By Alison Frankel

(Reuters) – Federal prosecutors and regulators from the U.S. Securities and Exchange Commission and U.S. Commodity Futures Trading Commission all told a similar story on Tuesday about Sam Bankman-Fried’s alleged scheme to divert billions of dollars of customers’ money from the FTX crypto exchange to Alameda Research LLC.

They all accused Bankman-Fried of fraud, asserting that he repeatedly lied when he insisted that FTX customers’ money was safe, secure and completely segregated from the affiliated but purportedly independent Alameda.

According to the indictment unsealed on Tuesday in federal court in Manhattan and separate complaints filed on Tuesday by the SEC and the CFTC, Bankman-Fried knew or should have known that money was being siphoned from FTX customer accounts to fund Alameda’s speculative trading and that, despite its repeated protestations to the contrary, FTX gave Alameda special trading privileges that ultimately proved disastrous for the platform and its customers.

Who were the victims of this alleged fraud?

The CFTC’s complaint highlighted the deception of FTX users who, in the regulator’s telling, were duped into believing that their money was safe. The Manhattan U.S. Attorney’s indictment also cited FTX customers as the victims of wire fraud and commodities fraud charges against Bankman-Fried.

But the SEC’s lawsuit focused on a different group of alleged victims: the investors that plowed $1.8 billion into FTX in a series of stock purchases between 2019 and 2022. (The 90 U.S.-based FTX shareholders held a $1.1 billion stake, the SEC said.)

Reuters has reported that FTX’s equity investors included such firms as Sequoia Capital, SoftBank Group Corp, BlackRock Inc and Temasek – not exactly small-time crypto customers who wanted to trade on the FTX platform and trusted Bankman-Fried’s promises that their money would be secure.

An important note here: Bankman-Fried’s lawyer, Mark Cohen of Cohen & Gresser, told Reuters on Tuesday that his client is “reviewing the charges with his legal team and considering all of his legal options.” The SEC, meanwhile, did not respond to my query about the framing of its lawsuit.

And to be fair, the SEC’s complaint, as I mentioned, cast FTX customers as victims, too, albeit parenthetically.

I’m being literal: The second sentence of the SEC’s complaint says, “Unbeknownst to those investors (and to FTX’s trading customers), Bankman-Fried was orchestrating a massive, years-long fraud, diverting billions of dollars of the trading platform’s customer funds for his own personal benefit and to help grow his crypto empire.”

My point is that the SEC’s pleading strategy in Tuesday’s lawsuit shows that crypto remains a big challenge for U.S. regulators. An alleged fraudster is accused of misappropriating billions of dollars from customers who wanted to buy and sell crypto, yet the foremost investor protection agency in the United States is not claiming securities fraud on behalf of those customers.

Securities law professor Ann Lipton of Tulane University School of Law said that’s probably because of regulatory uncertainty about which crypto assets meet the definition of a security. (As you know, that question, in turn, is the subject of intense litigation between the SEC and Ripple Labs Inc.)

“The SEC is limited to suing over securities fraud – and that requires the existence of a security,” Lipton said by email. “At the very least, each crypto asset would have to be analyzed individually to determine whether it was a security, which is presumably not feasible for customers who traded many different kinds of assets.”

By focusing instead on the individuals and funds that acquired an equity stake in FTX, Lipton said, “The SEC ducks that issue – those investors certainly bought securities in the form of stock.”

Former Manhattan federal prosecutor Timothy Howard of Freshfields Bruckhaus Deringer agreed: “It’s easier and more straightforward for the SEC to focus on equity investors.”

Unlike private shareholders who sue for securities fraud, the SEC does not have to prove that investors relied on alleged misrepresentations. (The U.S. Justice Department, which has charged Bankman-Fried with defrauding FTX equity investors in addition to FTX customers, similarly does not have to show reliance to prove securities fraud.)

“This greatly eases the SEC’s and DOJ’s prosecutions because it takes off the table all questions associated with the adequacy of investors’ due diligence,” Stanford Law School professor Joseph Grundfest said via email.

Many of the SEC’s allegations involve claims that FTX lied in publicly issued statements and reports on its websites. But, perhaps anticipating arguments from Bankman-Fried that he cannot be liable for general corporate statements, the SEC complaint did cite two instances in which FTX investors were allegedly misled by Bankman-Fried himself.

He gave a U.S. investor who had bought $35 million in FTX shares in July 2021 a document promising that FTX and Alameda did not comingle funds, according to the SEC. And in the late summer of 2021, the complaint alleged, Bankman-Fried told a potential U.S. investor who ultimately acquired a $30 million stake that FTX did not hold its native cryptocurrency, tokens known as FTT.

Bankman-Fried, according to the SEC, knew or should have known that his statement to the investor was false.

Those specific allegations, said Freshfield’s Howard, seem intended to show Bankman-Fried that FTX investors are cooperating with the government – and that he can’t evade liability simply by claiming he wasn’t aware of FTX’s public statements.

Looking way down the road at the potential fallout from FTX’s collapse, I’ll be interested to see if any FTX customers or creditors attempt to pin blame on the equity investors that are cast as victims in Tuesday’s SEC complaint, arguing that their due diligence failures enabled the platform’s subsequent alleged misconduct.

If that happens, it will be even more interesting to see if FTX’s equity investors point to their depiction in the SEC complaint as evidence that they, too, were victimized by Sam Bankman-Fried.

(Editing by Leigh Jones and Himani Sarkar)

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