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SBF Trial: What Did FTX’s Terms of Service Say About Customer Funds?

Phase one of the trial was exciting. Former FTX exchange insiders told a jury that Sam Bankman-Fried had directed them to let his hedge fund Alameda “borrow” billions of dollars from exchange customers in a secret arrangement facilitated through internal backdoors and hidden behind falsified documents.

We seem to be moving into phase two now, with witnesses who played secondary roles in this massive alleged fraud. Friday’s testimony from BlockFi CEO Zac Prince was important but dare I say almost boring. He and other upcoming witnesses are not likely privy to salacious details like “Sam told me to commit crimes.” There are two exceptions, which I’ll get to below, but our next few witnesses are customers, an FBI agent and an Alameda employee who may or may have also been an FTX US human resources employee(?).

So let’s talk about the defense again instead. We’re still waiting for the defense’s strategy to become clear. We’ve gotten hints, as Axios’ Crystal Kim points outA filing last week suggests the defense wants to get back to the argument that Bankman-Fried did not technically commit wire fraud because FTX’s terms of service were worded in such a way that there's no case to argue funds were misappropriated.

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We’ve heard this argument a few times already from the defense team, so I dug into what the terms of service actually said.

First off: Judge Lewis Kaplan, who’s overseeing the case, has already rejected one proposed defense witness, English barrister (basically British for “”) Lawrence Akka, from offering testimony because the defense wanted this individual to explain the English laws governing FTX’s terms to the jury, and explaining the law to the jury is the judge’s job.

In its new filing, the defense team continues to argue that FTX’s relationship with its customers “was governed by its terms of service,” and so “the question of whether Alameda’s use of customer fiat deposits was permissible within the scope of that relationship – and, thus, whether a theft of property occurred – is governed by foreign law,” at least with regard to counts one and three of the indictment (referring to the actual wire fraud, i.e. substantive, charges).

“It is the defense’s position that the rights and obligations of parties to a commercial relationship are not established by their expectations and understandings for purposes of the misappropriation theory of the federal fraud statutes,” the defense’s Oct. 12 went on to say.

So I dug up a PDF of FTX’s terms of service from May 2022.

According to that document, section 8.2.6, which governs FTX customers’ digital assets, holds that the “title to your digital assets shall at all times remain with you and shall not transfer to FTX trading.” While customers can’t blame FTX for loss in value due to price fluctuations, that’s not what the DOJ is alleging here.

“None of the digital assets in your account are the property of, or shall or may be loans to, FTX Trading; FTX Trading does not represent or treat Digital Assets in the User’s Accounts as belonging to FTX Trading,” section 8.2.6 (B) said.

I didn’t see the part of the DOJ filing which highlighted this section, but this section seems to contradict what the defense team is claiming in its Oct. 12 letter.

Then I took a look at the defense’s Sept. 11 letter arguing it should be able to call up Akka to explain the meaning of the terms under English law.

That letter made it clear that in the defense’s view, the DOJ is “relying on certain provisions in FTX’s terms of service,” suggesting there are other provisions that do undermine the misappropriation claim.

The Sept. 11 letter referenced a Sept. 1 filing asking for permission to introduce the entire terms as an exhibit (as opposed to just section 8.2), which in turn seemed to suggest that the question of misappropriation goes strictly to how FTX used customer fiat currency (emphasis mine).

“Among other things, the Terms of Service are relevant to whether FTX’s or Alameda’s use of customer fiat currency was inconsistent with representations to customers in the document itself and rights and obligations it sets forth regarding customer assets – and thus to whether there was any actual fraud or ‘misappropriation’ of customer funds,” the Sept. 1 filing said.

And sure enough, the “fiat currency” section of the terms of service, 8.3, is much more vague about how FTX held customer funds. FTX said it may convert fiat deposits into “e-money,” which the terms describe as a sort of internal accounting tool.

There are no clauses in this section addressing how FTX might hold customer deposits, unlike the digital assets section.

But is the DOJ only alleging that FTX stole customers’ fiat funds? No. It’s not. Assistant U.S. Attorney Thane Rehn, in his opening statement, told the jury that Bankman-Fried let Alameda withdraw FTX customers’ crypto (emphasis still mine).

“Using Alameda, the defendant withdrew billions of dollars worth of customer crypto out of the FTX digital wallet and into Alameda's digital wallet that he owned and controlled,” he alleged.

Unsurprisingly, the DOJ disagrees with the defense’s Oct. 12 argument. In its own filing, which seems to have dropped late Friday (Oct. 13), prosecutors say that “misappropriation occurs when a party breaches a ‘fiduciary duty.’” Prosecutors have already spent the early days of the trial pointing out that Bankman-Fried, through advertisements (including the infamous Super Bowl ad with Larry David) and other public appearances, said FTX was a safe and “trusted way to buy and sell” cryptocurrencies.

The DOJ filing also said “the defendant is simply wrong” that prosecutors are just arguing misappropriation. They’re also alleging Bankman-Fried made “material misrepresentations and omissions.”

If any lawyers know what I'm missing in the defense’s argument, please let me know.

The DOJ's Oct. 13 filing, interestingly, did not bring up the whole English law question, though prosecutors did express their opposition to that argument in a late August filing. At the time, the DOJ said that “framing the issue as a dichotomy” between the terms of service and other legal structures may be misleading for the jury.

Speaking of FTX’s terms of service, it’s maybe worth highlighting that on page one, the document said, “Affiliates of FTX Trading may execute trades on the Platform provided, however, that such Affiliates shall not be afforded any priority in trade execution.”

Former FTX Chief Technology Officer Gary Wang told the court that Alameda Research “had the ability to place orders slightly faster than other accounts.”

There is also a section on page 22 where the terms say “nothing in the terms shall limit or exclude a party’s liability … for fraud or fraudulent misrepresentation."

Which, sure, good detail.

Courtroom scenes

  • Sam Bankman-Fried spent most of Friday’s session working on his air-gapped laptop, as usual.
  • Zac Prince gave very lengthy answers to Assistant U.S. Attorney Nicholas Roos and defense counsel Mark Cohen, going well beyond the questions asked. He seemed almost defensive at points during Cohen’s cross-examination, when asked about BlockFi’s processes that led to its exposure to FTX and Alameda, telling the court that he was a part of the decision-making when it came to BlockFi’s loans to Alameda.
  • The court has set up overflow rooms when there are more reporters and members of the public than the 20 or so available seats in the courtroom. The court needed two overflow rooms on Wednesday. There was only one on Thursday but it was practically standing room only. ? Tons of space left over. A court security officer even asked if any reporters or members of the public wanted to enter the main courtroom.

What we're expecting

Prosecutors told Judge Lewis Kaplan on Friday that they expect to wrap up their case by Oct. 26, allowing the defense to begin (if it plans to present a case) by that Thursday afternoon. In practical terms, this means the DOJ believes its remaining witnesses will take 4.5 days to testify (reminder: there is no trial on Oct. 20, 23, 24 or 25). Note that the defense has also requested to adjourn the Tuesday, Oct. 17 hearing to deal with an issue relating to Bankman-Fried’s prescription medication.

The list of upcoming witnesses includes FTX customers Elan Dekel and Tareq Morad, former Alameda Research employee Delaney Ornelas, former FTX head of product and investor relations Ramnik Arora, former FTX director of engineering Nishad Singh and FBI agent Richard Busick. Singh and Arora are probably the most anticipated remaining witnesses. Arora likely had a key role in working with some of the investors in FTX and Alameda. It wouldn't surprise me if he's the second of the two witnesses testifying under a grant of immunity (the identity of first, former FTX developer FTX developer Adam Yedidia, was revealed the week before last). Singh, of course, is another FTX inner circle member who pleaded guilty to crimes tied to the exchange, and has emerged as a central figure in both Gary Wang’s and Caroline Ellison's testimonies as someone who communicated vital information.

Prosecutors have not yet mentioned their proposed expert witnesses Peter Easton or Andrea van der Merwe, and we haven’t heard anything more on the proposed Ukrainian FTX customer who was at dispute earlier.

Edited by Marc Hochstein.

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 10/17/2023

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