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U.S. DOJ Office of US Trustee filed motion seeking appointment of independent examiner to investigate alleged “substantial and serious allegations of fraud, dishonesty, incompetence, misconduct and mismanagement” related to FTX. Let me discuss why the DOJ's motion requesting appointment an examiner to investigate allegations of fraud relating to the FTX bankruptcy case may open the door to a potential criminal investigation.

First, let me explain why the DOJ is involved in the FTX bankruptcy case. In 1978, the US Bankruptcy Trustee Program was formed "to promote the efficiency and protect the integrity of the Federal bankruptcy system." The Attorney General of the United States appoints United States Bankruptcy Trustees. These Trustees are part of the Department of Justice and it is their job to "promote the efficiency and protect the integrity of the Federal bankruptcy system." Part of the duties of a US Trustee are to take "legal action to enforce the requirements of the Bankruptcy Code and to prevent fraud and abuse" AND refer "matters for investigation and criminal prosecution when appropriate."

So, if the US Trustee's investigation uncovers compelling evidence of fraud related to the FTX bankruptcy case, then the Trustee can refer the matter to the DOJ's criminal division for further investigation and prosecution. The US Trustee's motion lays one of the best summaries of the alleged FTX fraud and mismanagement that I've seen to date. Let's break it all down.

The motion notes that Section 8.2.6 FTX's Trading Terms of Service with its customers provides that "Title to your Digital Assets shall at all times remain with you and shall not transfer to FTX Trading." The terms further provide that: "None of the Digital Assets in your Account are the property of, or shall or may be loaned to, FTX Trading; FTX Trading does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading."

The motion then breaks down a very simple timeline discussing how FTX allegedly acted contrary to its own terms and conditions relating to investor funds and triggered the ultimate collapse of company. "In May and June of 2022, according to news reports, Alameda suffered severe losses from many deals it was engaged in, including a $500 million loan on which its borrower defaulted." ¶14 The New York Times has reported that Bankman-Fried was heavily involved in the decision-making for all of Alameda’s “big trades." On or about November 2, 2022, CoinDesk published that a substantial part of Alameda’s $14.6 billion in assets were held in FTT, the cryptocurrency created by the FTX Debtors, per Alameda’s June 30, 2022, balance sheet." ¶15

The Wall Street Journal reported that Bankman-Fried said in investor meetings during the week of November 6 that Alameda owed FTX about $10 billion based on loans FTX extended to Alameda to fund risky bets." ¶16  "The $10 billion came from money customers had deposited on the exchange for trading purposes. Bankman-Fried described the decision to move FTX customer property to Alameda as a “poor judgment call.”

"The $10 billion constituted more than half of the approximately $16 billion in customer funds on the FTX cryptocurrency exchange." "According to a Reuters report dated November 9, 2022, Bankman-Fried issued an apology to all FTX employees via an internal messaging application that stated: “I’m deeply sorry that we got into this place, and for my role in it." ¶17 "That’s on me, and me alone, and it sucks, and I’m sorry, not that that it makes it any better.” That same day, The Wall Street Journal reported that Alameda CEO Caroline Ellison—joined by Bankman-Fried and two other members of FTX Digital Markets Ltd.’s (“FTX Digital”) management team (Messrs. Wang and Singh)—told Alameda employees that they were aware of the decision to send customer funds to Alameda." "Specifically, according to the report, Ms. Ellison stated that “FTX used customer money to help Alameda meet its liabilities.”

The US Trustee's motion also provides and excellent summary of the declaration filed by FTX's new CEO, John J. Ray III, who is tasked with guiding the company through bankruptcy proceedings. Ray's declaration summarizes troubling business practices by debtors. Mr. Ray described a “complete failure of corporate controls and [] a complete absence of trustworthy financial information. ”As summarized in the Trustee's motion, Ray's declaration stated that: (1) debtors used "software to conceal the misuse of customer funds." (2) absence of any accounting department; 3) absence of centralized controls over Debtors' cash and an absence of an "accurate list of bank accounts and account signatories"  (4) absence of "appropriate books and records, or security controls, with respect to [the Debtors'] digital assets; (5) "[u]nacceptable management practices" such as the use of an unsecured group email account as the root user to access confidential private keys.

In summary, the Trustee seeks appointment of an independent investigator to help answer the critical question of whether FTX was an "unsuccessful business or a successful fraud"

According to court documents unsealed today, 21 individuals have been charged for their roles in transnational money laundering networks, including those that laundered millions of dollars stolen from United States fraud victims through romance scams, business email compromises, technical support schemes, and other fraud schemes. “These defendants orchestrated highly organized and sophisticated schemes to launder fraud proceeds through cryptocurrency,” said U.S. Attorney Brit Featherston." “Today’s announcement sends a clear message that money laundering networks that service fraud schemes targeting American victims, especially the elderly, will not be tolerated, and those operating such networks will be held accountable." "By acting as domestic money launderers for foreign co-conspirators, these defendants played indispensable roles that allowed foreign actors to reach from overseas to target victims in communities across the United States.” DOJ Press Release

Lot's of questions swirling in the space about whether FTX will be charged criminally. So what factors do federal prosecutors generally consider when deciding whether to pursue criminal charges against a business organization? The “Principles of Federal Prosecution of Business Organizations” in the Justice Manual describe specific factors that prosecutors should consider in conducting an investigation of a corporation, determining whether to bring charges, and negotiating plea or other agreements." These factors include “the adequacy and effectiveness of the corporation’s compliance program at the time of the offense, as well as at the time of a charging decision” and the corporation’s remedial efforts “to implement an adequate and effective corporate compliance program or to improve an existing one.” 

Three important factors prosecutors consider: (1) “Is the corporation’s compliance program well designed?“ (2) “Is the program being applied earnestly and in good faith? and (3) “Does the corporation’s compliance program work“ in practice? In answering each of these three “fundamental questions,“ prosecutors may evaluate the company’s performance on various topics that the Criminal Division has frequently found relevant in evaluating a corporate compliance program both at the time of the offense ...." 

"Prosecutors evaluating the effectiveness of a compliance program are instructed to reflect back on “the extent and pervasiveness of the criminal misconduct; the number and level of the corporate employees involved; the seriousness, duration, and frequency of the misconduct  and any remedial actions taken by the corporation, including, for example, disciplinary action against past violators uncovered by the prior compliance program, and revisions to corporate compliance programs in light of lessons learned.”DOJ Memo...

Attorney General Report to the White House on Crypto Criminal Regulation Recommends Amendments to 18 U.S.C. § 1960 (Unlicensed Money Transmitting Businesses). Let's discuss those proposed amendments regarding range of punishment and fines. Section 1960’s penalty provisions: "Under existing law, violations of § 1960 are punishable by a maximum of five years’ imprisonment, a term materially less than that prescribed for analogous fraud (20 or 30 years) and money laundering statutes (10 or 20 years)." "Enforcement efforts would benefit from increasing the statutory maximum sentence to 10 years (from five) and by adding an enhanced penalties provision, under which individual criminal fines would double—and corporate criminal fines would triple  for violations involving a money transmitter’s business of more than $1 million in a 12-month period to reflect the seriousness of the conduct at issue and allow for sentences more in line with the Guidelines range called for by the Sentencing Commission."

“In November 2021, Law Enforcement Seized Over 50,676 Bitcoin Hidden in Devices in Defendant JAMES ZHONG’s Home; ZHONG Has Now Pled Guilty to Unlawfully Obtaining that Bitcoin From the Silk Road Dark Web in 2012.” “On November 9, 2021, pursuant to a judicially authorized premises search warrant of ZHONG’s Gainesville, Georgia, house, law enforcement seized approximately 50,676.17851897 Bitcoin, then valued at over $3.36 billion.  Department’s second largest financial seizure ever.” “Today, in United States v. Ross Ulbricht, S1 14 Cr. 68 (LGS), the Government filed a motion for entry of an Amended Preliminary Order of Forfeiture, … seeking to forfeit approximately 51,351.89785803 Bitcoin traceable to Silk Road, valued at approximately $3,388,817,011.90 at the time of seizure”DOJ Press Release

Deripaska’s Property Manager Arrested in U.K. for Funding U.S. Properties for Deripaska’s Benefit and for Attempting to Expatriate Deripaska’s Artwork from U.S. through Deception. 

“As alleged, Graham Bonham-Carter provided property management and other services to his employer, sanctioned Russian oligarch Oleg Deripaska.  Bonham-Carter obscured the origin of funding for upkeep and management of Deripaska’s lavish U.S. assets, in violation of the international sanctions.  OFAC sanctions preclude supporters of the brutal and unjust Russian war regime from using U.S. dollars in any financial transactions, and we thank our international partners for their continued partnership in enforcing this critical sanctions program.”DOJ Press Release

Defendants Allegedly Defrauded Victims of Almost $18 Million as Part of “Pig Butchering” Investment Fraud and Money Laundering Schemes and Illegally Converted More Than $52 Million of Cash to Cashier’s Checks. “For once the name of a scam - pig butchering - reflects the grotesque nature of the harm it causes victims. We allege these fraudsters bled dry each of their victims and then used the money to set up fake cryptocurrency accounts."

"We know there are many more victims of these types of scams, and we urge those people to report it to the FBI. We will do all we can to bring each and every criminal to justice,” stated FBI Assistant Director-in-Charge Driscoll." “These defendants betrayed the trust of hundreds of people for profit, stealing millions of dollars through their brazenly callous investment scheme,” said NYPD Commissioner Sewell."

"Through this scam, more than 200 victims were contacted through messaging applications and convinced to invest almost $18 million in trading platforms by sending funds to purported money manager bank accounts that were later stolen." "The defendants also operated an unlicensed money transmitting business in which they converted approximately $52 million in cash into cashier’s checks on behalf of customers."

"As payment for their services, the defendants received a fee, which was generally a portion of the fee that the business received."

Federal jury returned a guilt verdict against defendant for "money laundering and operating an unlicensed money transmitting business as part of a scheme to launder the purported Bitcoin proceeds of drug trafficking." "The verdict followed a four-day trial before United States District Judge Pamela K. Chen. When sentenced, Goklu faces up to 25 years in prison." “The defendant offered his customers the ability to launder their criminal proceeds, remain anonymous and conceal where their Bitcoin was coming from so they could continue to engage in drug trafficking and other crimes while avoiding law enforcement detection,” 

"As proven at trial, in July 2018, DEA special agents identified an advertisement posted on where an individual with the username “Mustangy” offered to purchase up to $99,999 worth of bitcoins (“BTC”), ... [and] convert them into U.S. currency for a fee. "A DEA Special Agent acting in an undercover capacity (the “UC”) began exchanging encrypted text messages with defendant to arrange in-person exchanges of BTC to U.S. currency."

"The UC and the defendant subsequently met and engaged in seven transactions or attempted exchanges of BTC to cash over a nine-month period"

OpenSea announced yesterday their new system that "proactively scans URLs shared on OpenSea to identify if they may be malicious. It starts by cross checking a given URL against a blocklist of known malicious sites." OS noted that "scammers ... try to spread these URLs on OpenSea through fraudulent collection listings and unwanted NFT transfers." According to OS, the new system also "analyzes interactions and transactions to identify malicious behaviors like signature farming and wallet draining"OS will "simulate interactions and transactions with new URLs to identify malicious behaviors like signature farming and wallet draining ... Scammers that attempt to spread detected malicious links will have their accounts banned, their collections delisted, and their transfer requests blocked when using OpenSea." Under this new pilot program, OS will try to "detect NFT theft in REAL-TIME and prevent further resales of suspected stolen items to unsuspecting buyers." OS will then display a new yellow “under review” module on those items. According to OS, this move is to better address the ongoing problem of thieves reselling NFTs before victims have an opportunity to file a theft report. 

OS tweeted that "items involved in detected suspicious behavior will be temporarily disabled on OpenSea, and the previous owner will immediately be notified via email. The previous owner can then share feedback with us to reinstate the item and enable it to be sold again." Most importantly, OS announced that they are "working closely with other marketplaces, wallet providers, analytics organizations, and others, to develop holistic scam detection and prevention systems."
These measures by OS look like a good step in the direction of trying to address the issue of stolen and flagged NFTs. But, without cross-platform adoption of these measures, flagged NFTs continue to be bought and sold on other NFT secondary trading marketplaces. 
It will be interesting to see how this program works in real-time, whether it will curb the continued market for flagged NFTs and whether other platforms will agree to adopt similar measures.

To ensure that the Department continues to meet the challenge posed by the illicit use of digital assets, the Criminal Division recently launched the nationwide Digital Asset Coordinators (DAC) Network. The DAC Network is composed of designated federal prosecutors from U.S. Attorneys’ Offices nationwide and the Department’s litigating components. Led by the NCET, and in close coordination with CCIPS and the MLARS Digital Currency Initiative, the DAC Network serves as a forum for prosecutors to obtain and disseminate training, technical expertise, and guidance about the investigation and prosecution of digital asset crimes. Each DAC acts as their district’s or litigating component’s subject-matter expert on digital assets, serving as a first-line source of information and guidance about legal and technical matters related to these technologies. 

As members of the DAC Network, prosecutors will learn about the application of existing authorities and laws to digital assets and best practices for investigating digital assets-related crimes, including for drafting search and seizure warrants, restraining orders, criminal and civil forfeiture actions, indictments, and other pleadings. The DAC Network will also serve as a source of information and discussion addressing new digital asset forms, such as DeFi, smart contracts, and token-based platforms. In addition, the DAC Network will raise awareness of the unique international considerations of the crypto ecosystem, including the benefits of leveraging foreign relationships and the challenges of cross-border digital asset investigations. 

The DAC Network will be a crucial part of the Department’s efforts to continue to address the ever-evolving challenges posed by the illicit use of digital assets, by ensuring that prosecutors receive training, technical expertise, investigative resources, and direct legal guidance for investigations and prosecutions in this area. The DAC Network is modeled on the success of two previously established coordinator programs: the Computer Hacking and Intellectual Property (CHIP) Network and the National Security Cyber Specialist (NSCS) Network. The Criminal Division established the CHIP coordinator program in 1995 to ensure that each U.S. Attorney’s Office and litigating division has at least one prosecutor who is specially trained on cyber threats, electronic evidence collection, and technological trends that criminals exploit.58 The National Security Division similarly launched the NSCS 

Network in 2012 to equip U.S. Attorneys’ Offices “around the Nation with prosecutors trained on national security cyber threats, such as nation-state cyber espionage.”

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