FTX collapse – 5 ways in which investors can seek recourse
18 November 2022
On 11 November 2022, FTX Trading Ltd and over a hundred related entities in the FTX Group have filed for protection under the US Chapter 11 regime. This means that Alameda, FTX’s hedge fund, Singapore subsidiary Quoine, and other entities such as FTX (Gibraltar) Ltd, FTX Digital Assets LLC, FTX Europe AG, FTX Exchange FZE and many others are protected from claims. As a result, any court suit or arbitration claims made by investors against these FTX entities would likely be suspended in favour of the insolvency framework. Even if investors have a judgment sum or arbitration award against FTX, that could at best be a ticket to queue up in the insolvency process.
At the same time, there are reports that the funds of FTX have been substantially depleted, including a mysterious hack which drained USD 650 million worth of cryptoassets from FTX wallets in the immediate hours after the Chapter 11 filing. Bahamas based FTX Digital Markets has filed for bankruptcy protection in the US on 16 November 2022.
One may not be too hopeful of getting substantial returns, if any at all, from queuing up in the insolvency process. No doubt the situation is dire, but that does not necessarily mean that there are no more options for investors. We set out some options that investors can explore.
US class action
A class action lawsuit has been launched in Florida by investors against FTX’s former chief executive Samuel Bankman-Fried, who is not known to have personally filed for bankruptcy himself. Interestingly, several third parties including celebrities alleged to have helped promote FTX are also joined as defendants to the class action. The suit alleges that FTX was a ponzi house of cards which “shuffled customer funds between their opaque affiliated entities, using new investor funds obtained through investments in the YBAs and loans to pay interest to the old ones and to attempt to maintain the appearance of liquidity”. The promoters were alleged to have helped FTX raise funds and drove users to invest in FTX’s accounts. It remains to be seen how this class action would transpire, and there could be more such class actions to come still.
Recourse against affiliated parties
FTX US president Brett Harrison stepped down from his role in September 2022 to move into an advisory role after less than 18 months on the job, while Sam Trabucco, former co-CEO of Alameda Research stepped down in August 2022. It is unclear what the reasons for departure are but what is clear is that the existing management and C-suite of FTX and Alameda who stayed on have fallen under intense scrutiny since its collapse.
The leaked balance sheets of Alameda revealed that out of its USD 14.6 billion assets, Alameda’s single largest asset was USD 3.6 billion worth of “unlocked FTT”, akin to a reserve pool of native tokens issued by FTX. There was in addition approximately USD 2.16 billion worth of assets that are “FTT collateral”. FTT constitutes at least USD 292 million of Alameda’s USD 8 billion liabilities. At the same time, FTX the exchange had approximately USD 9 billion in liabilities with just over USD 1 billion in liquid assets.
FTT tokens are effectively akin to digital money printed by FTX, the value of which is uncertain. At the same time, FTT is an illiquid asset with FTX and Alameda being the largest holders of these tokens. In these circumstances, with FTX issuing FTT and giving loans in FTT to Alameda, only to use FTT itself as collateral for those loans, the end result was ostensibly a hyperinflation of FTT and a gross overvaluation of FTX. In total, FTX directed approximately USD 10 billion in client funds to Alameda to help bolster its investments. At least USD 1 billion of those funds is reportedly still missing since the collapse.
The circumstances give rise to serious questions around the potential responsibility of those who have charge over these transactions and arrangements, and in this regard, investors may consider pursuing action against affiliated parties where there is evidence of wrongdoing involved, in claims such as tort of interference of the investors’ economic rights, tort of inducement of FTX’s breaches of contract owed to investors, and tort of negligence.
Clause 38.12 of the FTX user terms provide for any dispute to be resolved by international arbitration seated in Singapore and administered by the Singapore International Arbitration Centre (“SIAC”), while clause 27.8 expressly provides for the increasingly popular and internationally recognised SIAC emergency arbitration mechanism to be used.
Investors could agree with the defendants that they are seeking recourse to resolve their dispute via international arbitration. This is a private and confidential process where only the parties to the dispute can participate in, without the scrutiny of the media and non-parties. Parties have flexibility to agree on the process and rules in the arbitration. An international arbitration award is internationally enforceable in over 150 countries worldwide under the New York Convention.
Investor state considerations
FTX Digital Markets Ltd, the parent company of FTX, is a Bahamas entity and many investors are questioning if the regulatory authorities of the Bahamas have done enough to prevent the present crisis. The events that happened post collapse unfortunately did not help make things clearer.
Apparently, since the collapse, FTX released a statement stating that their accounts have been frozen by the Bahamian authorities but withdrawals by Bahamas-registered accounts should be allowed. This created a loophole where investors reportedly attempted to seek the help of Bahamians to withdraw funds, including paying owners of Bahamian accounts to withdraw funds, and bribing FTX employees to change the investors’ KYC information to Bahamas. The Securities Commission of the Bahamas later issued a statement to contradict FTX’s statement, noting that the transactions could be unauthorised.
The Bahamas provisional liquidator appointed by the Bahamas Supreme Court has also publicly commented that FTX was not authorized to file for bankruptcy in the U.S., taking the position that the assets of all FTX affiliates fall under the umbrella of FTX Digital Markets Ltd, which is a Bahamian entity and should consequently be administered under Bahamian law.
The actions of States’ regulatory authorities can potentially be challenged by investors by way of investment treaty arbitration, and we frequently advise international investors on matters concerning the actions of regulatory authorities.
Freezing of assets
About USD 650 million worth of cryptoassets was mysteriously hacked and dissipated away from FTX over the past weekend. It is possible with the assistance of forensic onchain analysts to trace the movement of digital assets on the blockchain. It is also possible to obtain worldwide freezing orders against the wallets of these unidentified hackers to try to put a stop to any further dissipation.
There is precedent from the Singapore Courts where freezing orders have been granted against unknown actors (see CLM v CLN and others  SGHC 46). Likewise, the England Courts have recently granted injunctions against hackers of digital assets (see Osbourne v (1) Persons Unknown and (2) Ozone Networks Inc.  EWHC 1021 (Comm)). We have successfully obtained similar orders from the Singapore and English Courts.
Get in touch with us
This article does not constitute legal advice and shall not be relied upon as such. With our 17 offices in across the world, we have a dedicated global digital assets disputes team with substantial experience in working with clients on cryptoassets disputes including disputes arising out of the digital assets and blockchain space, with Shaun Leong, FCIArb in APAC, Chris LaVigne in the United States, Hussein Haeri our investor state disputes specialist, and Eleni Polycarpou and Tatiana Menshenina in Europe. Please get in touch with us if you would like us to share our expertise or to understand in further detail any of the points covered in this piece.