Stoltmann Law Offices is investigating cases where financial advisors have recommended cryptocurrencies or dealt with the now-bankrupt firm FTX. The failed cryptocurrency firm FTX continues to dominate the business news headlines. With a recent development that the company may have used customers’ funds to finance risky investment bets, regulators such as the U.S. Securities and Exchange Commission are probing the company. As of this writing FTX’s CEO, Sam Bankman-Fried has been indicted for fraud, and his two closest associates at FTX and Alameda Research have “flipped” and agreed to plead guilty.
According to The Wall Street Journal, “FTX lent billions of dollars worth of customer assets to fund risky bets by its affiliated trading firm, Alameda Research, setting the stage for the exchange’s implosion, a person familiar with the matter said.” Not surprisingly, the FTX failure, which has buffeted most of the cryptocurrency industry, has triggered a wave of investigations by nearly all U.S. market regulators.
FTX Chief Executive Sam Bankman-Fried said in investor meetings that “Alameda owes FTX about $10 billion. FTX extended loans to Alameda using money that customers had deposited on the exchange for trading purposes, a decision that Mr. Bankman-Fried described as a poor judgment call,” The Wall Street Journal reported. All told, FTX had an estimated $16 billion in customer assets, which means FTX “lent more than half of its customer funds to its sister company Alameda.”
Not only is the SEC and other industry watchdogs looking into the potentially illegal use of customer funds, FTX client withdrawals are being blocked. The Securities Commission of the Bahamas has frozen the assets of FTX sister company Digital Markets Limited. BlockFi, a company connected to FTX that has filed for bankruptcy, also halted withdrawals.
How big is the FTX debacle for individual investors? Treasury Secretary Janet Yellen compared the crypto firm’s crash to the failure of Lehman Brothers in 2008. “It’s a Lehman moment within crypto, and crypto was big enough that you’ve had substantial harm of investors, and particularly people who aren’t very well informed about the risks that they’re undertaking,” she said last week. Yellen said a few weeks ago that the collapse of FTX supported her view that the cryptocurrency market requires “very careful regulation. I have been skeptical, and I remain quite skeptical,” she said.
When firms commingle customer funds with risky outside unauthorized investments, they are violating the law. The Commodity Futures Trading Commission, for example, fined brokerage MF Global $100 million in 2013 for misuse of customer funds during its collapse two years earlier—a meltdown driven by managers’ ultra-risky investing. MF Global customers were ultimately compensated after a bankruptcy process.
Under federal industry rules, firms must keep customer assets segregated from other company activities. Trading and brokerage firms can’t make investment bets without the explicit permission and disclosure of clients. Indeed, a specific rule by Finra, the federal securities industry regulator, is quite clear that broker-advisers keep customer funds in separate accounts.
“Firms are obligated to maintain custody of customer securities and safeguard customer cash by segregating these assets from the firm’s proprietary business activities, and promptly deliver to their owner upon request,” a Finra rule states. “Firms can satisfy this requirement by either keeping customer funds and securities in their physical possession, or in a good control location that allows the firm to direct their movement (e.g., a clearing corporation).”
Moreover, securities or advisory firms must have systems in place to protect client funds. That means rigorous recordkeeping and supervision of broker-advisors. Brokerage firms also have a legal obligation to supervise and monitor their brokers to ensure that they are not overtrading or “churning” accounts to generate excess fees and commissions.
If you invested with a financial advisor and lost money as a result, you may have a claim to pursue through FINRA Arbitration. Please contact Stoltmann Law Offices, P.C. at 312-332-4200 for a free, no obligation consultation with a securities attorney. Stoltmann Law Offices is a contingency fee law firm which means we do not get paid until you do!