Cryptoassets are traded on a global basis. Indeed, the markets are even more global and constant than markets in more conventional financial instruments, rivalled only perhaps by the foreign exchange markets in their reach.
The FTX collapse is the largest in the short but fast-moving history of the crypto markets, and is impacting investors globally at all levels. Undoubtedly, over the next few years, FTX’s creditors will explore avenues to recover their very significant losses.
FTX’s new chief executive, leading insolvency and restructuring lawyer John J Ray III, has committed to maximising the recoveries for FTX customers and investigating claims against its founders, including Sam Bankman-Fried.
As FTX and its creditors seek to recover vast sums of money, these are the most immediate options. FTX stated in its court papers recently that it has about 100,000 creditors and $10bn-$50bn (£8.3bn-£41.4bn) of assets and liabilities.
Clawback
It is alleged in court papers filed in Delaware, US, that just days before the insolvency of FTX, customers and insiders withdrew billions of US dollars in assets.
Indeed, this was also confirmed by FTX’s founder, Bankman-Fried, who said that approximately $5bn of withdrawals were made on 6 November 2022, just five days before the Chapter 11 administration (insolvency) filing.
This opens the door to creditors’ and the insolvency practitioner’s claims to seek to claw back the $5bn in assets that customers and insiders withdrew before the crypto company’s abrupt administration.
In order to recover assets, the IP will also investigate claims against directors for transferring assets out of the company.
There are natural comparisons with the collapse of Lehman Brothers
Preference claims
It is also reported that just before the administration, a select few creditors were paid. The IP may look at these payments as a ‘preference’ and seek to set aside the preference transactions.
Additionally, they could try to claw back payments apparently made after the administration but without the court’s permission.
Lawyers for FTX told the court they have “credible evidence” that the Bahamian government “is responsible for directing unauthorised access to the debtors’ systems for the purpose of obtaining FTX’s digital assets” after the Chapter 11 filings was made.
There has been at least $372mn of “unauthorised transfers”. If this is right, then any transfers of those assets could be clawed back.
They will also look at whether there were any transfers of assets and property designed to defraud creditors or made without receiving consideration, known as fraudulent transfers.
However, this may take some time, as before these claims may be pursued, the IP and their team will need to get a handle on FTX’s finances and transactions.
From the statements made by FTX’s new chief executive it is apparent that FTX’s existing financial data and documentation is inaccurate.
He is reported as saying that he has never “seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here”.
Other claims
As matters evolve and the picture becomes clearer, investors will also wish to explore other causes of action, including claims against auditors by those relying on audits of FTX companies, actions by investors and traders against investment advisers who negligently recommended using FTX, claims by investors against funds that provided crypto assets to FTX without adequate due diligence and perhaps most interestingly, claims against celebrity promoters of FTX crypto products.
Comparison with Lehman Brothers
There are natural comparisons with the collapse of Lehman Brothers in 2008, an event that dominated the credit crunch and cast a shadow over the financial landscape for many years.
However, Lehman was a business regulated globally by all the leading financial regulators. Moreover, Lehman Brothers operated under a legal and corporate governance structure that was designed to protect assets in the event of insolvency.
Indeed, it turned out that Lehman was so well capitalised and had such strong records that all its creditors were paid out in full.
By contrast, the incoming chief executive has commented of FTX that he “had never seen such a complete failure of corporate controls”. And this is from someone who oversaw the liquidation of Enron. Creditors are out of pocket to the tune of billions, and unlike Lehman, they will do well to recover even a percentage of their assets or money.
The dotcom boom and bust did not destroy the internet and web-based businesses. If anything, it led to greater rigour and better legal and regulatory structuresTurning points – signs of hope?
It is nonetheless possible, perhaps even hopeful, to conclude that FTX’s collapse will be a watershed moment that will lead to crypto exchanges and businesses being operated to the standard of regulated firms.
This would require co-ordinated efforts and the attention of governments and regulators across the G20 and beyond at a time when they are dealing with an intimidating list of global financial and political challenges.
Even so, while the price of BTC has fallen significantly on the news of FTX’s demise, it has not collapsed completely, indicating that investors retain faith in the fundamental concepts behind digital assets, crypto currencies and blockchains.
With better co-ordinated regulation, we can still hope for a more stable and optimistic future for the sector.
The dotcom boom and bust did not destroy the internet and web-based businesses. If anything, it led to greater rigour and better legal and regulatory structures that have contributed to its ongoing and unparalleled success.
We live in hope that the same can be said of the world of crypto exchanges and digital assets. The technology and advances they offer to business and the world in general are too good to squander.
Nigel Brahams and David Vaughan are both partners at Collyer Bristow
