The spectacular collapse of cryptocurrency exchange FTX has been compared to the collapse of Lehman, Enron and the Bernie Madoff scandal.
And just like in those cases, lawyers steeped in crypto know “there’s going to be a lot of work.”
Those are the words of Anthony Casey, a law professor at the University of Chicago and former practitioner specializing in bankruptcy law. He told Fortune that years of crypto bankruptcy await.
FTX filed for Chapter 11 bankruptcy and announced the resignation of Sam Bankman-Fried as CEO on Nov. 11, after he had been accused of mishandling customer funds on the exchange and using them to finance the operations of trading firm Alameda Research, another company he founded.
Bankman-Fried could face prison time if he is found guilty of fraud, and is reportedly being held “under supervision” by local authorities in the Bahamas, where FTX is based. But the implications of FTX’s fallout are set to spread much further than the company’s former leader. In an updated bankruptcy filing this week, FTX revealed the insolvency could impact more than one million people and businesses who are now owed money from the exchange, which is currently missing anywhere between $1 billion and 2 billion in customer funds, according to Reuters.
With numbers like that, legal experts tell Fortune the FTX bankruptcy alone could drag on for years, and kick off a major industry meltdown. And while that’s bad news for countless people and businesses who have invested in cryptocurrencies, the legal profession is about to have a field day.
“Everyone’s learning crypto bankruptcy right now, and I think there’s a lot of work that will be there for how to deal with crypto bankruptcy,” Casey said.
An ‘unprecedented’ failure
The sheer magnitude of FTX’s collapse could trigger enough lawsuits to compare with some of the biggest bankruptcies in history, according to Casey.
“Lots of law firms are going to be on this case,” he said. “If it’s bigger than Enron and more messy, it’s going to be one of the most complicated fraud bankruptcies of all time.”
Bankman-Fried has been replaced as acting CEO by John J. Ray III, an attorney who has presided over several high-profile insolvencies including Enron in 2002, after the energy company had been accused of fraud and false accounting. Ray was in charge of liquidating Enron’s assets and distributing them to defrauded creditors, but he says even that scandal doesn’t compare with the task he has ahead of him at FTX.
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” Ray said of FTX’s accounts in a bankruptcy filing on Nov. 17, calling the situation “unprecedented.”
Among the most concerning aspects of the company’s finances, Ray mentioned the absence of a working corporate governance structure, missing or nonexistent bank account information, and the misuse of corporate funds to pay for homes and other items for FTX employees. He also criticized the lack of a proper board for the company, where most decisions were made by a group of “inexperienced, unsophisticated and potentially compromised individuals.”
“Other crypto companies will need to pay attention to their corporate structures and their governance, otherwise there are going to be a lot of issues. I think this is going to be an example for other crypto companies,” Jiaying Jiang, a law professor at the University of Florida’s Levin College of Law, who specializes in blockchain and cryptocurrency, told Fortune.
Liquidators have found evidence of “serious fraud and mismanagement” at FTX, which is likely to instigate several lawsuits against the company, multiple law professors, former prosecutors, and in-house legal counsel told Fortune.
But while most of the legal attention is likely to be focused on FTX in the near term, it’s nearly certain to open a Pandora’s Box for the crypto sector. The collapse of FTX has sparked widespread fears of contagion in the industry, with many more companies at risk of collapse.
Before FTX, other collapses this year included Celsius, BlockFi and Voyager Digital. As the latter two were both bailed out by FTX, their potential bankruptcies is a major possibility going forward.
Even Changpeng Zhao, the CEO of FTX rival Binance, who arguably sparked his competitor’s downfall when he instigated a run on FTX’s assets, has warned that the FTX crash could have “cascading effects” on the industry at large.
Contagion fears
Law firms of all sizes have been steadily expanding their digital asset, cryptocurrency, and blockchain practices for years, but the scale of the FTX implosion could turbocharge that, bringing many more bankruptcy and litigation lawyers into the crypto sector.
Law practices often operate on a supply and demand basis, Yuliya Guseva, a law professor and head of Rutgers Law School’s Blockchain and Fintech Program, told Fortune. Before 2022’s crypto winter—when values for virtually all cryptocurrencies have fallen—Guseva said demand was much more active for “transaction-side attorneys,” or legal practitioners who could facilitate crypto-related business projects and investments.
But the steady downturn in cryptocurrency fortunes this year have dampened interest for lawyers on transactions and corporate projects, Guseva said.
“As more firms fail in this ‘winter,’ there may be more litigation against crypto firms,” she said, adding that more bankruptcy and litigation experts are set to enter the crypto space in the coming months.
“The FTX failure simply becomes a signal to these groups to pay more attention to crypto. I think this is what we may expect in this current climate,” Guseva said.
Three law firms contacted by Fortune declined to comment, citing their own potential business interests following the FTX collapse.
“In the next few months, there will be more crypto companies going bankrupt. That’s highly likely,” Jiang said. “And of course lawyers are going to do their business and deal with all these cases.”
Paradigm shift
In the wake of FTX’s collapse, many long-standing advocates of blockchain technology—including Binance’s CZ, Microstrategy founder Michael Saylor, and Crypto.com exchange CEO Kris Marszalek—stepped forward to say the time had come for stricter regulations to protect the industry against crashes of FTX’s ilk.
“Now regulators will rightfully scrutinize this industry much, much harder, which is probably a good thing, to be honest,” CZ said the day FTX filed for bankruptcy.
With a case as big as FTX’s collapse, experts say that regulation and higher government scrutiny on the industry is likely to follow.
“It’s still early, but this is going to be one of the biggest fraud-driven bankruptcies that we’ve seen,” Jared Ellias, a Harvard law professor and corporate bankruptcy expert, told Fortune. “When you have big fraud or big corporate bad behavior, history teaches us that you do have regulatory responses.”
Critics have accused the Securities and Exchange Commission, the primary regulatory entity in the U.S., of failing to protect users from the year’s numerous crypto-related collapses. One Washington insider recently told Fortune that SEC Chair Gary Gensler was “in a corner” with Congress, where lawmakers are said to be demanding answers over how his agency could have missed the fraud being committed by FTX.
The need for more crypto regulation was highlighted by Treasury Secretary Janet Yellen in a recent statement, saying that the FTX collapse and its widespread impact demonstrated “the need for more effective oversight of cryptocurrency markets.”
Critics, however, argue that crypto shouldn’t be regulated, as that would spread contagion from crypto into the mainstream economy. The Nobel Prize-winning economist Paul Krugman recently wrote that crypto has so far “made almost no inroads into the traditional role of money” and pointed out that crypto exchanges would be virtually indistinguishable from traditional banks under a more regulated regime. Similarly, economists Stephen Cecchetti and Kim Schoenholtz wrote in a recent Financial Times op-ed that “It is far better to do nothing, and just let crypto burn.”
Regardless of the regulatory future, the number of bankruptcies are likely to pile up. During this year’s crypto winter alone, over 12,000 cryptocurrencies virtually stopped trading while remaining active, becoming so-called “zombie” coins.
Either way, the lawyers will thrive. “If there’s going to be regulation, there’s work for lawyers,” the University of Chicago’s Casey said. Harvard’s Ellias said the next few months for crypto lawyers could be the equivalent of a “gold rush.”
Regulation could mean that demand for lawyers in the blockchain and crypto space becomes sustained beyond bankruptcies and litigations as focus returns to compliance and business projects, Paul Strickland, legal counsel with federal defense firm Oberheiden P.C., who advises clients on matters related to blockchain and government investigations, told Fortune.
“I hear this from a lot of my clients where they say, ‘we want to follow the rules, we just don’t know exactly what they are,’” Strickland said, adding that a more regulated environment “could stimulate overall growth and legitimacy of the industry.”
But as the extent of the damage caused by the FTX crash becomes clearer over the coming months, and the zombie crypto companies get weeded out, lawyers specializing in insolvencies are likely to be in much higher demand.
“I think that by the end of the year, a lot of bankruptcy lawyers are going to know a lot more about crypto than they do today,” Harvard’s Ellias said.
This story was originally featured on Fortune.com
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Source: https://finance.yahoo.com/news/everyone-learning-crypto-bankruptcy-now-120000474.html