Barely Legal
Fraud
With as much as we discuss fraud and fraudsters in these pages, legally it can be a term as slippery as those who stand accused? What is fraud? By a standard legal definition it is intentional deception or theft, when the perpetrator knows what they are doing is wrong. It is not only deceitful but willful practice to deprive someone of something or do them harm. By the SEC’s definition, fraud can include behavior by companies or their executives, people saying or doing things that alter a stock price and therefore deprive someone of their market gains or whatever.
In the last few weeks fraud has been talked about a lot in the news, but in different contexts. Let’s examine a few!
FTX
The burning question in FTX’s meltdown that will undoubtedly end up in many a legal analysis is: did SBF do fraud? Was the collapse of the crypto exchange and its associated hedge fund willful theft and deception or was it just, you know, a bunch of twenty-somethings running a multibillion dollar financial firm via some shared spreadsheets and Slack emojis?
With or without the blessing of his legal team, SBF has been on a media tour, attempting to convince the public and perhaps more importantly various law enforcement and regulatory agencies that FTX was not a fraud and merely a series of bad decisions made in good faith. It is not unusual for a disgraced CEO to attempt to tell his side of a story, but it seems SBF is everywhere, talking to everyone, and the media seem happy to oblige. Despite hours of transcripts, and piles of apologies and excuses, it remains unclear what SBF’s true motives were, because of course only he knows them.
But what actually happened? Here is one thing the now-CEO of FTX (a court-appointed bankruptcy CEO whose job it is to unwind the company) said:
[John] Ray, who also handled Enron's bankruptcy, said FTX is full of "inexperienced" executives and demonstrates a "complete failure of corporate controls."
Which, I mean, yes, sure. SBF was famous for wearing only shorts and playing video games (poorly) during meetings. It was kind of FTX’s whole thing that they were a bunch of crazy young finance geniuses who didn’t play by industry rules. Why would they have corporate controls? However, nothing in Ray’s statement implies intent, which may be because his job is only to unwind the company’s finances and not pass judgement on any fraud that may or may not have taken place.
Another thing Ray said in that same court filing was that FTX didn’t have an accounting department which yikes yikes yikes:
John Ray III said that FTX's lack of an in-house accounting team meant that it was now struggling to provide him with reliable financial statements as he oversees the group's restructuring as its new chief executive.
We talked a couple weeks ago about how FTX didn’t have a board of directors either, which might have included a few investors who would have perhaps insisted the company hire an accountant or two. But, despite a lack of any boring finance-y controls in place, investors gave FTX $900 million dollars with nearly no strings attached. Did they do so under false pretenses, really? Did anyone in any of the investor meetings say hey SBF, can we talk to your accounting department? Of course not, that is not how VC works. Investors overlooked the many lapses in FTX like they overlooked them at WeWork, Uber, etc. They were charmed by the same persona SBF is trying to use right now to avoid public humiliation and criminal indictment.
What about the depositors, the people (and firms) who invested their crypto or dollar assets with FTX? We can assume FTX had the standard terms of service saying they were not liable for market fluctuations, etc because they did have a legal team even if they didn’t have accountants - someone had to set up the 190+ offshore LLCs. Is it fraud to say if you deposit money we’re going to invest it in magic beans for you, oh wait sorry all the beans we traded for different beans are now worthless? Isn’t that standard - maybe not standard, but crypto standard - investment risk? If you give a hedge fund money to invest and they make a bad bet, that isn’t fraud, right?
The question might seem to be: what did depositors think FTX was doing with their money? Or, more accurately, what did FTX’s lawyers say the company was doing with their money? A central issue in the inevitable FTX lawsuit(s) and trial(s) is going to be SBF sending FTX ‘customer’ funds to his hedge fund Alameda to cover trading losses because that would be fraud if a bank or investment firm did it. But! Was FTX ever claiming depositor funds were safe? Did it have the same fiduciary responsibility a big bank does? Do all these arguments sound completely specious? Yes, of course, but those of us deranged enough to read court transcripts in fraud cases will be familiar with these arguments - they’re the same ones FTX’s defense lawyers are going to make. If consumers thought FTX was a bank and invested accordingly, that’s not necessarily FTX’s fault, and FTX will point to its lengthy ToS saying customers might incur investment losses. Hedge funds giving FTX money might have had different agreements, but surely FTX’s lawyers wrote the possibility of loss into those as well. Right?
Really, of course, this is all academic. In the US you can sue any company that does any thing you don’t like and say it’s fraud, especially when you’ve suffered losses to the degree which many of FTX’s largest creditors claim. Prosecutors can charge SBF with fraud because he seems incapable of not Tweeting, and publicly saying as many words as possible about what may or may not have happened, all of which will be admissible in court. His ignorance/general incompetence defense might not convince a jury - billions of dollars are gone, there were no accountants or directors, the company allegedly kept two sets of books, SBF and his fellow execs led lavish lifestyles, etc. It sounds exactly like every other crypto rug pull, the sole difference being SBF is still in the public eye, still talking to Bloomberg and the New York Times and honestly anyone who will interview him, claiming it was all a big mistake and not fraud, nope not at all. At a certain point, does it really matter? If everyone feels defrauded and some lawyers think what you did could possibly be fraud - even if it really was incompetence! - the outcome may be the same. Is fraud just vibes?
In closing, I feel I must include this amazing excerpt from the NYT:
In May, a flood of sell orders for TerraUSD overwhelmed the market for the digital currency and depressed the price of Luna. The markets for the two coins eventually collapsed.
The bulk of the TerraUSD sell orders appeared to come from one place, according to The Times: S.B.F.’s trading firm, Alameda, which had also bet against Luna. If things had gone as expected, Alameda would have reaped a huge profit.
But the trade may have been S.B.F.’s undoing. The two coins’ meltdown unleashed wider chaos within crypto, including at Alameda. The firm, facing billions’ worth of loans being called in, used customer money at FTX to cover the payments. When FTX customers, worried about the exchange’s health, began rushing to withdraw their money, the company was unable to meet their demands and collapsed.
Wow. Just, wow. There is something poetic about SBF attempting to tank the TerraUSD token in what he believed was a clever short position, filling Alameda’s rapidly emptying coffers. In doing so, he tanked the project entirely, which worsened his losses, which he (allegedly!) may have used FTX customer funds to cover. By exposing one crypto empire built on shaky claims, SBF tugged at the thread that unraveled his own.
If you believe, as some do, that the entire crypto industry is a bunch of people attempting to rip one another off, hoping they won’t be standing when the music stops, the FTX debacle makes perfect sense. SBF can do all the interviews he wants, but nothing short of finding $8 billion in the couch cushions is going to stop people from calling him a fraudster.
Trump Organization
SBF may be staring down one or more criminal fraud trials holding him personally accountable for his actions, but one guy who is not is Donald Trump. However! This week, two of his companies were found guilty on 17 counts of fraud by a New York jury:
Two subsidiaries of the Trump Organization were convicted Tuesday by a jury in New York City of multiple crimes, including tax fraud, falsifying business records and conspiracy.
Basically, Trump’s companies - not Trump, the guy who owns them - paid lavish benefits to their top executives in ways that evaded business and personal taxes. Trump’s CFO Allen Weisselberg, who is still employed by the Trump Org, pleaded guilty to 15 felony charges related to millions in illegal benefits and agreed to testify in the case.
So the guy who literally signs the checks - including the fraud ones - was not named as a defendant but his companies were, and the companies were criminally convicted, and now they have to pay a fine. Weisselberg will probably serve a brief jail sentence for his cooperation, even though he refused to admit under oath that Trump was personally involved. Seems good!
It was undoubtedly obvious to everyone in the courtroom and anyone who’s familiar with Trump’s management style that he was not only involved but the architect of the schemes - there is no way he would allow his executives to line their pockets at his expense, without his explicit permission. Yet, because prosecutors felt they could not win in court against the former president, we got a philosophical experiment in whether a corporation can be guilty of yearslong systemic fraud if the person running it is somehow entirely unawares.
This gets at the difficulty of proving intent - by allowing Weisselberg to plead out without implicating Trump, prosecutors gave away the strongest card in their hand. But it would have been Weisselberg’s word against his boss’s, unless he’d recorded or saved some form of conclusive proof. It’s not that fraud is necessarily a difficult thing to define in court, but it can be difficult to prove if opposing lawyers successfully muddy the waters of intent. Who knew what, and when, and why? Those questions can stymie a jury room.
So will this harm Trump or the Trump Org in any way? I don’t know. Here is an article citing a bunch of law professors saying the conviction will make life very difficult for Trump’s companies because it may trigger covenants with their banks and lenders:
"A criminal conviction will impact the ability to get licenses, to borrow money, to get insurance, to do business with anyone," said Cornell University law professor Randy Zelin. "Who wants to lend money to or insure a convicted felon organization? There will be statutory disqualifications because of the convictions."
Trump’s businesses lean heavily on debt and financing to operate, and if he lost lucrative branding partnerships due to the conviction it could damage his bottom line, sure. I am still a bit…skeptical:
To be sure, the Trump Organization could turn to nontraditional lenders if it encounters roadblocks with domestic banks and other lenders, legal experts said. For instance, the business could tap lenders in other countries, such as Saudi Arabia, which may have more flexibility or willingness to lend to a company tarnished by a criminal conviction.
Right, yes, the shady foreign governments and banks with whom Trump has spent years nurturing relationships might come to his aid, since he remains popular despite or due to his profligate criminality. He is also running for president again, of course, giving him a fresh batch of favors to promise potential benefactors.
The conviction does help the New York AG’s civil case against Trump and his children personally, which could potentially bring an end to his most lucrative ventures in New York and elsewhere, but that case could take years to wind through the courts. It is a little ironic that the public figure most honest about his dishonesty and flagrant disregard for the law may prove the most difficult to pin down in court.
Theranos
This week Theranos COO Sunny Balwani was sentenced to 13 years in prison. He was found guilty on all 12 charges the government brought against him - you may recall his co-conspirator Elizabeth Holmes was only found guilty on four of eleven and received an 11 year sentence. The premium of the founder’s myth is apparently 2 less years behind bars.
Despite a bizarre side drama surrounding Holmes and her trial, we can finally(!) say that both the architects of the Theranos fraud will soon be behind bars. Is it satisfying? I don’t know, really. After years of drama, podcasts, and television shows the whole thing feels as though it’s been picked clean by the content vultures.
However! Unlike Trump who is careful not to put his frauds in writing or SBF who was too incompetent to keep a clear record of his, Holmes and Balwani faced significant evidence they knew about the problems with Theranos’s tests and intentionally misled investors about the company. And while it may be morally satisfying that they mostly stole money from the worst people on the planet, their inaccurate tests did harm countless lives of patients who thought they had serious illnesses or miscarried a pregnancy.
With Theranos, the fraud was obvious and ran two ways - they lied to investors about their technology and covered up its failures, and they gaslit patients and doctors who questioned the faulty results. I guess if there’s anything we can learn from this winter’s fraud news it is -
don’t document your fraud
don’t make claims that are provably false
if you do get caught, either bribe everyone who can implicate you or fail to hire anyone who could have documented your malfeasance.
I hope this has been instructive.
Short Cons
Gizmodo - “The European Union reportedly built a nearly $400,000 digital metaverse, and only 6 people showed up to the gala celebrating it. On Tuesday night, journalist Vincent Chadwick went to the party and found his virtual avatar almost entirely alone.”
The Hill - “The 2022 Florida gerrymander alone appears to have delivered the House majority — not to mention aggressive GOP gerrymanders in red states such as Alabama, Louisiana, Ohio, Texas and others.”
NYT - “But once Mr. Musk took over the company, he refused to reimburse travel vendors for those bills, current and former Twitter employees said. Mr. Musk’s staff said the services were authorized by the company’s former management and not by him.”
NYT - “Soon, in a crucial reversal, sports leagues overcame their antipathy toward gambling, which they came to see as a way to keep increasingly distracted audiences tuned in. Casino companies also hopped on board.”
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