The Breakdown - The Sam Bankman-Fried Trial Begins - Everything You Need to Know

Episode Date: October 3, 2023

As SBF's trial kicks off in New York, NLW covers: The charges The timeline of events that got us here The key witnesses Likely defense arguments Recent bankruptcy updates Trial timeline Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

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. What's going on, guys? It is Tuesday, October 3rd. The SBF trial has begun. This is all the background that you need to know. Of course, before we get into all of that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review. Or if you want to dive deeper into the conversation, come join us on the Breakers Disaster.

scored. You can find a link of the show notes or go to bit.ly slash breakdown pod. Hello, breakers. As you can imagine, this is a fairly weird time for me. A year ago at this time, I was deep in the midst of planning FTX's second Super Bowl ad, and yet a month later, I had resigned, the company had declared bankruptcy, and the world had discovered a rotten core of fraud around Sam and his closest conigliaries. Now, I did a very long episode about the experience of the week of the collapse from the inside last November 14th. It was called Sam Bankman fraud to give you a sense of how I felt about it. Since then, I've been covering the FTX bankruptcy in Sam's legal battles as I would any other crypto story. In other words, just part of the necessary

cleanup of the last cycle, but ultimately something that is hopefully for the past and not for the future. When it comes to the trial, I've spent a long time deciding about how to approach it. The reality is, for the next five or six weeks or however long this takes, this is going to drown out a lot of other things that are happening in the space. I have to imagine that most products will choose not to launch during this time for fear of being outshined because everyone is just laser focused on this. The question then, of course, is how much time to give it? Is there a risk of overfocusing on it? You bet. It's going to have lots of drama. But does it need to be covered? I think that the answer is also ultimately yes. This is something that has to get concluded for the industry to fully

move on. It is in many ways an exorcism that just has to be done. And on top of that, I think that this trial and everything that surrounds it will have some impact in shaping. How much the external world sees the crypto space as itself inherently fraudulent versus Sam as specifically fraudulent. So how is the breakdown going to cover this? Well, I talked to a lot of you listeners, and the general request mirrored my own thoughts, which is to every few days do an update, sometimes with the guest discussion. This won't be then an everyday thing, at least there won't be some big feature every day, but you will get all the salient details as they come up. And with that in mind, I thought it would be valuable to try to create a bit of a definitive

primer, something that if you haven't been paying attention at all, if you were barely watching last year, you could pick up and listen to and feel pretty well prepared to get into what you're going to see over the coming weeks. What that means is that today we're going to go over the charges, the rough timeline of events, the key witnesses, what we expect from the defense, the latest procedural news and info from the bankruptcy, and the trial schedule. I don't think we'll have time to get into people's very strong feelings about Michael Lewis's book that just came out, but I imagine that that will be on the docket for later this week as well. However, where we begin is with the charges, of which Sam faces seven. Those include two charges of wire fraud, two charges of

conspiracy to commit wire fraud, as well as charges of securities fraud, commodities fraud, and money laundering. More generally, Sam is accused of fraudulently dealing with customer funds in a multitude of ways. The most damning allegation and the one prosecutors will likely focus on establishing is that Sam knowingly diverted customer funds to FTX-affiliated hedge fund Alameda Research. Alameda, of course, served as the primary market maker on FTX. Now, FDX is widely understood, not that to have been able to obtain bank accounts, and so in many cases used accounts held by Alameda research to receive funds from customers. The thing that prosecutors will seek to demonstrate is that Alameda not only held customer funds, but that it racked up billions of dollars in debt to FTX,

which it could not repay. Evidence has been put forward that Alameda did not have the same risk controls as other entities when it traded on FTX, and that the lack of limits allowed Alameda to continue to operate while carrying a large negative cash balance. To put a fine point on it, the prosecution will allege that this large negative cash balance represented implements, properly using customer funds to trade and lose on the exchange. Now, of course, Alameda had a significant balance sheet of assets held against this negative cash balance, but these assets were crypto tokens largely created by Sam and FTX. They were far too illiquid to realize it anywhere close to their full book value. The SEC summarized the allegations in their separate lawsuit by stating that

Sam, quote, orchestrated a year's long fraud to conceal from FDX's investors the undisclosed version of FTX's customer funds to Alameda research, afforded to Alameda on the FTCX platform, and the undisclosed risks stemming from FTC's exposure to Alameda's significant holdings of overvalued, illiquid assets such as FTX-affiliated tokens. Put more simply by Bloomberg's Matt Levine in an article published yesterday, when the customer money wasn't there, it was pretty much entirely because Alameda had lost it. Now, the key to proving these allegations will be establishing that Sam was aware of this financial artifice being run using Alameda. Fraud isn't fraud if it was caused by a mistake or an oversight. Prosecutors will need to show that Sam was either aware of the fraud or

willfully blind to it. As the judge put it, during last week, the issues here are pretty straightforward. Was there fraud or was there not? Now, let's move on to the timeline of events. Much of the DOJ's case will center around the fateful final weeks as the FTX empire came crashing down. Now, the beginning of the end came on November 2nd when CoinDesks Ian Allison published an ex-mose on the Alameda balance sheet. There had been some rumors of trouble at Alameda prior to that, but with a partial copy of the balance sheet, this piece of reporting blew the lid off the situation. TLDR, what the balance sheet showed was that a huge portion of Alameda's holdings, the collateral that they had used to back up their loans,

particularly from FTX, were pretty illiquid tokens, and in particular, the native exchange token of FTX, FTT. Now, in terms of a huge portion of their assets being in FTT, there were also a bunch of other Sam coins from D5 projects that barely got off the ground, which in some cases had Alameda representing up to 95% of the overall token supply. According to the Financial Times, just $900 million in assets on this balance sheet could be easily sold. The next major event was the very public sparring between Binance CEO, CZ, and Sam. Binance had been an early investor in FTX, but at that time had been bought out of their stake for $2.1 billion. That repurchase, a theoretically pretty good return on an $80 million investment, had been paid out in a mix of stable coins and FTT tokens.

On the Sunday, following the Coin desk article, CZ tweeted that, quote, due to recent revelations that have come to light, we've decided to liquidate any remaining FTT on our books. He said the firm would attempt to do so in a way that, quote, minimizes market impact over the next few months. But of course, when you have CZ the single biggest player in the industry, saying dump FTT and run for the hills, guess what happened next? Within the hour, Carolyn Ellison absolutely pissed gasoline all over the situation.

She had taken over as Seoul Alameda CEO just a couple months prior and tweeted to CZ, quote, If you're looking to minimize the market impact of your FTT sales, Alameda will happily buy it all from you today at $22. The market immediately plunged, with FTT's price being very visibly defended against frenzied selling. Throughout the week before, FTT had traded around $25 and a market cap of $3 billion. By Tuesday night, with Alameda's traders and balance sheet exhausted, the token settled at $5

and FTX closed withdrawals. Now, like I said, I gave my account of being on the inside. And while Tuesday when FTCS closed withdrawals was clearly, a final moment in the coffin for many of us inside. For me, when it was clear that something very nefarious had gone on was on Monday, when I started getting hit up by other friends outside of FTX in the industry, who were asking if I had heard anything about an FTX emergency fundraising round. Now, of course, as an exchange that was supposed to be fully backed, and given Sam's recent statements to the team that we had around $2 billion in cash in liquid assets,

thanks to trading revenue as well as recent fundraising, the only way in the world that we would need an emergency fundraising round was if Sam had been using FTX customer funds for purposes other than sitting on FTX's books waiting for those customers to reclaim those funds. Anyway, in the middle of that week after withdrawals were closed, there was also a weird sham sale announced to Binance, which they very quickly backed out of. And by Friday, with most FTX staffers having already fled the Bahamas, Sam finally capitulated to bankruptcy. Now, to this day, Sam claims that he was forced by external lawyers to place the FTX empire into bankruptcy, and appears to continue to be holding onto the idea that the exchange could have raised an emergency fundraising round

to make customers whole. For most people, that might be where the event ended, but not so much for Sam. What followed was a bizarre string of press interviews, an incredibly disjointed Twitter thread, and basically an odd media tour that attempted to paint Sam as a wayward and naive CEO in over his head, rather than a perpetrator of criminal fraud. This tour was capped off by a live broadcast interview with Andrew Ross Sorkin of the New York Times on November 30th. During that sprawling interview, Sam claimed that he, quote, didn't ever try to commit fraud on anyone. Authorities disagreed, and on December 12th, Sam was arrested in the Bahamas at the request of the U.S. government. Although initially defiant, Sam ultimately agreed to be extradited to face charges

and was released on bail. Once again, for any normal person, that might be the end of the story until we get to trial, but not for Sam. Although he was confined to his parents' house in California, Sam managed to continuously test the boundaries of his bail conditions. February, Sam was hauled before the judge on allegations that he had used encrypted messaging apps to contact the General Counsel of FDXUS, as well as using a VPN, which Sam claimed was just to watch NFL games. To the former General Counsel of FTCS, Sam had reached out to see if it was possible to, quote, have a constructive relationship, use each other as resources when possible, or at least

vet things with each other. The DOJ characterized this communication as an attempt to taint a potential witness. At that point, the judge decided not to revoke Sam's bail. but instead expressly forbid Sam from using encrypted messaging apps and VPNs. And yet, in July, Sam stepped over the line once again by leaking the private journal of Carolyn Ellison to the New York Times. The judge agreed that providing this material to journalists was, at best, an attempt to embarrass Ellison, if not a brazen attempt to intimidate her and discredit her in the public eye. During the course of that hearing, it was uncovered that Sam had held

more than 1,000 phone calls with journalists, including over 100 with the New York Times reporter who published the story. And thus, by early August, Sam had his bail revoked and was locked up at the Brooklyn Metropolitan Detention Center to await his trial. Since then, it's basically just been a never-ending set of appeals to try to get Sam out of jail, but alas, jail is where he remains. Next up, let's talk witnesses. What became clear quite fast was that there was a cohort of around four people, including Sam, that seemed to know about the extra special privileges that Alameda enjoyed, and the fact that for all intents and purposes, customer funds on FtX were just used as a slush fund, for their hedge fund traders. And it turns out that while Sam was still in the air being extradited

from the Bahamas, multiple FTX executives were revealed to be collaborating witnesses. Of those, Carolyn Ellison is the one likely to get the most attention. As well as being the CEO of Alameda, Ellison was also Sam's former girlfriend. The couple split prior to the collapse of FTX, and there will no doubt be extensive cross-examination which questions Ellison's motives in giving evidence against Sam. Although Ellison was only at the helm of Alameda for a little over two months, recent reporting describes her as essentially in charge of the trading firm for much longer, at least as much as anyone could be in charge of the firm relative to Sam himself. Nominally, Ellison and Sam Tribuco, another Sam in this story, had been appointed co-CEOs

of the firm in October of 2021 when SBF stepped away from the role. However, Tribuco had recently been described as almost entirely checked out at that point, leaving Ellison in charge of day-to-day operations. Ellison is expected to give evidence regarding the inner workings of FTX and has acknowledged that she knew about the hole in Alameda's balance sheet prior to the collapse of the exchange. Nishad Singh and Gary Wang are the other two executives known to be cooperating with prosecutors. Singh acted as engineering director while Wang was the exchange's CTO and co-founder. These two basically built all of FTX from the ground up, so anything going on with the code base is basically going to be mostly just their work.

Now Nishad is expected to give a firsthand account of how the Alameda back door was enabled in the code. Nishad was reportedly extremely distressed and racked with guilt during the final weeks at FTX and was confrontational with Sam during that time. Gary was one of the last employees left in the Bahamas as the exchange collapsed and famously coded almost the entire platform by himself. Some have speculated about how he will be as a witness given that he is notoriously quiet. Now, each of these three key witnesses have already pleaded guilty to criminal fraud charges and have agreed to testify in exchange for a lighter sentence. Prosecutors will need to demonstrate that each one is presenting an honest account of events rather than merely throwing Sam under the bus to save themselves. There are also complicated

personal relationships between each of these executives and Sam, which could be used by the defense. all three cohabitated with Sam and the Bahamas penthouse, and were some of Sam's closest friends as well as employees. To give an indication of how hostile cross-examination could become, last week a DOJ motion to prevent the defense from asking questions about recreational drug use was denied. The defense will need to provide notice to the court before asking witnesses about their drug use, but the subject was not ruled to be out of bounds. Another FDX executive who has pleaded guilty to criminal charges is Ryan Salem who served as CEO of FTX Digital Markets. FTCS digital markets was the operating company for the Bahamas.

Now, Salem was particularly involved in the political campaign side of things for Sam and was charged with violations of campaign financing law in relation to making straw donations to politicians on Sam's direction, as well as operating an unlicensed money transmitting business. Unlike the other three, Salem is not cooperating with prosecutors as part of his plea deal, but could be called to testify as a non-cooperating witness. Alameda co-CEO co-C CEO Sam Tribuco has not been heard from since he stepped away from the company last August. He has not been disclosed as a witness and has not been charged at this stage. The DOJ has also flagged that they have at least two additional witnesses set to testify under a grant of immunity, but have not publicly identified them at this stage. By and large, speculation about who those witnesses might be include not only Tribuco, who he just mentioned, but Daniel Friedberg, who served as FTX's chief compliance officer and who had formerly been implicated in a major online poker scandal, and Constance Wang, who was FTX's CIO, and was described as Sam's right hand during fundraising efforts. Now, in addition to FTX executives, the DOJ will also call multiple customers and investors to give brief test. testimony. Prosecutors have flagged that they will call upon retail customers who traded tens of

thousands of dollars on the platform, as well as institutional clients who traded millions of dollars. The high range could imply notable industry figures will make an appearance on the witness stand. Several high-profile market makers are listed as top creditors of FTCS and are no doubt and unduelly about their funds being locked up in the bankruptcy process. Both customers and investors are intended to present their understanding of the FTC's terms of service and representations made about the use of customer funds, which could be crucial in refuting possible defenses. which indeed brings us to that section of this primer, what are the defense strategies that Sam might try to employ? SBF's legal team have flagged a few potential arguments.

In a filing on Monday, they sought clarification on a few issues they may wish to present. The filing asked whether the defense could argue that FTX International was not regulated in the U.S., and therefore did not have to follow applicable rules. They also asked whether Sam could discuss the likelihood that creditors could see massive returns from the bankruptcy process. Still, the primary defense expected from SBF relates to instructions from legal counsel. In August, SBF's team flagged a plan to argue that he relied on advice from both in-house attorneys as well as lawyers from Fenwick and West in basically all elements of FTX's operation. Sam sought to introduce advice from lawyers on topics ranging from his use of self-deleting messages,

unconventional banking relationships, and intercompany financial arrangements. The DOJ objected to this defense, claiming that not enough detail had been provided, but the judge reserved their decision on this point until later in the trial. The judge said that they would make rulings on individual advice of counsel arguments on a case-by-case basis as they come up. Outside of what indications we've gotten from Sam's team, the industry in the wider world at large have had no problem speculating about how he might defend himself as well.

Bloomberg's Matt Levine paraphrased his view of a likely defense as, the crypto market crashed, there was a run on the bank, and the run on the bank is what evaporated the customer's money. It was an accident, perhaps a careless accident, but not theft. Certainly in media commentary, SBF has been focused on the bank run, rather than the whole in Alameda's balance sheet as the cause of FTC's collapse. Now, of course, there are some obvious issues with that defense, particularly if witnesses established that Alameda had effectively commandeered customer funds and contravention of the

exchange's terms of service. Another plank of Sam's defense will likely be to rely on prosecutors being unable to make out willful fraud rather than non-criminal gross negligence. In a New Yorker article published last month, the journalist wrote, Bankman Fried was adamant in my conversations with him that prosecutors would not be able to produce any documents showing him authorizing the unlimited borrowing because he says there are none. without hard evidence that Sam signed off on the Alameda back door, prosecutors will be left to rely on circumstantial evidence presented by witnesses to convince the jury. Going back to his article, Matt Levine again sketched out a plausible way that Sam could brush

off an $8 billion balance sheet hole as a careless oversight rather than willful fraud. He suggests that Sam could claim he thought FTX had so much money that $8 billion was a rounding error. From Levine's back of the napkin math, at its height, FtX had somewhere approaching $100 billion in crypto assets on its books. Finally, it's also expected that Sam will seek to blame Caroline from me. mismanaging Alameda. The publication of excerpts from Caroline's journal was an attempt to paint her as a naive child way out of her depths, and some of Sam's leaked writings also showed a belief that Alameda had failed to hedge correctly, as if that was the main issue here.

Now, one thing that's important to note is that when considering defenses, SBF does not need to prove his innocence. He only needs to introduce a shred of doubt in the minds of the jury. To convict, the 12 jurors must be convinced beyond a reasonable doubt that Sam is guilty and reach a unanimous decision. Prosecutors often fail to get their cases over the due to being unable to entirely convince each juror of the defendant's guilt. This can be even more of a difficulty when the case involves complicated financial crime, which can be difficult to fully understand. And yet, many commentators are convinced that the case is damning.

Daniel C. Silva, a former prosecutor who participated in the BickConnect case said, I think it's going to be pretty overwhelming if it's brought to a jury in the same way that it was laid out in the indictment. Now, in terms of the latest from the bankruptcy, as the trial gets underway, the FTCS bankruptcy process is entering its 10th month and has had no shortage of intrigue. The current focus has been on pursuing clawbacks from people and organizations that had been, in the estimation of the bankruptcy estate, unjustly enriched by FTX. On the very top of that list are Sam's parents, Joseph Bankman and Barbara Freed.

Two weeks ago, the estate sued Bankman and Freed, claiming that they had received over 26 million in gifts from FTX, including a luxury property in the Bahamas. The lawsuit alleges that Bankman was intimately involved in the operations at FTX and used his position to enrich himself. You may have seen the now famous email, where he tried to raise his salary to a million by threatening to involve Sam's mother. Now, speaking of Sam's mother, Barbara Freed is alleged to have directed political donation efforts at FTX. This included instructing Sam on how to structure donations to avoid donation limits. She is also alleged to have knowledge of loans made to FTCS executives,

which were then used to fund election campaigns. All in all, the lawsuit alleged that the pair, quote, deployed their decades of experience as sophisticated law professors and veneer of legitimacy, not to help the FTX group, but rather to plunder it in order to enrich themselves and their pet causes. Now, for their part, Sam's parents immediately hit back at the lawsuit through lawyers saying, quote, this is a dangerous attempt to intimidate Joe and Barbara and undermine the jury process just days before their child's trial begins. A last note on the bankruptcy, while current FTX CEO John J. Ray has no doubt been cooperating with prosecutors in providing internal documents. He is not currently expected to testify as a witness. Now, in terms of the latest trial procedural stuff and timeline, today was technically the first day of the trial with jury selection the goal.

Both sides have alleged the other is attempting to bias the jury pool. The DOJ claim that Sam's questions for the jury about effective altruism, political donations, and ADHD are intended to paint him in a sympathetic light. In particular, prosecutors are concerned that asking about charitable and political donations could improperly introduce the idea that Sam's actions were justified outside of evidence. The defense, meanwhile, have complained that the DOJ are treating Sam's fraud as an established fact in their jury questioning by omitting the word allegedly. They also claim a question about being stopped or questioned by the police,

is intended to racially filter the jury in a manner irrelevant to the case. Last week, as I intimated before, SBF placed a last-minute appeal to be released from jail for the duration of the trial. Sam's team claimed that his incarceration would be an unreasonable barrier to adequately preparing for each day's hearing. Unfortunately, for him, the judge found this argument insufficiently convincing and stated that they consider Sam to be a flight risk. They said, your client could be looking at a very long sentence. If things look bleak, maybe he would seek to flee. Sam was granted some concessions to be allowed to meet with his lawyers early at the courthouse each day, well as during jail visiting on off days. Now, while a decision is yet to be made on exactly how Sam can introduce the concept that he relied

on the advice of lawyers, limits were placed on what can be said during the defense's opening arguments. Specifically, Sam's lawyers have been prohibited for mentioning any advice of counsel arguments while presenting their case. The judge ruled that this argument may confuse or prejudice a jury when presented without specifics and evidence. The trial is currently scheduled to take six weeks. Jury selection is expected to be completed by the end of today's hearing, although before I was recording this, there were some indications that it might go into tomorrow morning as well. In either case, tomorrow we will likely see the beginnings of opening arguments. After that, the prosecution will present its case and call its witnesses.

The DOJ has estimated their case will take four to five weeks. The defense will then have an opportunity to present their case, which they have estimated will be much shorter, taking around a week and a half. Now, the defense is not compelled to present a case and can simply choose not to if they are confident the charges have not been proven. We don't yet have any indication of whether SBF will speak in his own defense. Traditional legal strategy suggests that defendants should never take to the witness stand to avoid giving prosecutors an opportunity to cross-examine them. However, this is no ordinary trial and SBF is no ordinary defendant.

Judging from how extensively Sam has defended himself in the media, I would not be surprised if his lawyers have a tough time keeping him out of the witness box. Hearings will be held four days a week with a short break after three weeks. If the trial takes longer than six weeks, it will be extended. But the consensus seems to be that it will be all over by Thanksgiving. And won't that be something to be thankful for? Now, even if Sam escapes a guilty verdict, his legal troubles will continue well into next year. The DOJ will present additional charges related to bribery of Chinese officials, as well as political donation violations during a second criminal trial, which is scheduled for March.

Sam will also face civil lawsuits from the SEC and the CFTC after the first criminal trial is concluded. Beyond that, there's still the possibilities of lawsuits from the FTX bankruptcy estate, as well as from former customers and investors. So, my friends, that is the lay of the land. That is what we are going into. Like I said at the top, for me, the most interesting thing, the thing that I will be watching most closely is actually the meta-narrative analysis around this. I want to know how much, especially mainstream media, looks at this and treats this, like what it is, which is Sam Bankman-Fried going on trial, versus what I fear it might

become, which is the entire crypto industry being put on trial. But in any event, this truly is a scenario where the only way out is through. So get on your boots, friends, because we are getting into the muck. Until next time, be safe and take care of each other. Peace.