FTX fraud suits offer blueprint for pursuing offshore crypto exchanges

The lawsuits filed Tuesday show how U.S. regulators have found a way to police global crypto conduct they don’t closely regulate. The Commodity Futures Trading Commission alleged, for instance, that Bahamas-based FTX affected the price of commodities sold in the U.S. That gave the CFTC authority to file a civil fraud lawsuit against FTX founder Sam Bankman-Fried and his companies.

Crypto exchanges including FTX don’t register with U.S. regulators such as the CFTC or the Securities and Exchange Commission and aren’t subject to inspections that check for compliance with American rules. But they are still subject to U.S. laws that prohibit fraud if they deal with local customers or work inside the U.S.

The CFTC wields another advantage in fraud cases, thanks to a change in law that Congress passed in 2010. The newer statute says the CFTC doesn’t need to prove market manipulation. Instead, regulators only have to show that a defendant committed fraud and that the conduct affected commodity prices.

The CFTC’s lawsuit alleges that FTX misused customer money to fund its sister trading firm, Alameda Research, and made misleading statements about the firms’ financial stability and risk-management practices.

When the exchange collapsed last month, the price of bitcoin futures fell more than 23%, the CFTC said. The agency alleged a clear connection between FTX’s conduct and the price of digital commodities such as bitcoin and ether.

“If you are impacting commodities in interstate commerce, the CFTC believes it has a jurisdictional hook," said Gary DeWaal, an attorney at Katten Muchin Rosenman LLP who defends clients in CFTC enforcement cases.

The CFTC’s lawsuit cites other reasons for its involvement. Mr. Bankman-Fried, who lived in the Bahamas and was arrested there on Monday, performed work for FTX and Alameda while he was in the U.S., according to the lawsuit. (Alameda was initially based in Berkeley, Calif., where Mr. Bankman-Fried and others worked, according to the lawsuit.)

In addition, some U.S. traders got access to FTX despite the exchange’s effort to wall itself off from Americans, who were supposed to use a smaller crypto platform known as FTX U.S.

It is unlikely the CFTC’s allegations against FTX and Alameda will need to be proven in court, Mr. DeWaal said. That is because FTX is now run by John J. Ray III, who was hired to steer the company through bankruptcy and ensure as many of its debts as possible are paid.

Mr. Ray and FTX are unlikely to spend precious resources litigating with the CFTC, making a settlement more attractive. “It is not in the interest of the trustee to use attorneys’ fees defending something like this," Mr. DeWaal said.

A spokesperson for FTX and Alameda didn’t respond to a request seeking comment.

The CFTC’s allegations against Mr. Bankman-Fried are likely to be put on hold while the FTX founder deals with criminal charges. A grand jury in Manhattan charged him with eight criminal counts related to what federal prosecutors described as a scheme to defraud his crypto exchange’s customers and his hedge fund’s lenders.

Mark Cohen, a lawyer for Mr. Bankman-Fried, said his client “is reviewing the charges with his legal team and considering all of his legal options."

The SEC on Tuesday accused Mr. Bankman-Fried of violating U.S. investor-protection laws.

The SEC said Mr. Bankman-Fried’s alleged misuse of FTX customers’ funds, and his failure to disclose the exchange’s flawed risk controls, defrauded U.S. investors such as Sequoia Capital that collectively poured $1.1 billion into FTX. The SEC doesn’t regulate private fundraising, but like the CFTC, it can police transactions that it alleges are fraudulent.

“FTX operated behind a veneer of legitimacy," SEC Enforcement Director Gurbir Grewal said at a news conference in Manhattan. “In reality, that veneer wasn’t just thin. It was also fraudulent."

This story has been published from a wire agency feed without modifications to the text