The Breakdown - Gary Wang and Caroline Ellison Plead Guilty to Fraud as SBF Lands In US

Episode Date: December 23, 2022

This episode is sponsored by Nexo.io, Circle and Kraken.   In breaking news last night, Sam Bankman-Fried was extradited from the Bahamas to the U.S. to face charges ranging from wire fraud to campaign finance fraud. Almost as soon as the plane took off, the U.S. Attorney for the Southern District of New York announced that Alameda’s Caroline Ellison and FTX’s Gary Wang had pleaded guilty and were cooperating with prosecutors. NLW breaks down everything we learned in the last 24 hours.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds and keeps innovating with products like the Nexo Wallet - a non-custodial smart wallet that allows you to create your Web3 identity. Get early access at nexo.io/wallet. - Circle, the sole issuer of the trusted and reliable stablecoin USDC, is our sponsor for today’s show. USDC is a fast, cost-effective solution for global payments at internet speeds. Learn how businesses are taking advantage of these opportunities at Circle’s USDC Hub for Businesses. - Kraken, the secure, trusted digital asset exchange, is our sponsor for today's show. Kraken makes it easy to instantly buy 185+ cryptocurrencies with fast, flexible funding options. Your account is covered by regular Proof of Reserves audits, industry-leading security and award-winning Client Engagement, available 24/7. Sign up and trade today at kraken.com/breakdown. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Back To The End” by Strength To Last. Image credit: Joe Raedle/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Last week, we announced charges against Samuel Bankman-Fried for a sweeping fraud scheme that contributed to FTX's collapse and for a campaign finance scheme that sought to influence public policy in Washington. As I said last week, this investigation is very much ongoing and it's moving very quickly. I also said that last week's announcement would not be our last, and let me be clear once again, neither is today's. I want to make two announcements. First, I'm announcing that the Southern District of New York has filed charges against Caroline Ellison, the former CEO of Alameda Research, and Gary Wong, a co-founder of FTX, in connection with their roles in the frauds that contributed to FTX's collapse. Both Ms. Ellison and Mr. Wong have pled guilty to those charges, and they are both cooperating with the Southern District of New York. Let me reiterate a call that I made last week. If you participated in misconduct at FTX or Alameda, now is the time to get ahead of it.

We are moving quickly, and our patience is not eternal. Second, I'm announcing that Samuel Bankman Freed is now in FBI custody and is on his way back to the United States. He will be transported directly to the Southern District of New York, and he will appear in court before a judge in this district as soon as possible. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and Cracken, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, December 22nd. And if you listened yesterday, you'll know that that means that I was supposed to be starting end-of-year episodes today. And, you know, drinking hot chocolate and wrapping presents and generally being full of Yuletide cheer.

However, last night, we had a huge development in the FTF. story, and since I'm still at home with all my podcasting equipment, it felt only right to give this one big update before we break for the holiday. The voice you heard at the beginning of this show was U.S. Attorney Damian Williams. As you heard, two major things happened last night. The first was was that Sam was in FBI custody and back on U.S. soil. The second was that we got our answer to the question of who was going to flip first on Sam. So early evening, we got word that Sam had officially been extradited. It had been processed and he was in U.S. custody. And then just minutes later, basically as soon as the plane bringing him back to the U.S. was in the air, we got the huge announcement that we played at the beginning of this show.

It was an announcement that the SDNY had filed charges against Carolyn Ellison and Gary Wong and that both had pled guilty to those charges. What's more, both were cooperating with prosecutors. So there is a lot to dig into here. Caroline, of course, had been widely assumed to be working with prosecutors ever since she was photographed buying coffee about a mile from the SD&s. NY offices in New York earlier this month, but Gary, on the other hand, has been widely assumed to be in the wind. Indeed, the lengths to which Gary went to avoid ever having photos of himself on camera, or if people ever really knowing anything about him, had created some fairly colorful rumors about him being a government operative. As we just learned, turns out he wasn't.

Now, in terms of the specifics, Caroline has pled guilty to seven charges brought by the DOJ, all related to wire fraud, fraud against customers of FTX, and counterparties of Alameda. Gary has pled guilty to four charges only relating to wire fraud, fraud on FtX customers, and securities and commodities fraud. However, just like when the charges were announced against Sam, the SEC and CFTC also filed civil complaints against both Carolyn and Gary last night as well. In this case, Caroline and Gary are both agreeing not to contest them. While the criminal charges from the DOJ are clearly the most important, the additional charges from the SEC and CFTC are required to obtain orders barring the former FTX insiders from participating in capital markets, being granted relevant licenses or holding roles as corporate officers or directors basically ever again. Caroline faces up to 110 years in prison, while Gary faces up to 50 years in prison in relation to

charges from the DOJ. Both could also be liable to make huge payments in restitution and disgorgement of profits from the charges across all agencies. The sentencing will now be a matter for the judge to decide, with the plea deal impacting the leniency that will be shown in sentencing rather than setting a particular punishment. But let's focus now on some of the new information in the docs. A lot of the previous scuttle now has more color and confirmation. And first, let's talk about timing. If you look at these agreements with Carolyn and Gary, they were signed on Monday the 19th. Why then weren't they released until Sam was literally in the air on the way home?

It seems fairly clear that U.S. authorities really, really wanted to make sure that they could get Sam on U.S. soil and didn't want him to learn just how detailed their case against him was until he was extradited. But second, let's talk about the broad narrative that's coming to light. The TLDR is more or less that Sam never even pretended to want to try to do things the right way. It is increasingly clear that it wasn't just an ends-justify-the-means situation where you grapple with the means kind of a thing. Instead, Sam was engaged in a multi-year calculation of doing everything, with an eye to accumulating as much power as humanly possible, without any regard whatsoever for silly little things like ethics or laws. So, broad brushstrokes.

The allegations begin in May 2019 when FTX was founded, implying that the account, exchange was fraudulent to begin with. From the very beginning, customer funds were diverted from FTX to Alameda. Regulators claim that Alameda Research had special privileges on the exchange, being exempted from liquidation and having higher latency due to bypassing several checks performed by the trading engine. This included the ability to dip into negative balances, meaning that Alameda Research accounts were functionally borrowing customer funds without their knowledge. And that's above and on top of customer deposits actually being sent directly to them. Alongside this, Alameda research were borrowing billions of dollars from external lenders,

using FTT tokens as collateral, which were obtained from FTX at no cost. The set of facts reads as if Alameda originally required collateral, so posted FTT tokens, which were printed out of nowhere, with massive quantities held off exchanges but still valued at their quote-unquote full market value. Later, when Alameda had dug a much larger hole, it seemed that collateral was no longer required, with the firm able to borrow FTC's customer funds with no limit or collateral. Now, the problems with all of this really began to show up in May of 2022, when Alameda's lenders pulled their credit lines and demanded the repayment of billions of dollars.

Alameda could not meet this recall of loans, so Sam Bagman-Fried directed that additional billions of dollars worth of customer funds should be diverted to meet the loan recall. During the summer of 2022, while the financial state of FTX was already in jeopardy and Sam knew he could not make customers whole, he continued to direct hundreds of millions of dollars worth of customer funds to be used to make venture investments and loans to himself and other FTCX executives. While it's not mentioned in these particular court filing, some of these venture investments now appear to be little more than arrangements to funnel customer funds to friends and related parties under the guise of funding their startups. Another cute thing that's not mentioned in these court

filings but has been in others is the moment during this time when all of this was clear that FTX and Alameda were in trouble, when Sam invited FTX employees to invest up to $250,000 each into the company at a discount. Now, according to these filings, when Caroline Ellison and Sam Tribuco were appointed co-CEOs of Alameda research in late 2021, SBF remained firmly in control of decisions made at the trading firm. Much is made in the charges about the claims made by Sam in promoting FTX to investors and customers. Regulators highlight that Sam consistently claimed that FTX was a safe crypto trading platform, that it had a comparative advantage due to automated risk management systems and that customers were protected from other customer losses due to FTX automated liquidation process.

Given that customer funds were siphoned for Sam's personal use and that Alameda was allowed to run a gigantic account deficit with no liquidation, these claims made to investors and customers, and I will add to employees, seem to be wildly and deliberately fraudulent. The allegations mentioned the fact that FTX did not have its own bank accounts, so customers instead wired money to Alameda. They mentioned that funds were commingled with deficient accounting records, and alleged that in balance sheets provided to creditors and investors, these facts were obscured with generic titles like loan. These loans to Alameda cause problems within the internal systems at FTX, as Alameda was being charged interest on the $8 billion

dollars it had outstanding. To amend this, SBF directed that the account should be moved to a special account attributed to an unrelated person, which would not be charged interest. It appears that this was done to avoid raising suspicion among staff. The special privileges afforded to the Alameda account are outlined in detail. Alameda was allowed to hold a negative balance with no collateral requirement. The amount that they were allowed to draw down into the negative was increased by engineers multiple times on Sam's direction, eventually being in the tens of billions of dollars range, functionally limitless credit sources from customer funds. Maybe the most egregious superpower was immunity to liquidation. This feature was

allegedly added in May 2020 and allowed Alameda to take and hold positions that would be impossible for other traders on the platform. Alameda was the only account exempted from liquidation. While this was going on, Sam was representing to investors that appropriate separations were in place between Alameda and FTX. In a Bloomberg article published in September this year, he said Alameda is a wholly separate entity, while Ellison is quoted as saying, we're at arm's length and don't get any different treatment from other market makers. In an ecosystem where innovation is the norm, it's the basics that are in the spotlight. Nexo is a company that has never put the safety of clients' funds in question.

With over 50 global licenses, $775 million in insurance, and a real-time audit of custodial assets, Nexo sets an example for security standards in the industry. Apart from keeping their 5 million clients safe, Nexo has kept building. They've just announced their non-custodial smart wallet. nexo.io, that's nexo.io, and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation

as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted staple coin. As one of the largest, longest-lasting, and most secure exchanges, Krakken sets the example for transparency and trust, while delivering on their mission to empower people with new ways to connect and transact. Millions of people around the world count on the Krakken mobile app as the easiest,

safest, and most flexible way to start building their crypto portfolio. Cracken's industry leading security keeps your funds and information safe, and their award-winning client engagement teams are available for support 24-7. Download the Cracken app on Google Play or the Apple App Store, or visit crackin.com slash breakdown to join. The complaints also describe the software backdoor, which was used to siphon funds from FTX to Alameda. They paint a picture of a very deliberate process of coding up special systems to allow this to happen,

coded by Gary under the instruction of Sam. The SEC filing states, Wong created and participated in the creation of the software code that allowed Alameda to divert FTX customer funds. The filings continue and outline other lies and misrepresentations told to investors and customers about the sophistication of the risk and liquidation of the risk engine, the value of collateral held by Alameda and FTX, which by the end was mostly an FTT and other Sam coins. Of particular note is the fact that Sam brought these claims about the sophistication of the FTX risk engine before Congress and sworn testimony. The allegations also deal with the sparsely documented loans to FTX executives, the purchases of luxury real estate, and they also spell out all of the misrepresentations made by Sam during the final week of FTCS.

The big takeaway from all of this is that authorities appear to have comprehensive and solid information about exactly what went down at FTX. In other words, they are not falling for Sam's claims that he was unaware of anything within the FTCS and Alameda operations. The charges repeatedly and clearly set out a story of a CEO who is knowing that he was knowingly and deliberately conducting a multi-year fraud on customers and investors. The details on attempts to cover up the fraud, to calm markets, and to smooth over problems in the scheme leave little room for Sam to be successful in his attempts to paint a picture

of a bumbling and naive founder who just got in over his head. What's more, authorities do not appear to be willing to settle for a negligent conduct explanation, as this looks like a carefully laid out case for deliberate and repeated fraud. One of the things that really stands out when you look at the specific phrasing is the extent to which both Gary and Caroline seem to be saying Sam made us do it. Check out this section, for example. Quote, beyond its line of credit with FTC, Ellison, at Bankman-Fried's direction, caused Alameda to borrow billions of dollars from third-party lenders. These loans were backed in significant part by Alameda's holdings of FTT, an illiquid crypto-asset security that was issued by FTX and provided to Alameda at no cost. Ellison, acting at the direction of Bankman-Fried,

engaged in automated purchases of FTT tokens on various platforms in order to increase the price of those tokens and inflate the value of Alameda's collateral, which allowed Alameda to borrow even more money from external lenders and increased risks to the lenders and to FTC's investors and customers, all in furtherance of the scheme. Now, obviously the point that I was just noting is the phrase at Bankman Freed's direction used twice, but also in here are two other big details from the SEC complaint. The first is the labeling of FTT as a security, and the second is the accusation of market manipulation. Already a lot of the discussion in the crypto community is the implications of the SEC having labeled FTT as security. John Reid-Stark writes, the SEC just blasted a shot across

the bow of crypto-exchange tokens. More proof that the SEC-cryptor regulatory onslaught, which currently stands at approximately 120 crypto-related SEC enforcement actions without a loss, is poised to grow exponentially. Kaborger-Box writes, the SEC is alleging that FTT is a security. In my opinion, it's a mistake to try to established exchange token precedent in this context instead of focusing on fraud, theft, and other crimes committed by FTX and Alameda. The matter deserves a fair and independent discussion. And whether Gabor is right or not, the SEC is certainly using this as a moment to send a clear signal. There is so much in these documents to just be confounded and angry and incensed about. One of the crazier things to me has been these huge amounts, billions of dollars of loans to

Sam and other executives. And interestingly, in these complaints, we can a little bit more color. Between March 2020 and September 2022, Bankman Fried executed promissory notes from loans from Alameda totaling more than $1.338 billion, including two instances in which Bankman Fried was both the borrower in his individual capacity and the lender in his capacity as CEO of Alameda. Ellison knew or was reckless in not knowing about these loans. Bankman Fried also used commingled funds from Alameda to make large political donations and to purchase tens of millions of dollars in Bahamian real estate for himself, his parents, and other FtX Specifically, in 2020 and 2021, Wong executed promissory notes with Alameda totaling approximately

$224.7 million. The funds borrowed under the promissory notes in Wong's name were not intended for Wong's personal use, but were instead used by Bankman Freed for other purposes, including additional venture investments. However, Wong did withdraw approximately $200,000 in funds for his own purposes. So basically, on top of the billions of dollars that Sam loaned himself, Gary is accusing him of using the majority of the $224.7 million that he was theoretically loaned. I have a feeling that those stories and what these loans were for have not finished coming to light. So anyways, that's where we are, and Jake Trevinsky from the Blockchain Association sort of sums up how head spinning it is. Last night, he tweeted, two months ago, SBF was debating the future of crypto

policy and nobody knew FTX was a sham. One month ago, SBF was apologizing for losing billions, and everyone worried he might get away with fraud. Today, SBF is an FBI custody and his chief co-conspirators have pled guilty. It's amazing how fast this is all unfolded. I agree entirely Jake and just wanted to come back and give you the breakdown of what we got last night before, actually, as I promised before, signing off for the year, leaving you with some great interviews and conversations with some really smart people. Once again, I will say I have huge appreciation for all of you guys for your time and care and attention and engagement, and I hope you have the very best of holidays. Until tomorrow, be safe and take care of each other.

Peace.