Forbes: Full Compensation, Why Are FTX Creditors Still Unsatisfied?

Author: Nina Bambysheva, Forbes

Translated by: Luffy, Foresight News

Last month, the lawyers overseeing the FTX bankruptcy case submitted a restructuring plan that would not only fully compensate nearly all customers but also provide them with an additional 18% interest. If the majority of creditors and the bankruptcy judge agree to the plan, compensation checks will be mailed within two months.

Compared to typical bankruptcy cases, the compensation amount for FTX is substantial. Few creditors receive payment in cash, and some creditors may have to wait years to recover a small portion of their claims. FTX creditors belong to a fortunate group, but not everyone is overjoyed.

Some are dissatisfied because they cannot retrieve their original cryptocurrencies from the exchange. Instead, customers will be compensated in dollars based on the value of the cryptocurrencies held by FTX at the time of its bankruptcy filing in November 2022, when cryptocurrency prices were hit hard by industry turmoil. Since then, Bitcoin has nearly doubled, and many other tokens have reached new highs. For investors whose cryptocurrencies are trapped on the exchange, this is a lost opportunity. Many lawyers (including those currently working for FTX) believe that this is how bankruptcy operates, but creditors unanimously claim they have been wrongfully deprived of their property, which is not their only grievance.

They argue that FTX (currently led by John J. Ray III and represented by several legal and financial firms) failed to maximize the company's value and neglected the interests of former customers and other creditors. Sullivan & Cromwell, the primary law firm representing FTX and its legal advisor before the bankruptcy, has faced ongoing complaints.

The FTX Customer Committee (CAHC, composed of over 1,700 former FTX customers) represents Arush Sehgal, summarizing this frustration: FTX "promoted the narrative that everyone would receive full compensation and interest, but the reality is that they valued some FTX assets at zero. We estimate they misvalued assets by $10-16 billion. As long as John Ray retains unilateral power, with no creditors on the board, this plan lacks any credibility."

Below are some key issues summarized, along with FTX's detailed responses:

I. Creditors Accuse FTX of Selling Some Assets at Low Prices

a) Taking the cryptocurrency derivatives platform Ledger X as an example, FTX founder Sam Bankman-Fried acquired the platform for nearly $300 million in October 2021. In May 2023, the entity was sold to an affiliate of Miami International Holdings for $48.8 million, a price that, according to Grant Thornton's March 2023 audited financial statements, is far below its net asset value of $98.8 million as of December 31, 2022.

In a class action lawsuit filed against Sullivan & Cromwell in February 2024, a group of FTX investors also claimed that the lawyers "deliberately excluded FTX US Derivatives (formerly LedgerX) from the FTX bankruptcy proceedings because they knew the company held about $250 million of FTX customer funds, which could (and has) generated significant income." The lawsuit alleges that Sullivan & Cromwell was involved in the fraud that ultimately led to FTX's collapse, thanks to their relationships and resources prior to the bankruptcy filing. The complaint states: "FTX could not have perpetrated such a large-scale fraud on its own. The vast resources, relationships with regulators, expertise, and assistance of Sullivan & Cromwell were critical to executing the scheme."

The independent examiner of the FTX case, former federal prosecutor Robert J. Cleary, defended the FTX companies involved in the bankruptcy (i.e., the debtors) in a report released on May 28, but recommended further investigation into two pre-bankruptcy transactions involving Sullivan & Cromwell: Bankman-Fried's purchase of shares in Robinhood and the acquisition of LedgerX.

Like most responses, FTX referenced the report: The court-appointed independent examiner has investigated and reported on this issue. He found that "S&C did not make any final decisions about which entities would file for bankruptcy," and that "John Ray and the directors made the final decision. … At the time of the filing, Ray believed 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 debtors received six non-binding letters of intent," but only two actual bids, of $35 million and $14 million. The debtors negotiated a higher final sale price of about $50 million, and "the agreement (1) was approved by the debtor's board, (2) required stakeholder review and feedback (no objections were received), (3) required an auction process allowing for higher or better bids, and (4) was approved by the court," based on undisputed "evidence that the sale transaction was 'the highest or best offer'." The examiner concluded that the sale price being lower than the purchase price indicated that FTX overpaid for LedgerX in October 2021, and thus claims against certain original sellers should be investigated.

b) The dollar value of the millions of SOL tokens owned by FTX has increased more than fivefold since the exchange filed for bankruptcy, with these tokens sold at significant discounts to numerous large cryptocurrency companies and hedge funds, including Galaxy Digital, owned by billionaire Mike Novogratz, which helped orchestrate the sale. Most tokens were locked under multi-year vesting schedules, but Kavuri and others claim that these sales harmed the interests of creditors. Companies like Galaxy Digital could profit by billions 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 hit the market and quickly soared above $1, indicating that FTX's initial investment was worth nearly $1 billion.

"A simple review of the SUI secondary market would reveal that selling tokens at a discount before a public offering does not maximize profits. Furthermore, this raises questions about whether FTX's asset management was merely immature or negligent," wrote Rob Hadick, a general partner at cryptocurrency-focused venture capital firm Dragonfly, in a statement shared with Forbes.

FTX responded: The debtors, the bankruptcy court, and their advisors approved the sale of the tokens before their issuance. Token trading prices are typically high initially but drop significantly within months and have been very volatile since issuance. Certain tokens may have extremely poor liquidity and high volatility, with no fundamentals driving trading prices. While extreme price fluctuations will attract those willing to gamble, FTX assets are not for hedge funds, long-term investors, or gamblers. Additionally, the auction of tokens has a four-year lock-up period. Due to this vesting period, the sale price of locked tokens is far below market prices.

II. FTX 2.0

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

"Among our group of over 1,600 creditors, the total claim value is close to $1 billion, and we conducted a survey that 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 allowed FTX 2.0 and debt-to-equity swaps, everyone's compensation would increase by 3%. The simple fact that John Ray abandoned the restart of FTX is detrimental to all creditors," said customer committee member Sehgal.

However, Dragonfly's Hadick expressed skepticism, citing FTX's relationship with hedge fund Alameda Research, which is owned by Bankman-Fried: "The exchange's technology itself does not have much value. It worked well largely because they had an agreement with Alameda Research, which acted as an internal market maker and operated at a loss to provide a better experience for FTX traders. This clearly would not exist in a restarted FTX," he said. "If you can retain customers when the exchange restarts, then the customer base has value, but a reasonable estimate is that there will be significant customer attrition, and the valuation of the new exchange will largely depend on user retention."

Nonetheless, last year several companies expressed interest in acquiring the exchange, including the cryptocurrency exchange Bullish, operated by former NYSE president Tom Farley, fintech startup Figure Technologies, and private investment firm Proof Group.

FTX's response referenced the disclosure statement released alongside its restructuring plan (pages 45-49): The restart plan was thoroughly considered and was only rejected when it was clearly unfeasible. In a process designed with the official committee of creditors and under the supervision of the U.S. bankruptcy court, the debtors contacted dozens of investors. Each investor conducting due diligence reached the same conclusion: the offshore exchange's operating system was flawed. The exchange lacked sufficient custodial, security, and financial reporting arrangements, and there was no reconciliation between customer "positions" and actual underlying assets. Bankman-Fried left a mess, and the Chapter 11 case and criminal trial documents partially describe the issues with FTX's business. After a thorough investigation process, no investor was willing to spend the necessary time and money to establish these systems and restore the offshore exchange. The asset and its creditors' trustee also explored selling the offshore exchange business to a third-party operator or even merging with another exchange. In each case, after weighing costs, delays, and other factors, no serious investor was willing to make a substantial offer. We didn't even receive any meaningful offers for intellectual property, as the code is outdated, and the brand is synonymous with fraud. … The fairest thing we can do is prioritize returning as much cash as possible to the victims so they can decide for themselves how to handle that cash.

III. Unpursued Claims

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

FTX responded: The order and timing of the debtors' investigations and lawsuits are based on various considerations, and the legal deadlines for such lawsuits are lengthy. The debtors have not yet made a final decision regarding 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 regarding tax liabilities proposed by the IRS, amounting to $885 million. Of this, $200 million will be treated as a priority claim and paid within 60 days of the settlement's effective date. The remaining $685 million will be paid "as funds become available." This is a significant reduction from the IRS's initial demand of over $44 billion (later modified to $24 billion), but the customer committee questions the validity of the U.S. government's claims and argues that customers of the international exchange based in the Bahamas should not have to pay U.S. taxes without trading on a U.S. platform, which is unfair.

FTX responded: Income tax withholding is governed by applicable tax laws, which provide for certain reporting and withholding exemptions. If such exemptions apply, withholding will not occur.

b) The debtors proposed to pay creditors in cash via checks or wire transfers. "They have actually made it more difficult for FTX customers to recover their funds," said another FTX creditor, Sunil Kavuri, pointing out that the claims portal set up by FTX for creditors is difficult to navigate and lacks flexibility for customers from jurisdictions with limited banking services or unreliable mail. An additional provision in FTX's plan states that claims may be denied if any subsequent KYC or withholding tax requirements are not met.

FTX's response: The debtors are currently discussing the possibility of appointing a distribution agent and exploring different distribution options, including cash or stablecoins. Customers who do not have priority in withdrawing funds from the exchange need not worry.

c) "The current draft of the plan includes a governance structure that grants the debtors broad, comprehensive, and unilateral powers, while also retaining John Ray and a board not subject to any creditor oversight," wrote bankruptcy expert and FTX creditor advocate, X user Mr. Purple, in a letter to Forbes.

FTX responded: The confirmation order from the bankruptcy court requires that the plan be administered in accordance with its terms or other provisions of the court order. During the post-confirmation period, the U.S. bankruptcy court will continue to exercise comprehensive oversight over the bankruptcy estate.

In addition to these issues, the customer committee raised objections on June 5 to a disclosure statement from FTX, claiming that the plan is "legally unconfirmable" due to inconsistencies in the statement, omissions of important information, and insufficient descriptions of the statements regarding the release of certain types of corporate debt liabilities. In another objection, the litigation administrator overseeing the liquidation of cryptocurrency lending company Celsius also mentioned incomplete disclosures, as Celsius has filed a claim against FTX.

Mr. Purple added: "Currently, the draft plan only provides superficial clarity to creditors with claims below $50,000 as of the application date. According to FTX's data, these creditors account for only $1.2 billion of the estimated $16.5 billion in claims. But the timing and handling of claims above $50,000 lack adequate detail to make an informed decision on the draft plan." These include clarifications regarding 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 regarding potential avoidance actions, such as recovering payments to Binance.

The bankruptcy plan is expected to be voted on by the end of this summer. Customer committee leaders Kavuri and Sehgal urged creditors to vote against the plan. Vladimir Jelisavcic, founder and manager of investment bank Cherokee Acquisition, which focuses on bankruptcy claims, expects that most people will vote in favor of the plan and accept the funds.

"Sullivan & Cromwell and John Ray have done some very valuable and important things," said Jonathan Lipson, a law professor at Temple University who has studied the FTX bankruptcy case, basing his analysis on bankruptcy documents and interviews with Bankman-Fried and his parents. "Bankruptcy is indeed about sharing the pain. However, the right metric is how to maximize the value of this estate, what you will get. I think there are reasonable questions about this."