Forbes: Why are FTX creditors still not satisfied after receiving full compensation?

Original article by Nina Bambysheva, Forbes

Original translation: Luffy, Foresight News

Last month, lawyers overseeing FTXs bankruptcy case submitted a reorganization plan that would not only fully compensate almost all customers but also give them an additional 18% interest. If most creditors and the bankruptcy judge agree to the plan, checks for compensation will be mailed within two months.

The amount of compensation paid by FTX is a considerable sum, as is typical in bankruptcy cases. Few creditors have been paid in cash, and some have had to wait years to recover a small portion of their claims. FTX creditors are among the lucky ones, but not everyone is ecstatic.

Some are upset because they can’t get their original cryptocurrency back from the exchange. Instead, customers will be compensated in U.S. dollars based on the value of the cryptocurrency they held when FTX filed for bankruptcy in November 2022, when cryptocurrency prices were hit by industry chaos. Since then, Bitcoin has nearly tripled and many other tokens have hit new highs. For investors whose cryptocurrency was trapped on the exchange, it’s a lost opportunity. Many lawyers (including those working for the current FTX) believe that this is how bankruptcy works, but creditors unanimously claim that they were wrongly deprived of their property, and that’s not the only thing they are upset about.

They say FTX, which is currently led by John J. Ray III and represented by a number of law and financial firms, has failed to maximize the value of the company and ignored the interests of former customers and other creditors. Sullivan Cromwell, the lead law firm currently representing FTX and its pre-bankruptcy legal counsel, has been the subject of numerous complaints.

Arush Sehgal, a representative of the Special Committee of FTX Customers (CAHC, which is made up of more than 1,700 of FTX’s former customers), summed up the frustration: FTX “is promoting a narrative that everyone is being fully compensated with interest, but the reality is that they valued some FTX assets at zero. By our estimates, they misvalued $10-16 billion in assets. As long as John Ray retains unilateral power and there are no creditors on the board, there is no credibility in this plan.”

Some of the main issues are summarized below, along with FTX’s detailed responses:

1. Creditors accuse FTX of selling some assets at low prices

a) Take the crypto derivatives platform Ledger X, for example, which was acquired by FTX founder Sam Bankman-Fried for nearly $300 million in October 2021. In May 2023, the entity was sold to an affiliate of Miami International Holdings, which operates several options exchanges in the United States, for $48.8 million, a price far below its net assets as of December 31, 2022 (then $98.8 million), according to financial statements audited by Grant Thornton in March 2023.

In a class action lawsuit filed against Sullivan Cromwell in February 2024, a group of FTX investors also claimed that the attorneys deliberately excluded FTX US Derivatives (formerly LedgerX) from the FTX bankruptcy proceedings because they knew that the company held approximately $250 million in FTX customer funds from which it could (and did) extract significant revenue. The lawsuit alleges that Sullivan Cromwell participated in the fraud that ultimately led to FTXs collapse, thanks to their connections before the bankruptcy filing. FTX could not have pulled off a fraud of this magnitude alone, the complaint reads. Sullivan Cromwells vast resources, relationships with regulators, expertise, and assistance were essential to carrying out the scheme.

In a report released on May 28, Robert J. Cleary, an independent examiner in the FTX case and a former federal prosecutor, defended the bankrupt FTX company (i.e., the debtor), but recommended further investigation into two pre-bankruptcy transactions involving Sullivan Cromwell: Bankman-Fried’s purchase of a stake in Robinhood and the acquisition of LedgerX.

Like most responses, FTX referred to the report: An independent examiner appointed by the court had investigated and reported on the issue. He found that the SC did not make any final decisions regarding which entities would file for bankruptcy and that John Ray and the directors made the final decisions. … At the time of the filing, Ray believed that LedgerX was solvent… The examiner did not see any evidence that the decision to exclude LedgerX from the bankruptcy filing was problematic.

The examiner found that “the debtor received six non-binding letters of intent” but only two actual bids, at $35 million and $14 million. The debtor negotiated a higher final sale price of approximately $50 million, and “the agreement (1) was approved by the debtor’s board of directors, (2) was subject to stakeholder review and feedback (no objections were received), (3) was subject to an auction process to allow for the submission of higher or superior bids, and (4) was approved by the court,” based on undisputed “evidence that the sales transactions were ‘highest or best bids.’” The examiner found that the sale price was lower than the purchase price, indicating that FTX overpaid for LedgerX in October 2021, and that claims against certain original sellers should be investigated.

b) The dollar value of the millions of SOL tokens owned by FTX has grown more than fivefold since the exchange filed for bankruptcy, with the tokens sold at deep discounts to a number of large cryptocurrency firms and hedge funds, including billionaire Mike Novogratz’s Galaxy Digital, which helped FTX orchestrate the sale. Most of the tokens are locked up under a multi-year vesting schedule, but Kavuri and others claim the sales hurt creditors. Firms like Galaxy Digital stand to reap billions of dollars in profits from their opportunistic purchases.

In April 2023, FTX sold its stake in Sui blockchain developer Mysten Labs for $96 million, $5 million less than its initial investment. It also sold warrants for 890 million SUI tokens, which would be exercised after the platform launched. The following month, these tokens entered the market and quickly soared to over $1, meaning that FTXs initial investment was worth nearly $1 billion.

“A brief review of SUI’s secondary market reveals that selling tokens at a discount prior to a public offering does not maximize profits. Furthermore, it raises questions about whether FTX’s estate was simply sloppy or negligent in its approach,” Rob Hadick, general partner at crypto-focused venture capital firm Dragonfly, wrote in a statement shared with Forbes.

FTX Response: The debtor, the bankruptcy court, and its advisors approved the sale of tokens before the tokens were issued. Token trading prices are often initially high but fall sharply within a few months and have been very volatile since issuance. Certain tokens may be extremely illiquid and volatile, without any fundamentals driving trading prices. While short-term or long-term assets will experience extreme price fluctuations and thus attract those willing to gamble, FTX Assets is not a hedge fund, long-term investor, or gambler. In addition, the auction tokens have a 4-year lock-up period. Due to this vesting period, the locked tokens are sold at a price far below the market price.

2. FTX 2.0

Creditors claim that FTX could have received hundreds of millions of dollars in additional value if it had decided to restart its trading platform, which was one of the largest in the world before its collapse.

“Among our group of over 1,600 creditors with claims valued at nearly $1 billion, we conducted a survey and received commitments of $200 million to $300 million from creditors willing to convert their claims into equity in the new FTX (FTX 2.0). If the debtors allow FTX 2.0 and the debt-to-equity swap, everyone’s compensation will increase by 3%. The simple fact that John Ray gave up on restarting FTX is bad for all creditors,” said Sehgal, a member of the ad hoc customer committee.

But Dragonfly’s Hadick is skeptical, citing FTX’s relationship with hedge fund Alameda Research, which is owned by Bankman-Fried: “The exchange technology itself doesn’t have much value. It works well largely because they have an agreement with Alameda Research, which acts as an internal market maker and operates at a loss to provide a better experience to FTX traders. This obviously won’t exist in the relaunched FTX,” he said. “If you can retain your customers when the exchange relaunches, then the customer base has value, but it’s reasonable to expect a lot of churn, and the valuation of the new exchange depends largely on user retention.”

Despite this, several companies expressed interest in acquiring the exchange last year, including Bullish, a cryptocurrency exchange run by former New York Stock Exchange president Tom Farley, fintech startup Figure Technologies and private investment firm Proof Group.

FTX’s response refers to the disclosure statement released with its reorganization plan (pages 45-49): Restart plans were exhaustively considered and rejected only when it became clear that they would not work. In a process designed with the official committee of creditors and supervised by the U.S. Bankruptcy Court, the debtors contacted dozens of investors. Every investor who conducted due diligence came to the same conclusion: the offshore exchange’s operating system was flawed. The exchange did not have adequate custody, security, and financial reporting arrangements, nor did it have reconciliations between customer “positions” and the actual underlying assets. Bankman-Fried left behind a mess, and the problems with FTX’s business are described in part in the docket for both the Chapter 11 case and the criminal trial. After an exhaustive investigation process, no investor was willing to spend the time and money necessary to build these systems and rehabilitate the offshore exchange. The trustee for the estate and its creditors also explored selling the offshore exchange business to a third-party operator or even merging it with another exchange. In each case, no serious investor was willing to make a substantial offer after weighing the costs, delays, and other factors. We did not even receive meaningful bids for any of the intellectual property because the code was outdated and the brand was synonymous with fraud. … The fairest thing we can do is to prioritize returning as much cash as possible to the victims so they can decide for themselves what to do with it.

3. Unpursued Claims

FTX may have filed claims against other cryptocurrency entities. The most obvious example pointed to by creditors is Binance. Bankman-Fried spent $2.1 billion worth of FTT (FTXs token) and stablecoins to buy back equity from its early investors, which played a major role in FTXs collapse. In early November 2022, Binance founder and former CEO Changpeng Zhao posted a series of posts on social media suggesting that FTX had liquidity problems, which exacerbated panic among cryptocurrency investors.

FTX responded: The order and timing of the debtors investigation and litigation are based on a variety of considerations, and the law provides for a long period of time for such litigation. The debtor has not yet made a final decision on matters related to Binance.

IV. Objections to the Restructuring Plan

a) According to recent documents, FTX has reached a settlement with the U.S. government for $885 million over tax liabilities filed by the IRS. Of this, $200 million will be considered a priority claim and paid within 60 days of the effective date of the settlement. The remaining $685 million will be paid within the availability of funds. This is a significant reduction from the more than $44 billion initially requested by the IRS (later revised to $24 billion), but the Special Committee of Customers questioned the validity of the U.S. governments claims and believed that it was unfair that customers of the Bahamas-based international exchange had to pay U.S. taxes without using a U.S. platform to trade.

FTX Response: Income tax withholding is governed by applicable tax laws, which provide for certain exemptions from reporting and withholding. If such exemptions apply, no tax withholding will occur.

b) The debtors are proposing to pay creditors cash via check or wire transfer. “They are actually making it more difficult for FTX customers to recover their funds,” said Sunil Kavuri, another FTX creditor, noting that the claims portal FTX set up for creditors is difficult to navigate and lacks flexibility for customers from jurisdictions with limited banking services or no reliable mail. An additional clause in FTX’s plan states that claims may be denied if any subsequent KYC or withholding tax requirements are not met.

FTXs response: The debtor is currently discussing with various parties the possibility of acting as a distribution agent and is exploring different distribution options, including cash or stablecoins. Customers who have not prioritized withdrawing funds from the exchange do not have to worry.

c) “The current draft plan includes a governance structure that gives the debtors broad, sweeping, and unilateral powers, in addition to retaining John Ray and a board of directors that is not subject to oversight by any creditors,” bankruptcy expert and FTX creditor advocate X user Mr. Purple wrote in a letter to Forbes.

FTX Response: The bankruptcy court order confirming the plan requires that the plan be administered in accordance with its terms or as otherwise provided by the court order. During the post-confirmation period, the U.S. Bankruptcy Court will continue to exercise overall supervision over the bankruptcy estate.

In addition to these issues, the Special Committee of Customers filed an objection to an FTX disclosure statement on June 5, calling the plan “legally unverifiable” citing inconsistencies, omissions of material information, and inadequate descriptions of the statement waiving the company’s liability for certain types of debt. In a separate objection, the litigation administrator overseeing the liquidation of Celsius, a cryptocurrency lending company that has filed a claim against FTX, also cited incomplete disclosures.

Mr. Purple added: “Currently, the draft plan only provides superficial clarity to creditors whose claims were less than $50,000 on the filing date. According to FTX data, these creditors only account for $1.2 billion of the estimated $16.5 billion in compensation. But the timing and treatment of claims above $50,000 lack appropriate details to make a reasonable decision on the voting on the draft plan.” These include clarification on the $400 million hack that occurred shortly after the exchange filed for bankruptcy, when funds controlled by the U.S. Department of Justice will be distributed to creditors, and details on potential circumvention actions, such as recovering payments to Binance.

The bankruptcy plan is expected to be voted on in late summer. Kavuri and Sehgal, who head the special committee of clients, urged creditors to vote against the plan. Vladimir Jelisavcic, founder and manager of Cherokee Acquisition, an investment bank focused on bankruptcy claims, expects a majority to vote in favor of the plan and accept the money.

“Sullivan Cromwell and John Ray did something very valuable and important,” said Jonathan Lipson, a Temple University law professor who has studied the FTX bankruptcy, basing his analysis on bankruptcy documents and interviews with Bankman-Fried and his parents. “Bankruptcy is really about sharing the pain. However, the right metric is, how do you maximize the value of this estate, what do you get? I think there are legitimate questions about that.”

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