The Journal. - How FTX Found Billions to Repay Customers

Episode Date: May 13, 2024

When FTX collapsed into bankruptcy in 2022, many customers never thought they'd see their money again. But FTX's assets have rebounded. WSJ’s Andrew Scurria unpacks why FTX will have more than enough money to fully repay customers and many creditors. Further Reading: - Crypto Exchange FTX Is the Rare Financial Blowup That Will Repay Victims in Full  Further Listening: - The Trial of Crypto’s Golden Boy  Learn more about your ad choices. Visit megaphone.fm/adchoices

It took just over a week in November 2022 for FTX to go from one of the biggest cryptocurrency exchanges in the world to declaring bankruptcy. So FTX was experiencing a run on its bank. furiously pulling money out in November 2022 because it was reported in the press that the exchange didn't have enough money to cover its deposits and was in financial straits. That's our colleague Andrew Scuria. FTX declared bankruptcy because it owed more money than it actually had.

At the time, the company was thought to have an $8 billion shortfall. And most FTX customers and investors thought they'd never see their money again. I woke up and lost $5 million. I am very skeptical that people will be made 100% whole at the end of the day. So I guess the chance of having my money back

is nearly zero. When FTX went bankrupt, Andrew and some colleagues debated how many cents on the dollar FTX customers might get back. One colleague guessed five cents. Another one said 10. I said 30.

And the answer is 100. 100 cents on the dollar, meaning customers who thought they lost their money forever will now be getting all of it back with interest. So relative to the expectations that people had after FTX filed for bankruptcy, I think this has vastly exceeded those expectations because it was viewed as almost a near total loss for investors. It seems like this all happened so fast. I mean, the bankruptcy didn't even happen not even two years ago. That's the other thing that's notable about this is that not only are customers being paid back in full for their claims

on the petition date, but it's happening in less than two years. And if you look at some of the other big financial blowups in the 21st century, it's taken a lot longer than that to clean up the mess. For example, Bernie Madoff's fraud. Customers have still not been made whole today, about a decade and a half later. Compare that to less than two years. It's a very, very short turnaround. Welcome to The Journal, our show about money, business, and power. I'm Ryan Knudson. It's Monday, May 13th. Coming up on the show, where did FTX find the money to pay customers back? Attention all soccer fans.

From Orlando to Los Angeles, take to the fields of the USA for your next vacation. Ready to kick off? Discover exciting games and events. Plus, find amazing hidden gems in cities full of adventures, delicious food, and diverse cultures. You'll love it so much you'll want to extend your stay beyond the matches. Get the ball rolling on your soccer getaway. Head to visittheusa.com. Before FTX collapsed, millions of customers used it to trade and store billions of dollars worth of crypto. Many of them were drawn to the platform by its CEO, Sam Bankman-Fried, and his promises to take crypto mainstream.

But when the company tanked in 2022, Bankman-Fried stepped down, and a new leader was brought in to fix the mess. John J. Ray III, a man who's built a career taking over companies in distress. John J. Ray III, a man who's built a career taking over companies in distress. Longtime turnaround specialist, right? Known for cleaning up the aftermath of failed companies, most notably Enron, where similarly he came in after the fraud that the company had engaged in was already uncovered, and his job was to clean up the mess, figure out where its assets were, and figure out how to pay back all its debts.

One of Ray's first actions was to file for bankruptcy, a move that Bankman Freed opposed. Bankman Freed said there was enough money to pay everyone back. He just needed time to find it. I believe that withdrawals could be opened up today, and everyone could be made whole from that. Bankman Freed was later charged and convicted of fraud and is currently serving a 25-year sentence. He's appealing the ruling.

What did John Ray say about FTX once he took over and had a chance to start looking at his books? He said, this is a crime scene. He famously said in his initial court filing that never in his decades of service in the bankruptcy world had he seen a company with such shoddy record keeping

and just no idea where its funds were. So he had to reconstruct what FTX did with all this customer money almost from the ground up, right? Using the company's internal systems where they communicated over Slack and had very few internal controls about what they were investing in.

Ray talked about just how bad it was at a House committee hearing in December 2022. They used QuickBooks, a multi-billion dollar company using QuickBooks. QuickBooks? QuickBooks. Nothing against QuickBooks. It's a very nice tool.

Just not for a multi-billion dollar company. Ray's job was to figure out where FTX's money had gone and how to get it back. His goal is to maximize the value available to pay creditors. And he had several different buckets to do that. Any restructuring professional has several different buckets to do that. You look at the company's existing assets, you figure out how to maximize the value of them. You look at anyone who owes the company money, and you go after them. And you look at anybody who the company may have legal or litigation claims against, and you explore whether it's in the company's best interest to sue or otherwise

settle with the people that may have gotten money out ahead of its creditors. One of Ray's early ideas was to try and restart FTX. He and his team spent months trying to find a buyer. So he was looking into that as a way to make creditors whole, not because he wanted to get back into the crypto trading business, but if that was in the best interest of creditors, then that's what he would have done. Instead, over time, it became clear that no one was really willing to pay enough for FTX's code, its proprietary information, its brand, in part because the brand had become synonymous with fraud, so who really wants to own it, right? They could have restarted it under a new name, possibly, but there just wasn't enough investor interest to do that. In the end,

Ray didn't need to relaunch and sell FTX because he found plenty of money elsewhere. And he got it from a few different areas. So one of the biggest buckets was the crypto that FTX did have, right? It did have billions of dollars in crypto that was just parked there. And a lot of that crypto really appreciated over the course of the bankruptcy case, right? Bitcoin went from $16,000 up to 60. So that grew the amount of assets that he had at his disposal. Another bucket was this many, many, many investments that FTX made, often using customer money to do so, in all sorts of ventures, speculative crypto projects, new tokens, and some that actually really appreciated a lot over time. For example, FTX owned a significant stake in Anthropic, which is an AI startup. Over the course

of the bankruptcy, Google and Amazon both invested in Anthropic, and FTX's stake became a lot more valuable and appreciated, and FTX was able to sell that to generate almost a billion dollars to pay creditors back. Ray also managed to recover some of the big purchases Bankman-Fried made with customer money, including luxury real estate in the Bahamas and two private jets. One more bucket is the money that FTX spent on donations to politicians and charitable causes, which it was very big into under Bankman-Fried's leadership. It's still trying to get that money back and actually hasn't gotten back a lot of those political or charitable donations. The politician's like, no, I'm going to keep it.

The Department of Justice is also involved in trying to get some of that money back. And some recipients have voluntarily returned it, but not all. Once Ray had finished tallying up all the money, he found that there was between $14 and $16 billion. It's still not clear exactly how much he'll have. And it changes every day based on cryptocurrency prices. how much he'll have, and it changes every day based on cryptocurrency prices. But FTX feels comfortable at this point saying that they will have enough surplus to cover in full the full account balances that customers had on the day FTX filed for bankruptcy. So FTX customers are going to get all their money back. They must be thrilled.

They're thrilled to get as much back as they are, but they would have been better off had the bankruptcy never happened. What customers have lost out on is next. Introducing TD Insurance for Business. www.tdinsurance.com a pet groomer, a contractor, or a consultant. You can get customized coverage for your business. Contact a licensed TD Insurance advisor to learn more. buckle up. With Cate Blanchett, Kevin Hart, Jack Black, Ariana Greenblatt, and Jamie Lee Curtis. Wow, you never see that. Borderlands. So if you were a customer of FTX, somebody who had money on the platform, what can you expect to get back? So what FTX is projecting is that most customers,

98%, which are the retail customers, individual traders, they will get back what they had invested as of the day FTX filed for bankruptcy, plus interest to compensate them for the time value of their money, the little less than two years that their crypto has been locked up, within about 60 days after the bankruptcy plan goes effective. And that could happen as early as September, subject to court approval. Customers are getting paid back in U.S. dollars, not cryptocurrencies. And they're only getting paid back what those cryptocurrency holdings were worth the day the bankruptcy was filed, back in November 2022. The bankruptcy crystallized their claim on that day and crypto prices were really beaten down on that day. So their claim was crystallized at a pretty low level for a lot of them. So if you had one Bitcoin

deposited at FTX and Bitcoin was worth around $16,000 on that day, you have a $16,000 claim. So, you know, now Bitcoin is at $60,000. So customers will never be in the same position as if there had been no bankruptcy, right? Because they've missed out on that asset appreciation. If they had just held the Bitcoin that whole time, now they would have a Bitcoin worth $60,000. But instead they have a $16,000 claim against FTX. Now that $16,000 claim will be paid in full plus interest, but you'd rather have the Bitcoin. Right. So even though FTX is able to capitalize on the massive increase in the rise of Bitcoin. Customers don't get to share in that. Customers don't. Yeah. Interesting. FTX says it would be impossible to pay the

appreciated value of each customer's holdings because, quote, we cannot give tokens back that we never had. There are also some people who aren't going to get any money back, like investors who owned FTX's own cryptocurrency called FTT. Holders of FTT will get zeroed out, at least under this current iteration of the plan. And the reason is that FTX's management team is treating that as akin to equity in FTX, which is what it was, right? It was a token that was akin to stock in the exchange. FTX gave it out to its most valued customers, gave it out to insiders, right? It was kind of like equity, and it was expected to appreciate in value as FTX became more valuable. And the reason that equity holders don't get any money back is because

bankruptcies are about getting money back to the people the company owed money to. Creditors outrank shareholders under the law. Shareholders generally do not get a penny unless creditors are paid in full. And that's what happened here. Other customers who might be unhappy right now are the ones who decided to sell their claims before the bankruptcy process was complete. A lot of people had cash needs that they needed to meet, and for some, their life savings had just been frozen on the exchange, and they didn't know when they were going to get it back

or if they were going to get any back. So some of them, to come up with some money today, decided to sell their claim, effectively sell their account and their rights to an eventual recovery from FTX to outside investors. So the outside investors would come in and say, hey, we'll give you five or 10 cents upfront and a small slice, whatever the upside is in return for the rights to whatever rights they would have against FTX. So if I had $100,000 in FTX, some investor would come along and say, I'll pay you $5,000 or $10,000, $20,000 today, right? To walk away from this case, right? Here's your $20,000.

You're done with FTX, right? And a lot of people took that option at the time because, again, no one knew how much John Ray would be able to get back. He did not know how much he was going to get back. And he was also saying that this is a mess, the worst thing I've ever seen. He said it was a crime scene. So you can understand why for a lot of people, the opportunity to get 10, 20 cents back today rather than wait years for what could be zero was a risk they were willing to take. These claims were bought by some of Wall Street's biggest investment firms. They bought billions of dollars of claims from customers

for as little as pennies on the dollar. These claims are actually now worth 100 cents on the dollar. Wow. And they're still being traded. So the point is that if you sold your claim really early on, you might have a bit of seller's remorse now. Conversely, if you're a hedge fund who bought a customer claim really early on, you are looking at a windfall.

You're popping champagne. Possibly one of the best distressed investing trades in recent years or all time, actually. Wow. Wow. Mm-hmm. Actually. Wow. Does this moment sort of show that Bankman-Fried was kind of right all along, that his company was solvent?

So what John Ray said last week was that in an alternate universe where FTX hadn't filed bankruptcy, things would not have been as rosy as Sam Bankman-Fried says they would have been. However, it does cast Bankman-Fried's assertions in a bit of a different light. Do you think that there's a chance that this might help Bankman-Fried's appeal, the fact that customers were made whole? So when he was sentenced, the judge who sentenced him said that even if the customers are ultimately made whole,

that doesn't lessen Bankman-Fried's culpability. And what he said from the bench was that, a thief who steals money and then successfully gambles with it in Las Vegas and then gives it back does not make him any less of a thief. So in the judge's mind, that did not enter into his sentencing decision. Bankman-Fried has appealed his sentencing decision, so we'll see if it gets any traction at the appellate level, but it didn't help him out during his criminal trial. What do you think this says about FTX's business, or the kind of business that it was? Crypto has existed in an unregulated state for a good amount of time, and FTX was the result of that.

The lack of controls, lack of meaningful regulatory oversight, the global nature of its business all contributed to an environment where the fraud wasn't caught until it basically became public in the media. Then things shifted into the hyper-regulated legal world. And in that environment, customers actually did pretty well. So in the unregulated kind of wild west of crypto, customers got fleeced. Once things went into bankruptcy, there was at least a legal avenue for them to enforce their rights and get a recovery. So the institution of bankruptcy court holding strong. It held strong. It does show what bankruptcy can accomplish, right? By just stopping the music,

right? Stopping the bank run and giving independent administrators like John Ray a chance to maximize the pie and make the most out of what they do have. I mean, how big of a victory is this for John Ray? For him, it's huge, right? I mean, he's already had a long and illustrious career, but this tops it off, right, for him, because he's able to say that because of the work that he and his management team did in tracking down FTX's assets all over the world, filing a bunch of lawsuits, and undertaking the administration of this huge blow-up, he's now able to tell a really good story about the result. That's all for today, Monday, May 13th. The Journal is a co-production of Spotify and The Wall Street Journal. Additional reporting in this episode by Becky Yerrick and Soma Biswas.

Thanks for listening. See you tomorrow.