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How might banks be affected by the Sam Bankman-Fried trial?

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    Bankman-Fried Released on $250 Million Bond in FTX Fraud Case

    Stephanie Keith/Bloomberg


    Penny Crosman (00:04):

    Welcome to the American Banker Podcast. I'm Penny Crosman. The spectacular implosion of the cryptocurrency exchange FTX had repercussions in the banking industry as banks like Silvergate Capital, Farmington State Bank and others that worked with the company were brought down with it. The trial of FTX CEO Sam Bankman-Fried is bringing to light some of the specific ways the company was mismanaged and perhaps committed fraud as the closely watched trial could affect how cryptocurrency and digital assets are regulated going forward and how much banks are allowed to be involved in this industry going forward. We have with us today Seoyoung Kim, department chair and associate professor of finance and business analytics at the Levy School of Business at Santa Clara University. Welcome Seoyoung. 

    Seoyoung Kim (00:54):

    Well, thanks so much for having me, Penny. 

    Penny Crosman (00:56):

    Thank you. So as we tape this podcast, the trial's been going on for about a week and I know you've been following it. What are some of the things that you've learned from the testimony of the first few witnesses? 

    Seoyoung Kim (01:11):

    Well, I first and foremost want to say that it's so unfortunate that this intersects with crypto, but it really isn't a crypto case. So it's throwing shade on an industry that has already had quite a few problems that really aren't crypto related, but are just simple fraud. So in this case, the major players, especially the most recent with Caroline Ellison's testimony, I think that was probably the most damning in terms of setting up the stage to prove that this wasn't simple negligence or ignorance or even any sort of advice of counsel defense. It really is outright fraud if you can prove that Sam Bankman-Fried actually knew that Alameda was funneling actual customer deposits from FTX and using it to make investments or to repay their lenders. The big issue here is that with FTX, FTX isn't an actual bank. 


    So with your commercial bank, we go in and we start a checking account. So that would mean that I literally lend the bank a thousand dollars and with all of the onerous rules and requirements that banks have to follow, they are allowed to take that thousand dollars because it is a loan from me, a very short-term loan, and they can turn around and invest it in other things so that people can buy a home or buy a car or get an education. And FTX is not a chartered bank. So FTX had no right to dip into consumer funds even if you had every intent of paying it back. If I explain what a custodian, a proper custodian is supposed to do as opposed to a chartered bank, if you are purely a custodian. So it would be as though, Penny, if you gave me a hundred dollars to keep in a custodial account for you, let's say that I have to pay $50 for gas and I have every intent of getting a paycheck in two days and topping off your account to be whole again, that is still considered fraud and theft because I am not allowed to commingle and I'm not allowed to draw on the funds that you entrusted in my custody. 


    You didn't lend it to me. I'm holding it for you. So this case really does hinge on did Sam Bankman-Fried know that customer funds from FTX were being used. Even if he had every intent of repaying it as a custodian, you're not allowed to do that. So that's where the various fraud charges come in, the conspiracy to commit fraud. And then there are separate securities fraud and commodities fraud charges in addition to money laundering. So those are the things that he's facing right now in trial and what the bulk of the testimony so far has addressed. 

    Penny Crosman (03:58):

    Well, you mentioned that it's not so much an issue involving cryptocurrency as an issue involving plain and simple fraud. Do you think that they could have hidden these movements of funds between Alameda and FTX as well if cryptocurrency was not involved? In other words, did the use of digital assets help to obfuscate what they were doing? 

    Seoyoung Kim (04:27):

    So the digital assets that were actually transferred from FTX to Alameda, that actually has greater transparency because those kinds of transfers happen what we call in industry, it's called on-chain. So because it's a public blockchain, an on-chain transfer, you can actually trace that back and everyone can see it publicly. Now, any of the fiat money, and when I say fiat money as opposed to cryptocurrency, that would mean any sort of actual currency that's issued by a government. So U.S. dollar or Euros, any fiat money that's wired from FTX to Alameda would have some other type of trail that wouldn't be publicly visible, but under subpoena you would be able to see the money that's being wired from one end to the other. So actually crypto is unique in that everybody can see on a public blockchain without a subpoena. There's far greater transparency for things that happen on-chain. 

    Penny Crosman (05:25):

    What do you think is likely to happen to happen to Sam Bankman-Fried if he is found to have been fully aware and kind of the mastermind of these activities as some of these witnesses are pretty much saying? 

    Seoyoung Kim (05:40):

    It doesn't do him any favors, that people are likening him so much to Bernie Madoff. And the difference here though is I mean both of them are fraudsters. Bernie Madoff took money from people with no intent of actually investing it. It's okay, it would be a simple breach of contract and it wouldn't be a criminal charge, it would just be a civil charge if you take money and you intend to do the right things with it, but then you're unsuccessful. So there's nothing criminal about being unsuccessful or failing at something. But when you take money and claim that you're going to do something and you never had any intent of doing it, or you do something else with the money than what you actually claimed you would do, that's where the fraud charges come and being compared so much to Bernie Madoff, who, well, if we think back to some of the other fraud cases, and this is why I said it's not a crypto case so much. 


    This is just a bad custodian. So I like to repeat hundreds of millions of dollars. Bad custodian, Sam Bankman-Fried FTX billions of dollars, bad custodian, but Bernie Madoff was close to $70 billion bad custodian and he had nothing to do with crypto. But if crypto had existed back then, he would've had his finger in that crypto pie instead of being a simple hedge fund. Now with Bernie Madoff, he was sentenced to far in excess of a hundred years, and with Sam Bankman-Fried with all of the separate charges that he's facing right now and not even talking about the severed charges for campaign finance violations that's supposed to take place next year if he is found guilty and gets the maximum sentence on the charges that he's facing right now during this current trial that is far in excess of a hundred years. But then the question is, will those be concurrent years or consecutive years? 

    Penny Crosman (07:35):

    That sounds like a long time. And what about his former colleagues who are testifying against him and who took plea deals? Are they also going to jail? Do you think 

    Seoyoung Kim (07:47):

    They were facing decades in prison? Well, with one exception, one of the key players who has testified he had immunity, and so Adam Yia, he's not facing any charges and he testified under immunity simply because in his role as a software engineer, he was concerned that in testifying he may have inadvertently or unknowingly have done something as the software engineer who was building the code. The other two, Gary Wang and Carolyn Ellison, they also faced decades on the charges except they took out a plea and they pled guilty early on and they're cooperating. So as fully cooperating witnesses, I'm not sure. They haven't done the sentencing yet and I suspect that the sentencing is going to happen after seeing the extent of their cooperation and to make sure that they do everything that was promised under the plea agreement. 

    Penny Crosman (08:43):

    Sure. Do you, do you suspect that regulators and lawmakers are following this trial and that this could be part of the thinking that goes into new laws about cryptocurrency and new regulations for all industries with regard to custody and other services around cryptocurrency? 

    Seoyoung Kim (09:08):

    Oh, absolutely, and I think I would treat this separately because it really isn't a crypto case. It's a bad custodian. And so it's just like whenever there's a big banking failure or if there's a failure with someone who is just a pure custodian or if there's a failure, a massive failure of a broker dealer, it makes regulators pay attention to say, what happened here? How can we prevent it, and how can we also provide consumer advice so that you don't entrust so much of your wealth to a bad custodian, a bad broker dealer, or a bad commercial bank. 

    Penny Crosman (09:45):

    In your opinion right now, banks are kind of off on digital assets for the most part. There are very few that are actually banking crypto companies and that are offering any kind of services around cryptocurrency. Do you think they'll ever get the old clear to get more involved? 

    Seoyoung Kim (10:09):

    It's on the way there. We already have major financial institutions that have signed on to be custodians of crypto, and recently we're seeing a lot more regulation that's headed in the right direction in terms of putting the right rules and boundaries on something. The scariest time to participate in a particular industry is when there are no rules because you have no idea when the rules come, how onerous they'll be if you'll have been found ex-post to be violating certain things that you didn't know were going to be an issue. So right now there's a lot of interesting litigation that's forcing a lot of crypto issues in terms of how are you going to classify crypto, how are you going to regulate it? People are a lot more sophisticated now in terms of knowing the traceability of on chain activity. And so there are a lot of blockchain analytics firms that help governments in terms of detecting money laundering or other types of fraud that's enacted through crypto. 


    So it's unfortunate that this case intersects with crypto. It really is just a case of a bad custodian and pure fraud, simple dumb fraud, I would say, where you tell someone where I say, if you give me a million dollars, I'm going to build a home for you, and then I'd run away, and I never intended to build the home. We've had people enacting simple dumb fraud since the beginning of time, and that is all that this case is, but it's still throwing some shadow onto crypto just because FTX and Alameda we're both heavily involved in, well, one was a crypto exchange and the other made a lot of crypto investments. 

    Penny Crosman (11:48):

    Sure. And of course, I think Sam Bankman-Fried's argument is that he wasn't intending to be fraudulent. He just didn't understand the rules or was sort of unaware and so forth. So that all has yet to be figured out in court. But he was also quite famously a proponent of effective altruism. This movement that aims to find the best ways to help others. For instance, one way is to make as much money as possible and then give as much of that money away to the charities that you have reason to think we'll do the most good. And sin, Beckman Fried was a proponent of this. He did admit to a reporter that he was kind of doing this for show more than in a heartfelt way, but do you think this whole case has done damage to the reputation and the idea of effective altruism? 

    Seoyoung Kim (12:51):

    Oh, absolutely. And that's another unfortunate part where the idea of effective altruism, it comes from a good place in terms of if you're going to give money to something, you want to have the most impact possible. And so there are ways to look at that analytically and to try to get at what your impact is and getting at what impact is is a very difficult question in terms of if you set up a system in an area that doesn't have access to running water, then how do you quantify exactly how useful that was? Something like that. There's just the general feel that it's obviously useful, but then when it comes to other areas where you would give money to be able to quantify how impactful you were, and that's the heart of effective altruism. And then the ancillary portion of that is in terms of being an effective altruist, the idea is that instead of going and donating your time, right, instead of volunteering, if you have a skill that's hugely valuable to be a true effective altruist, you shouldn't be volunteering your time at a community center. 


    You should be going out and making as much money as possible so that you can go and contribute in a way that's more effective. Now, the idea behind that is, well, it hasn't killed the movement, but people are going to be a lot more skeptical of this idea of effective altruism are the people who are involved or who are so-called defective altruists. Now, there's a shadow hanging over their heads as well in terms of people don't trust anymore, that your idea of if you have a skill that can make money, you should go out and make as much money as possible rather than donate your time so that you can be more effective in your donations. Now, I mean, at least in this case with Sam Bateman Freed, it wasn't effective altruism if you were taking other people's money to invest it and donate it. 

    Penny Crosman (14:51):

    I guess the movement doesn't really put forward that idea as it should not. Do you think it's been affected so far? 

    Seoyoung Kim (15:00):

    A lot of people are very skeptical of many effective altruists. There was skepticism already, and I think now with what's happened with FTX, Sam Bankman-Fried was such a huge face for effective altruism, and the idea of someone going and making billions of dollars and driving it was either a Toyota or a Honda Civic, which Carolyn Ellison's testimony also said that that was part of his image in terms of he wanted to project that image of he's going to go make lots of money and then donate it so he could be a true effective altruist. But once you have such a big face for it and people start to get excited, more and more excited, a lot of people weren't aware of the term effective altruism until Sam Bateman freed hit the scene and was on covers of all sorts of magazines, hobnobbing with a lot of celebrities and politicians, and now I think that because he was a face for it, it's unfortunate that now crypto and effective altruism are kind of entangled in this, where this case also doesn't have anything to do with effective altruism. The movement has nothing. The movement is not intended for you to steal money from other people, so you can give it away. It's not the Robinhood movement that was never the heart of effective altruism. 

    Penny Crosman (16:18):

    Yeah, that makes sense. Well, so young, thank you so much for coming and sharing your thoughts about this trial. It truly is fascinating, and I am very eager to see what the outcomes are. 

    Seoyoung Kim (16:33):

    Thanks so much for having me, Penny. And you're not alone. A lot of people are watching this and very, very eager to see what comes at the end, especially when Stan Bateman free takes the stand if he chooses to. 

    Penny Crosman (16:44):

    Yes, exactly. Thank you all for listening to the American Banker Podcast. I produced this episode with audio production by Wen-Wyst Jeanmary. Special thanks this week to Seoyoung Kim at Santa Clara University. Rate us, review us and subscribe to our content at www.americanbanker.com/subscribe. From American Banker, I'm Penny Crosman, and thanks for listening.

    Executive Editor, Technology at Arizent, American Banker


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