the debtors are suggesting here, first of all, estimation we don't believe is even appropriate in this case, Your Honor. Estimation hearings are appropriate when the claim is difficult to quantify, when you're dealing with something like emotional distress, that it's like how can anybody even

assign a value to that? We're dealing with numbers here. We're dealing with taxes. We're dealing with income taxes, employment taxes. These are numbers that can be calculated. We don't have to ask somebody to assign a value to them. They can be calculated. The problem is that the debtors don't have the support they need.

That's a different problem. That doesn't mean estimation is appropriate here. Even if Your Honor finds estimation is appropriate, the deadlines that they're proposing are, are somewhat preposterous. EY filed these returns in August and has yet to provide the support. It's taken them months to work on it.

But the debtors think they can give us 21 days to do all of our discovery, review all of that support, conduct up positions, do a 30B6 of UY, all of that they think we only need 20 days for. There's no reason for this emergency. It's completely fabricated by the debtors. If they wanted to deal with the IRS claim, they could have done it when the IRS filed in April.

If they wanted to present Your Honor with nothing more than tax returns with no support, they had those tax returns in August. Why didn't they file something in August? The claims bar deadline was at the end of September. They wanted to wait till then, they could have filed something in September. Now they choose to file this motion

a week before their proposed plan and their own self-imposed deadlines and say because of that, because of the plan support agreement, which we weren't to part two, which they did not bring us in on. Because of all of that, they need this impossibly rushed and truncated schedule

that deprives us of the opportunity to actually litigate this claim. If Your Honor wants to move this along, we suggest that you give the debtors a deadline and say, you know what, in 21 days, EY needs to provide the rest of what is owed to the IRS and what's owed, Your Honor. All the support for 2022.

All the support. They filed those returns. Some partner must have been looking at support when he signed his name on that return. Where is that support? We have not been provided. They should give that to us. What else should they give us? EY has told the IRS that they will not support the prior year tax returns. So they have three options. They can tell the IRS we don't have support for them, so do what you will with them. or they can amend them. Or they can say, you know what, those returns are good. We'll sign them. We support them.

Do one of those things, and then tell the IRS, we're done. So if they have spent this enormous amount of work that they say they have, and I'm not disparaging EY, I know that it's an unprecedented situation with the company, but they need to give the IRS a finite universe of information. The reason it's taken so long is because the IRS makes a request, they give them a lot of time, they come back, they say, oh, well, we only gave you what you asked for, you haven't asked for 2022 support yet,

because the returns haven't technically been processed, all of those technicalities. Let's do away with the technicalities. Let's tell the debtors, you know what, you're touting your return so highly, give the IRS all the support for them and tell them when you're done, tell them when you've given them everything you've got.

And then from that date, from the date they tell us they're done, give us at least three, four months to review it, and then we'll come in and we'll have a hearing on it. But to come up and say, you know, it's on the IRS to come and put forward all their information. When EY has not provided all support for it,

it is just flipping everything on its head, Your Honor. It's misrepresenting who has the burden here. It's misrepresenting who has the ability to provide the information. This is the one-way street. It's always that case. When a tax return is filed, the tax fear has all the information. It's on them to provide that information to the IRS. It's not on the IRS to make up a number.

But isn't that what you did? Where did the $24 billion come from? Well, it started with the tax returns filed by the debtors, and they've made adjustments based on the lack of information that they've received. That's what I was going to attempt. Basically, Your Honor, it's based on what they found in the pleadings, which relates to misappropriation of income and underreported income. But how do you know that?

How do you know it's underreported? It was in the filings, Your Honor, the fact that they had no books and records. The company was bright with fraud. They were stealing money, so they were taking cash from customers, reporting it as deposit, and using it to run the business. So you're assuming, you're just making assumptions. Well, those were facts that were filed with this court, Your Honor. What facts?

In John Ray's report. All you're saying is there was fraud in the company, and then somehow that turns into $24 billion. tax claim it's the application of those facts to their tax returns the ones that they had that were filed and then they did have to make estimates for later years at the time they didn't have any tax return for 2022 in April so essentially your honor EY doesn't trust the return everyone who said the company doesn't have books and records that it was a fraud but the debtors think that the IRS should be forced to

accept nothing but a single page of a tax return and say, this is gospel. Oh, we don't, when you ask, when the IRS asks for support, we don't have it, but you should just take this as gospel. When they know that the IRS is going to be auditing those returns and they have months to provide that support, they don't do it. But we're supposed to just take that tax return in and accept that.

I think that expectation of the IRS is preposterous and they're expecting treatment that no other taxpayer would get. And they know that. They put in their pleadings, they complain that they're being treated like every other taxpayer. That's their complaint in their plea. That we're treating that, we are treating them like every other taxpayer. We are expecting them to substantiate their tax returns. So if that's their biggest complaint, then that is what the IRS has done.

The IRS does expect them to substantiate. So we would ask that you deny their motion, Your Honor, to the extent you find that an estimation hearing is appropriate, we would ask that you would approve a schedule similar to what we propose, where you give them a deadline to provide us information and then provide us a reasonable amount of time to review it and prepare for a hearing. All right. Thank you. Thank you.

Do you want to cross the witnesses? Mr. Shea, we would like to cross, yes. Okay. Mr. Shea, you want to step forward, please? You please come forward and take the stand and remain standing for the oath? Please raise your right hand. Please state your full name and spell your last name for the court record, please. Thomas Michael Shea. Do you affirm that you tell the truth, the whole truth, another but the truth to the best of your knowledge and abilities?

Yes. You may be seated. Your Honor. Good afternoon. Good afternoon. What is your current place of employment? Ernst & Young, Elbe. And what's your role there?

I am a principal in our tax practice. Mr. Shea, do you recall having a phone conversation with me and David. Harrington from Sullivan and October. Objection, Your Honor. Mr. Shea's declaration is the direct testimony. Anything that's outside of the four corners of the declaration are outside of the spoken trial.

I don't know if we're picking you up on that one. Sorry, Your Honor. James Bromley of Sullivan and Cromwell. The appropriate subject for cross-examination is the declaration which forms his direct testimony. So we'd ask that the IRS focus on the declaration. The idea that she's going to ask questions about a conversation that she had with Mr. Shea is certainly not within the four corners of the declaration.

Your Honor, it does go to how E&Y has been responding to the IRS, what they've been aware of, and what responses they have provided. But you're going to... Objection for lack of foundation, Your Honor. You're going to ask him questions about a conversation he had with you? Yes, Your Honor. I would like to know whether... It goes to whether he was aware of information that the IRS needed.

Does that make you a witness? Because if you're going to ask him that question, I'm going to let him cross-examine you, which means you can't argue this case. Okay. I can withdraw the question. Thank you. Mr. Shea, do you have your declaration available? I do over in my seat. Okay.

If we could get you a copy of it. Yes. If you can look at paragraph six of your declaration, Mr. Shea, in this paragraph you summarize the request that E&Y has received from the IRS. Is that correct? Yes. In the table that you list here, are any of these requests related to the 2022 year for income tax? No. Has E&Y provided any support to the IRS for the 2020 catchers?

No. Has the IRS asked you for support for the 2022? Not through an official IDR. Have they asked you informally? Yes. Have you been working with them to provide that support for 2022? Yes. How long have you been working with them to provide that support?

Specifically over the last few weeks. When do you anticipate being able to provide them that support? Friday, December 15th. And what support is it that you will be providing on that date? It will be document requests that are similar to what we have provided for the previous taxable periods. Will it include support for the losses claimed on the tax returns? Yes. will include support for the expenses claims on the tax returns?

Yes. To the extent there are expenses we can support. Are there expenses on the tax return that you are unable to support? I don't remember, don't recall all the details. So you're not sure if there are expenses that will be unsubstantiated? I believe if there were expenses that were unsubstantiated, we have already considered that in the filed returns. But it is true that as of today, the IRS has not received any support for the 2022 tax returns. That is correct.

In regards to the 2021 and 2020 tax returns, have E&Y signed off on those returns in any way? We have not been asked to sign off on the returns. We have assisted with the compilation of information to provide to the IRS. Does E&Y believe that those returns are accurate? We believe that there are potentially adjustments in those returns. So you believe that the returns do need to be amended? Amended or adjusted through the audit process, yes. Is there support that the IRS requested for those returns that E&Y has been unable to provide?

Some requests we have been unable to provide support for it. What type of requests? I don't recall offhand. I have an example of one. that I can provide you an approach. Yeah. You have a copy for me. Mr. J,

you could take a moment and look at this document and let me know if you recognize it. I do, yes, but I admittedly, you know, we have a team full of professionals that are involved with compiling all this information. Is John Healy who signed this return is he on your team at Y? Yes.

And he's working on the FTX audit. This at the top here it says FTX response to IRS information document request. So is it accurate to say that this document is a response that your team at EY provided to the IRS? Yes. Could you please turn to the third page of the document I just provided you? And could you read the response under number 16? Would you read the title of number 16, what was asked for and then the response? C-response 11.

Invoices for business expenses were not stored in a centralized location and are unavailable. And the request, what number 16 was asking for, the description of that? Could you read that? Detail of substantiation for all expenses. So is it fair to say that the IRS requested substantiation of all expenses and in response to that, your team was? said that the expenses were not stored in a centralized location and are unavailable. Is that an accurate representation?

Yes, and this is with respect to specifically the entity elevator research LLC. And that's if you look in the upper left hand corner of this document, correct, the elevator research? Yes. And the date on this response, what was the date? November 30th, 2023. I don't know, do you have any idea when the debtor's filed the most? in this case that we're here on today?

I believe it was shortly after. Since November 30th, 2023, do you have any reason to believe that this response has changed? I do not. So as of today, if you were asked to substantiate the expenses for Alameter Research LLC, EnY's response would have to be that they have no support. Is that correct? Yes.

I also have excerpts of the 2022 tax return that that E and Y prepared if you're a second approach on it. Mr. Shea, do you recognize this document? Yes. What is it? It is the 2022 tax return for Alameda Research Ovalcy. And this tax return was prepared by your Fermi and Y, correct? Correct.

If you could flip to, I believe it's about eight pages in, and on the lower right hand corner, the document says statement 16. Yes. Do you just take a moment to read this so I can ask you a question about it? This is a footnote that was included in the 2022 tax return that you're a firm filed, correct? Correct. Does this footnote say that none of the prior year net operating losses were being utilized for 2020? Correct.

If the 22 tax return had utilized the prior year net operating losses, would you have signed no tax return? I can't say we didn't deal with that situation. What was the purpose of including this footnote in the tax return? It was to alert of basically what I declared that we do anticipate possible adjustments to prior year returns. If you could flip one more page over Mr. Shea, this is the beginning of several pages of support here. Do you recognize this schedule? Is this a schedule that was included in the 2022 tax return? Yes.

And is it the support for the capital loss that was claimed on the 2022 tax return for Alameda? It is a summary of the losses. On the right-hand column where the heading says proceeds slash basis, right underneath that, could you read me what it says right below that? Further details available upon request. Have the IRS requested these details? Yes. Have they been provided?

We have started previewing that information on some of the weekly calls with them. So we've gone through the format to make sure that it's everything that they're looking for, and we're working with them on a way of transmitting that data because it is rather substantial. But I'm sorry, just to pinpoint your answer, that data has not been provided. the IRS correct it has not yet your honor I'd like to move the information document request in as exhibit one and the excerpts of the tax return in as exhibit to any objection we would say the entire tax return rather than that's I'm sorry we were your honor the entire tax return rather than excerpts do we have

the entire tax return well the entire document that has been provided I don't I didn't have print out copies of the entire tax return return your honor can't provide it electronically so these are the excerpts that you're seeking the ones that we have on our hands these are those are just the excerpts that we're seeking to introduce the question that the entire document I have in my hand is what you're seeking to that's correct okay they don't have an objection to that they're both admitted without objection I have no further questions at this time your honor thank you read right your honor I just have a few questions mr. Shagg so the

the question the council for the asked you about further details available on request. That's the information you're going to provide on Friday? That's correct. That's two days from now, right? Yes. And the information requests that are outstanding with respect to the 2022 tax year, I think you mentioned that they were not the subject of official IDRs?

That's correct. So notwithstanding the lack of official IDRs, Ernst & Young has been complying with informal requests to produce materials. Correct? Correct. And that's going to be produced on Friday? Yes. Now, Ernst & Young has reviewed the tax returns for 2020, 2021, correct? Correct.

Okay. And the what is the dollar amount of the losses relating to the tax years? 2020, 2020 and 2021? In total about $11 billion. Okay. And the question that was asked to you with respect to the Alameda research set of questions, you would recall that? Yes.

Mr. Gileys document. Item 16 detail of the substantiation for all expenses. You see that? Yes. Yeah. How many, with respect to the business expenses for these debtors that relate for this debtor amount of Alameda research, has Ernst & Young calculated them in the billions of dollars? No.

Can you think of the ballpark of what the business expenses are? That's tough to estimate. I mean, if we go off what's in 2021, I mean, there's about 34 million. About 34 million? Yes. Not billion. Right. And yes.

I'm sorry, in 2022, the return I'm looking at. And the corporate tax rate that's applied to Alameda Research LLC? 21%. 21%. So $34 million of business expenses? In a instance, the reclassified as taxable income, you apply a 21% interest rate to that? So, 21% of $34 million is how many billions? It's a couple million.

A couple million. A couple million. About six, six of change. Thank you. Now, there was a reference in your earlier testimony about potential adjustments. Do you anticipate that any potential adjustments will have a material? impact with respect to creating incremental additional tax liabilities for the debtor? No. Thank you, Your Honor.

Thank you, Mr. Shah. You may step down. Thank you. Any other evidence? Not, Professor. Okay. The openings were kind of argument, but anybody want to make some final comments before we finish up? Very briefly, Your Honor. We think that this is additional.

evidence of the compelling need to move this exercise forward and with dispatch. The Internal Revenue Service has it backward. These have the idea that a taxpayer files a tax return and the Internal Revenue Service has the ability to ask endless questions about irrelevant issues while asserting claims that are literally to infinity and beyond. simply have no credibility. There are two processes that we're talking about here. One is dealing with taxpayer process,

and the other is talking about bankruptcy process. The Bankruptcy Court is the place where those two processes come together for a practical solution. Now, the Internal Revenue Service says that this isn't a motion for estimation. Well, Your Honor, we could have simply filed a motion, the equivalent of a motion to dismiss Once a proof of claim is filed, yes, it is deemed valid until objected to it.

There is no basis for these claims. Zero. The idea that we need to move the process forward. So whether we refer to this as an estimation proceeding or a motion to dismiss for failure to state a claim is kind of irrelevant. We need to have a process to have a process to come to a conclusion.

That conclusion needs to be obtained quickly so that the victims of Sam Bankman-Fried's fraud can be compensated and receive payment. The Internal Revenue Service has decided, in its wisdom, to simply put numbers which have no basis in fact. And those numbers are so large, so astonishingly large, that it creates a complete opposite. complete obstacle to moving forward with the plan of reorganization.

It can't happen. It can't be allowed. We can't have a situation that the Internal Revenue Service is allowed in its own bureaucracy to hold up the movement forward of these cases. And they need to be able to be brought in front of this court and have a credible, logical objection to what the debtors have put forward. The Internal Revenue Service has none. It's made some allegations about misappropriation, this or that.

Your Honor, I don't know of any American taxpayer that could owe $24 billion. I don't know if you took Apple and Tesla and Amazon altogether if they were going to have to pay that sort of amount of money for taxable profits earned in the United States over the past four years. I doubt it. And, you know, the question is, you know, But the questions that have been asked is, you know, go to completely irrelevant issues. The magnitude of their claim, they were sitting here today and had a $5 million claim or a $10 million

claim, we wouldn't be asking for this kind of expedited treatment because it's something that could be worked through and dealt with in the process. The sheer size of their claim is the reason why we have to deal with it on an expedition's So the rationale that they use to say that we shouldn't be moving forward fast is exactly the reason why we have to. And, you know, it is disappointing that there's no explanation whatsoever. And even with Ernst & Young on the sand, the only thing that we can point to is a failure to back up some expenses that might, you know, yield to a 21% tax on $34 million of expenses. of expenses that can't be supported. If that's what we need to do to deal with a claim of that magnitude,

sure we can deal with that. But to sit here and try to imagine how one would say $24 billion is the wrong number is simply not anything that we, the debtors and the creditor constituencies should have to bear. Internal Revenue Service is to say why they think that tax returns are wrong and why they think any dollar amount of taxable income exists and taxes are owed on it. We have filed tax returns which show $11 billion worth of losses.

Internal revenue supported by tax returns prepared by one of the leading tax preparers and experts in crypto tax in the world. And the fact that they haven't signed on, two years of tax returns that were prepared by other accountants is self-evident. But have they provided the backup and support? Yes. And do they feel that there are adjustments? Perhaps.

Will those adjustments have any material impact on the tax profile of these debtors? No. The fact is that that's the evidence here today. That will be the evidence in February. If the Internal Revenue Service wants to put something else out there that we can respond to this is the time to do it and we believe the schedule that we propose is the appropriate schedule under the circumstance thank you very thank you mr. Squally thank you mr. Squally for the committee very quickly council

mentioned in her opening that the way the IRS views the schedule for litigation it should be that EMI turns over some information on behalf of the debtors and then three to four months later the IRS will get back to us well your honor that by that stage in these cases we should be really at the finish line not starting and that's just unacceptable the other comment I just wanted to respond to your honor is this is not like any other situation that the IRS deals with this is not just the IRS and the tax the tax file up is a bankruptcy debtor and this is not a two-party dispute there are all the creditors of

these estates who this issue this is a a gating item for their recoveries. And so, Your Honor, this is not the situation where the IRS can treat this like any other situation. And so we fully support the motion and ask the court to impose the schedule that's proposed by the debtors. Thank you, Your Honor. Ms. Bruce?

Yeah, thank you, Your Honor. The evidence today here has shown that there is significant gaps in lack of support for what the debtors are saying given the IRS. Now, they say it's irrelevant, but I don't think all the support for the 2022 tax returns is irrelevant. I don't think the support core, all the expenses claim on the 2021 and 2020 tax returns is irrelevant. Any other taxpayer would have to substantiate those returns. It's very relevant. And the fact that the debtors can't provide it, it's just further evidence that they're here trying to turn the table and get away from the fact.

that the burden is on them to support their tax returns. The bankruptcy code follows the tax law, and the debtors are trying to get away from that. The estimation hearing they're asking for is the incorrect venue for that. All that the estimation hearing would do is need to follow the tax code. Now, they've brought up other issues about their being victims here, which we are aware of, about subordination being possible. Estimation is not the right venue for that.

If they want to address those issues, they could have asked for that. they could have asked for mediation or some other avenue or productively engaged with us in negotiations rather than just saying you guys are either at the bottom of our plan or we're not going to talk further. So that is not, the fact that there are victims here is not a reason to hold an estimation hearing, Your Honor. And I think it's very clear that they have not been able

to support and meet their burden. And we would ask that you deny their motion on that basis. And in the event you granted provide a reasonable schedule, which at least gives the IRS a finite universe of data. In other words, give the debtor a deadline to finish what they need to do, provide the support. They say adjustments need made, make the adjustments, amend their returns,

and then set deadlines from that point. And the IRS is not holding up distributions. The debtors make it sound like checks would be going out the door tomorrow if it weren't for us. That's not the case. This is not an emergency situation. There's an entire claims resolution process that needs to be got through.

Checks are not going to go out tomorrow if you make our claim zero, Your Honor. So we respectfully ask that you deny their motion. All right, I'm going to take a short recess and then I'll come back and give you my ruling on this. Let's recess until 2.30. Three questions, actually, before me today. First is whether or not the IRS's claim is subject to estimation under 502C.

Two, if it is, what schedule should be imposed for that estimation? And three, who bears the initial burden of proof at any estimation hearing that might be helped? On the first question of whether or not estimation is allowed of an IRS claim, I find that it is. 502C allows for the estimation of any claim that is unliquidated or contingent. The IRS's proof of claim is based on estimates only. It is not a solid number, and the testimony heard today was there's no real basis to make that determination at this point in time. A number of courts have held that in situations where the IRS has filed just an estimate of taxes,

it is subject to a determination through an estimation process. For example, Rev.C. DS. Inc. 131B.R. 615, 621. Bankruptcy, Northern District of Ohio, 1990, determined that debtors could challenge the IRS's estimate of pre-petition taxes through either 505 or through 502C. Also, in a matter of Carr, CIR, CIRR, 134 BR, 370 at 373, bankruptcy court, Northern District of Nebraska, 1991, came to the same conclusion. And also in Ray Southern Commodity Corp, 62 BR, 4 at 6, bankruptcy, Southern District of Florida, 1986, same conclusion. Therefore, I find that the IRS is claimed because it is based only on estimates, it is subject to an estimation process under Section 502C.

The next question then is what's the scheduled date? The debtors have submitted their proposed schedule. The IRS has requested an additional five to six months or four to five months on top of that. debtors point out, bankruptcy requires that bankruptcy is a process that moves quickly, and it requires that a debtor, the debtor here has already been in bankruptcy for over a year. It's a complicated case, obviously. There were complicated issues with trying to pull together the information that was not available when the case was first filed, and the debtors have been working diligently trying to gather that information.

So in that vein, and with the need to get this, and mindful always of the fact that is the customers and the creditors here who need to get paid. And I understand the IRS is a creditor as well. But because of the size of the claim, $24 billion estimated, it has an impact on the ability of the debtors to move forward with this case. Therefore, I'm going to modify it only by adding two weeks to the proposed schedule. So all the dates should be about two weeks. That's both to give the IRS a little bit more time and to accommodate the court on its calendar as well. I don't know when the debtors are planning on setting a hearing on their confirmation. I don't know whether there will be objections to confirmation.

There may be, but I have held hearings in late 2022 right around the time this case was getting filed. No, it was 2021. In the Malamacrop one case, I ended up with six weeks of trial time for confirmation and to hold in between, right in the middle of that, a two-week trial on whether or not the debtors had a post-petition claim against them. for antitrust violations. So it can be done. It's not unusual. It's not unheard of.

As far as a date for the hearing, I'd ask the parties to confer with chambers to get a date for the hearing within that, again, a two-week extension of time. On the burden of proof issue, I'd like the benefit of a little bit more briefing on that issue, because it is an important issue and one that I want to make sure I'm making the right decision.

So I'm going to ask the parties to make simultaneous filings, briefs, short briefs, no more than 10 pages, addressing the question of, as between the IRS and the debtors, who has the initial burden of proof at the estimation here? And I'll let you meet and confer and come up with a date given the holiday season so everybody can be accommodated as to when those will be submitted. And I want to make sure the parties understand and keep in mind. estimation is not a determination of the liquidated value of the claim. It can't be. And it's a summary process. It is not a full-blown evidentiary process where parties can request all kinds of discovery

and take all kinds of depositions and bring in all kinds of expert witnesses. So I'd like to get some sense from the parties, given that I've now ruled that it can be estimated, as to what this process is going to look like. What are the parties into it? I saw something in the papers, both sides, saying we might not even need expert witnesses, might be able to decide it on a question of law. If there is facts, they're easily determined.

For example, I heard a testimony today about the deductions for business expenses and that there's at least some evidence at this point. that as for 2022 it might only be $34 million. And if that's true, given the $24 billion claim followed by the IRS, it would seem that it would be easier to determine factually that even if there's information missing, it's not going to change the number,

because you're never going to get to a point where the debtors are going to owe $24 billion of taxes. It might not get to a point where the debtors owe any taxes. Might be they owe a little bit of taxes. Might be they owe a few million dollars, tens of millions of dollars. I don't know at this point because they don't have the benefit of the evidence. But it would seem the parties could look at the evidence ahead of time and make that determination without having to spend the time and effort to come to a trial

and spend a week or two going through tons of tax information to determine the value of the claim. It might not be necessary to do that. If the missing information doesn't rise to a level where the debtors actually owe taxes, that's the end of the story. So let's look at that that we're going through the discovery process here

and keep that in mind. The idea here in bankruptcy, we're on a tax court, so in bankruptcy, we're trying to get to conclusions quickly and be as accurate as possible without wasting a lot of time and resources of the estate. Or the other part, the creditors. So let's keep that in mind and give me some thoughts.

I'd like to have, when's the next omnibus here in this case? January 25th, I believe you're on. Okay. Let's set up something before that. Contact chamber, see we can get a date the second week of January for a status conference. to see where we are on that issue, what this hearing is going to look like. Hopefully by then I will have the benefit of the briefing.

Maybe I don't, it depends on it. The additional briefing is up to you guys. If I do have that briefing, we'll talk about that at that status conference. But otherwise, let's talk about what this estimation hearing is going to look like. Any questions, comments? Anything else before we adjourn?

That's it for the debtors, Your Honor. Okay, thank you. Thank you all very much. I appreciate the presentations. It was very helpful for me, and I will see everybody sometime in early January. Have good holidays. Thank you. Thank you.