Richard Squire on the Crypto Bankruptcies

Given the recent collapse of some of the major players in the crypto space, its future is uncertain. Joining us for the very first episode of the Bite Sized Business Law Podcast to discuss crypto bankruptcies and what some are calling the ‘crypto winter’, is business law professor and faculty director of Fordham University School of Law’s Corporate Law Center, Richard Squire. Richard breaks down some of the similarities that exist between the auto industry bubble, the dot-com bubble, the 2008 financial crisis, and what we’re currently seeing in the crypto space. We discuss the interconnectedness between companies and whether or not insolvency leads to insolvency before Richard sheds light on what he expects for the future of crypto. You’ll hear his thoughts on whether or not we should expect more regulation, why he doesn’t believe there is a path forward for FTX, and the likelihood of FTX’s creditors getting their money back. To find out why Richard is actually positive about the future of crypto despite its current state, tune in today!

Key Points From This Episode:

• An introduction to Professor of Business Law, Richard Squire.
• Today’s topic: crypto bankruptcies or the ‘crypto winter’. 
• Parallels between the auto industry bubble, the dot-com bubble, the 2008 financial crisis, and what’s happening currently in crypto. 
• To what extent there will be contagion. 
• Concerns about the Federal Home Loan Bank system lending billions to crypto companies and whether or not insolvency leads to insolvency. 
• The expansion of the monetary base by the Federal Reserve in recent years and how this has affected what has happened in crypto.
• Whether or not we should expect more regulation on crypto than that which already exists.
• Why big firms are in favor of stricter regulations. 
• Whether or not there’s a path forward for FTX, as its CEO believes there is.  
• The likelihood of the FTX creditors getting their money back. 
• The emergence of markets where you can buy and sell FTX claims and whether or not they are specific to crypto bankruptcy.

Links Mentioned in Today’s Episode:

Richard Squire 

FTX

Fordham University School of Law Corporate Law Center

Transcript

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SPEAKER_01 0:00

Either he forgot that he worked on Enron, or this is even worse than Enron, which is hard to believe.

SPEAKER_00 0:08

You're listening to Bite-sized business law, where we discuss big issues in small doses. This podcast is sponsored by the Fordham University School of Law Corporate Law Center, which is run by Fordham Law Professor Richard Squire and me, your host Amy Martella. Okay, let's get down to business. Welcome to our very first episode of Bite-Sized Business Law. We're very excited to be coming to you from the Corporate Law Center at Fordham Law School, and I'm beyond thrilled to have my first guest be Professor Richard Squire, who is an esteemed professor of business law here at Fordham Law School. Richard teaches corporations, business law, corporate bankruptcy. He's a scholar, he's a beloved law professor, and he's also the faculty director of the Fordham Corporate Law Center. Richard, welcome.

SPEAKER_02 0:58

Thank you, Amy. It is an honor to be your first guest and in your new podcast. And congratulations on it. I'm sure it's going to be a great success.

SPEAKER_00 1:06

Thank you. We're excited. Very excited. And we're so lucky to have you in particular here today because we are going to talk about something that's been all over our news feeds that I know you will have a lot of insight about. And that is the crypto bankruptcies, or as some people are calling it the crypto winter. Okay.

SPEAKER_02 1:21

Oh, I like that.

SPEAKER_00 1:22

Yes.

SPEAKER_02 1:22

Winter always gets a bad rap, but they're calling it the crypto winter. Right. In the popular culture now, people say winter is coming. And they have a sense that that's a winter that lasts seven, eight years, right? It's not even a season anymore. Right. So you want to know are we in a crypto winter that's going to be Game of Thrones level winter?

SPEAKER_00 1:40

Exactly.

SPEAKER_02 1:40

Okay, good.

SPEAKER_00 1:41

And I'm I I mean, I didn't coin the term. It's coming, everyone's calling it the crypto winter. Which sooner it'll be March than April. So I don't know what we're gonna do then. But so yeah, over the past few months, a variety of crypto firms have faced insolvency. As we all know, on November 11th, FTX and over a hundred of its affiliates filed for Chapter 11 bankruptcy. Right. We've got here in the Southern District, Voyager and Celsius, the Third Circuit has FTX, obviously, and BlockFi. Sam Bankman Fried is now facing criminal charges. He's got the DOJ and the SEC both charging him with fraudulently raising billions of dollars, mishandling his customers' funds. And just as a point of perspective, John Ray is the person who has come in to oversee the restructuring of FTX. He was hired to shepherd them through the bankruptcy. He stated publicly that this is the biggest mess he's encountered in his career. Right. Now, that's a lot coming from the guy who oversaw the Enron liquidation.

SPEAKER_01 2:37

Either he forgot that he worked on Enron, or this is even worse than Enron, which is hard to believe.

SPEAKER_00 2:43

Well, yeah. So that leads me to my first question. We've all come to realize that the crypto meltdown is very serious and very real. So let's start by talking about what similarities we can draw between what's happening with crypto and what happened in 2008 and even any past financial crises that we've faced.

SPEAKER_02 3:00

Aaron Powell It's a great question because I think it is always important when something like this happens to say, okay, can we learn anything from history? Is there anything new under the sun? And certainly aspects of crypto are new things under the sun. Crypto, the basis of it is blockchain technology, which I understand to the extent that I can read a Wikipedia article. But I know that blockchain is an important and very useful innovation, and it is the basis for cryptocurrencies. And crypto is essentially short for cryptocurrencies, which are a way of engaging in transactions and maybe buying and selling things using blockchain. And so one parallel I see with maybe past financial crises or just past potential adjustments, painful adjustments in industries, is that often what happens is that there is a new technology that's introduced. And it takes the market a while to figure out how it's going to be used, how many companies can exist in this space. And so there's a bit of a bubble. And we could go all the way back to Detroit when people realized, hey, this horseless carriage is going to be a big deal. But it wasn't clear how many companies they were going to be and how many customers would want these things and what they were going to look like. Would it be the motorized tricycles that sometimes you see in old movies and so on? And so you had lots of startups in Michigan that was kind of the Silicon Valley of its time. And all of these companies started, and many of them went bankrupt. Many of them failed. And there were, then there was consolidation, and eventually we got the big three in the United States. So the underlying technology was valuable, but it took a while for the market and for investors to figure out, okay, how are we going to sell this technology? How many companies can it support? And a lot of people lost money in the meantime. Then you mentioned Enron. Enron was connected to the dot-com bubble, which was about the internet. And again, that was an instance where we can obviously see all around us, including with this podcast, how valuable the internet is. But still, the excitement over the technology led to, you might say, overinvestment or malinvestment or just a learning process. And that's a lot of what capitalism is. It's a learning process. And a few companies did very well. And actually there are many online companies, but a few have done very well, such as Amazon and so on. But a lot kind of got wiped out during the dot-com bubble. In 2008, you mentioned that crisis as well. There was something a little bit different going on there. It wasn't that mortgages were new or even mortgage-backed securities were brand new. But there, I think, was some sense of whether mortgage-backed securities, the more specific technology there or innovation, whether they can be packaged in a certain way that will allow some people to expose themselves to relatively little risk, even though the underlying mortgages are risky, because the mortgages have been packaged so that there is a top, there's tranching going on, was the term. You know, if you use the a French word, it sounds more impressive, especially in the business world. We say entrepreneur, and we say financier. So we said tranche, right? Which just means slice. If we tranche these things and we put, even though it's maybe subprime mortgages, we put the riskiest mortgages together. We put risky mortgages together, excuse me, but then we tr we slice up the cash flow. So there's a triple A low-risk security that's issued at the top of the kind of the what they call the payment waterfall. Maybe that's going to be safe after all. And so we can kind of take risk and repackage it in a safe way. And I think we saw the limits of that. I think that that can happen to a certain extent. It's not a completely crazy idea, but again, in that bubble and then collapse, we had a discovery about how far we can go with that and where it works and where maybe it doesn't. So those are some components, kind of one components a new technology. Another component of these repeated crises, but in different areas, is lots of firms rushing in in the beginning. And that's part of the discovery process of capitalism. And some firms are going to figure out what works and other firms are not, and they're going to fail. But because there is a lot of firms being founded at the beginning, and also a lot of money coming in to found to fund these firms, because people are excited about the investments, there will be a lot of bankruptcies and a lot of people will lose their money. This actually happened in the auto industry. People don't know this because they think, well, it must have been always there were three or four automakers, you know, the big three out of eventually it became out of Detroit. But there were actually hundreds of companies in Michigan, really concentrated in Michigan, a little bit in Ohio, right around the turn of the last century, the start of the 20th century, and a little bit beyond, that said, oh, this is going to be big. And so they tried to make cars or components of cars. Many of them failed. And so it looked like there was a collapse. Others were bought up and then the industry consolidated. So I think that pattern is pretty consistent. And I think that we are what we're going to have again with crypto is the market will continue to figure out what this stuff is really useful for and what it's good for. And during the discovery process where we discover, okay, well, that's not so useful. That's not so good, firms will fail. And during the time that firms are failing, people will take losses. And so I think that's what we're going through right now. But I don't think that we will be in crypto winter forever, or we're going to, I think that when the last stage of a star, I've heard when it's burning out, is heat death or something like that. Now, I don't know anything about astronomy. I almost said astrology, which shows you how little I know about even the difference between the two of them. But I think that we are not headed, nonetheless, if I'm right, we're not headed toward a crypto heat death. Well, there'll be nothing there in the end. My sense is that there is something useful here, and we're still finding out what it is. But there's going to be pain, pain of discovery in the meantime.

SPEAKER_00 8:25

Right. Now, to what extent do you think there will be contagion or seepage into other areas? Because, so for example, Lehman, when they failed, they were so interconnected with other large businesses that it was a big old mess. Right. Now, crypto, I'll give you an example. This federal home loan bank system, right? This was just reported very recently. Right. This is a group of 11 banks across the country. They basically give loans to other banks. It's not, they don't get federal funding, but they're kind of blessed by Congress. They were created after the Great Depression to support housing, finance farming, things like that. It was just reported that they are now lending billions with a B to a couple of crypto firms who are facing massive withdrawals and a run on their, you know, on their exchanges. And this seems to be the traditional banking system, which was staying above the fray for a while, which seemed to be like not getting mixed up and ensnared in the crypto winter. Right. It seems that now it's getting intertwined. So are you worried about that at all?

SPEAKER_02 9:27

So one thing, whether I'm worried is an interesting question. Maybe this is one of the benefits of being a professor and being kind of in the ivory tower. You can sit back and kind of look dispassionately at what's happening, say, oh, that's interesting. I'm not a politician that has to run for re-election. And I have invested heavily in crypto, so I'm not worried about getting wiped out. So, but do I think there's a real possibility, a possible concern there? What's interesting to me about you what you've said is that when one of these bubbles happens, and I think crypto has been a bubble, and I that doesn't mean that the underlying technology is completely junk, but there can be an exuberance that has to be corrected. So 2008 was also a bubble, and you bringing up Lehman is, I think, apt. One of the things that happens when these bubbles inflate and then collapse is there is a worry about interconnectedness. Usually the degree of interconnectedness is not as great as the concerns about it. Now, that doesn't mean that the concerns are irrational. It just means that there's another discovery process that happens. First, there's the general discovery process of what's this new technology good for. But then there's something more specific when the bubble is bursting, which is okay, who's connected to whom? And there often isn't good disclosure of that, and people don't know. And so people will rationally kind of pull back from everybody who's suspected of being connected to one of the failing firms. Now, eventually it's it usually comes out that the amount of interconnectedness is not as great as the number of firms that suffer from fears of interconnectedness during the period when we're finding out exactly who is kind of who really has gotten in bed with the insolvent companies and who hasn't. So with Lehman, for example, it was actually there was only one other legal entity or firm that I know of that was directly interconnected with Lehman to the point that because Lehman was insolvent, it became insolvent. That was the reserve primary fund, which was a money market mutual fund. So the domino theory in terms of one domino knocking over another, which people were worried about with Lehman, actually didn't happen, at least in the sense of insolvency leads to insolvency. Now, there was, however, markets freezing up after Lehman failed. And I think that was for two reasons. One was this surprise that the government hadn't bailed Lehman out. And so there was an updating on, gee, maybe these other firms that I'm assuming will also get bailed out in case of trouble will not get bailed out as well. So I need to pull back. But then the other was, well, who's connected to Lehman? And until I'm sure, until I'm confident that my counterparty is not connected to Lehman or Lehman or connected heavily, I'm not going to deal with that counterparty. I'm going to withdraw. So the domino, the contagion is really one of liquidity, which just means there's a kind of a credit freeze-up. Nobody's lending to anybody because nobody is sure who's really insolvent and who isn't. So I think that certainly the same thing can happen with crypto. And I think that it is unfortunate that these entities that you're describing that people presumed were safe, maybe were intertwined in a way that was unwise or imprudent. And so it's going to take some time for the market to kind of figure out who really is exposed and who isn't. I don't think that, again, again, as it was true in 2008, I don't think the direct chain of insolvency leading to insolvency and insolvency is going to go very far. But I do think that there will be some freezing up while people figure out who exactly is still solvent and who isn't. I think there's one other parallel that I that is worth making, and it may explain why entities that we thought were safer and should have been more prudent were making bets on crypto. Both the 2008 financial crisis and the recent crypto kind of bubble and then collapse were preceded by a great deal of monetary expansion by the Federal Reserve. A great deal kind of, I mean, to put it bluntly, is money printing. And the Federal Reserve officials believe that this is a way to stimulate the economy to keep us out of a recession. But what this means is there's a lot of new cash coming into the economy. And it also means that returns on safer investments, such as treasury bonds, end up being very low. One of the main ways that the Federal Reserve expands the monetary base in order to stimulate the economy is by buying U.S. Treasury bonds. Well, when you buy a bond, the price goes up. And when the price goes up, the return that you get, because the ultimate payments are fixed. So if you have to pay more for future payments that are fixed, you're getting a lower net return. And so people start chasing higher returns. And a lot of people, I think, in the traditional banking sector, for example, in 2006, 2007, we're saying, gee, we're really not getting very good returns on treasury bonds or even conventional mortgages. It looks like something exciting is happening here in subprime and these margins backed securities. People are getting good returns there. Let's buy there, at least to a certain extent, to get higher returns. And crypto certainly has been preceded by a huge monetary expansion. It was happening under the presidency of Donald Trump, but in the last year of Trump, especially with COVID, we had unprecedented expansion of the monetary base by the Federal Reserve. Then we had high price inflation. So the Fed started reversing policy. Now it's tightening. And now suddenly people don't need to chase alpha and chase or higher returns anymore by betting on riskier securities. So they start pulling back. Crypto, I think, has definitely suffered from or been another example of a monetary policy-based kind of bubble and then popping of the bubble. And this also certainly happened in 2008. The Fed started tightening the money supply actually as early as 2007. And that was the pin that kind of popped the balloon. So there's another parallel between the two of them. And during that pulling back period, which is associated with contraction of the monetary policy of the monet money supply more generally, you do then this have this concern of, okay, who's actually going to be able to survive this and who can't?

SPEAKER_00 14:52

Right. Well, that's an interesting point of connection that the government floods the economy with money. Yes. And then we start seeing these aggressive people take these aggressive positions. Yes. So just to draw another parallel, after the 2008 financial crisis, there was the bubble, the mania, the burst, and then the regulation. So I want to ask you about that because there's kind of this dangerous mix happening with an unconventional financial instrument and like a mostly unregulated space that emboldens people to take purposefully or not sometimes unreasonable risks. And so I'm wondering what your thoughts are on whether we should expect more regulation than that which already exists on crypto.

SPEAKER_02 15:32

So there's no doubt that we do have a history in the United States of new regulation after a bubble has burst. The federal securities law apparatus, which lawyers know well and now influence almost all aspect of business, especially in publicly traded companies, the 1933 Securities Act, the 1930s, but especially the 1934 Securities Exchange Act. These were all made politically possible, I would say, by the collapse of the stock market in 1929. And there are many people who think that, you know, it's not a coincidence that we had the Federal Reserve created in 1913, and then we had the worst stock market bubble in history, stock market collapse, I should say, in history, up to that point, only 16 years later. Again, it looks like there was expansion of the monetary base by our central bank and then a collapse. And so, yes, so going all the way back to the origins of kind of aggressive federal regulation in the financial markets. So we saw this after the stock market crash, after and then in the 30s, the first major federal securities regulation, after the dot-com bubble, I mentioned that a little bit earlier. Then there was the collapse, and then we had the Sarbanes-Oxley Act, which did again expand further securities regulation. Now, none of that was nearly as big, just in terms of the number of pages of regulation, than what we got after the 2008 crisis, which was we got ended up with the Dodd-Frank Act of 2010. It was a banner year for Congress, 2010. It passed its two largest, longest, in just terms of word count pieces of legislation in history. One was the Affordable Care Act, known as Obamacare, and the other was the Dodd-Frank Act. Dodd-Frank was a response to the 2008 crisis, and it was unprecedented in its scope and its length. And we did see massive new levels of regulation. So now, so will we see something similar with respect to crypto? I think we will certainly see both a call for it in the industry, and we'll see politicians responding to that call, either because of noble incentives, because they want to protect people, investors from getting defrauded or taken advantage of, or maybe some politicians just see this as an opportunity to expand power in certain ways that I wanted to do all along. We will see a call, I think, for more regulation and more maybe an impetus for it or a motivation for it in the halls of power. We've already seen being proposed.

SPEAKER_00 17:47

And as you've mentioned to me offline, the big institutions like Goldman, they also want regulation.

SPEAKER_02 17:53

Yeah, there's a pretty standard critique of regulation. This is by no means original to me, which is that one of the things that happens when you regulate an industry more is that you tend to raise compliance costs. And so those fixed costs mean that larger firms, which have more revenue, can more easily kind of accommodate those or bear those costs and continue to be profitable because they can spread them over a larger revenue base. Whereas a small firm now says, well, you know, I'm only going to make a certain amount of profit and that will all get eaten, or revenues that'll all get eaten by these largely fixed compliance costs. And so regulation can actually end up becoming a barrier to entry. So it's good for the big firms, Goldman, you named, one of the biggest investment banks, is certainly the most prestigious, says, yeah, we can eat those costs. And in fact, not only can we, but this will help us protect us from upstarts because there's now a much higher regulatory hurdle for them to clear, even to get in the game. And so I don't think it would be a surprise if the biggest remaining firms in crypto advocate for regulation. Again, I know this is a cynical interpretation, and they may, the people there, at least some of them may honestly think, no, this is good for us. But it also is good for their bottom line to build kind of a regulatory ring around the industry. And so you have to be a big player if you want to get in at all. Because most of the kind of real in any industry, most of the disruptive change, what brings down one big firm is usually not another established big firm in the industry. Big organizations tend to be sclerotic, they tend to have a status quo bias. It's usually upstarts who come along and knock them down. And so if you can make it harder for upstarts even to enter your industry, it's good for the people who are currently there. And who are the future upstarts in crypto? Well, we don't know yet. Maybe the people who would start those firms don't even know yet. So they're not going to be in a good position to lobby against punitive or exclusionary regulation. But the the people who are in the industry now are therefore at a political first mover advantage as well. I don't think it's a big surprise that Sam Bankman-Fried of FTX renown, or I should say of notoriety, was known for being an aggressive uh proponent of regulation. Now, I don't want to speculate too much on his motives, but FTX was one of the biggest players. It came, became one very quickly, demonstrating how this was still a space in which you can go from small to big very fast. But if you can go from small to big very fast and the industry is open, you can also go from big to collapsed very fast. We also saw that with FTX. Maybe it would be easier for the big players in the future to make it harder for someone new to come along and knock them down.

SPEAKER_00 20:28

Interesting. So I want to spend our remaining time talking more specifically about the bankruptcies. So as you mentioned, we think we can all agree that crypto and the technology it's based on is pretty much here to stay. Like the dot-com bubble, you know, you had your Amazon, your eBay, they survived, they came out alive. Many, many startups failed. Yes. In Silicon Valley.

SPEAKER_02 20:48

I think so. I've I've been told by people that blockchain really is useful for certain applications. Again, I'm not an expert in that. I'm not a I'm not a computer programmer, so I'm deferring to people there. But what they say seems plausible. We don't know exactly what the applications will be, but it does seem plausible to me. There's a good chance that there will be some real economic benefit in this technology that will be realized.

SPEAKER_00 21:07

Right. And so some crypto firms who are playing by the rules and making a good product, they'll they'll survive. Yes. But what's interesting is as you've mentioned in the past, and you know, we've got a bankruptcy expert in our midst, so you can tell us more about this. But most of the time when a financial firm faces insolvency, they don't come out of life alive. They don't go on to be a going concern, they kind of fold. Right. However, the CEO of FTX, and he was installed after the after they file for bankruptcy, he's shepherding them through the bankruptcy. He recently said that he does think there's a path forward for FTX.

SPEAKER_02 21:39

Well, I I guess I respect his optimism. Usually, when a firm survives bankruptcy going through a chapter 11 reorganization, it's because there's a perception that there's some product or service that the firm provides that remains valuable. The firm maybe borrowed too much, it kind of maybe expanded too much and used debt to do it, so it needs to write down debt. There's some nugget of economic value creation in there that is still, there's some engine kind of of value creation that is still can produce profits and can still keep running. And there's sufficient confidence in the market, in buyers and consumers and also investors that under right management and kind of once it's right-sized, that that will continue to be viable. This happens all the time with the airlines. The airlines go through chapter 11, they shed costs. Often what the airlines have been doing historically is shedding costs associated with very expensive for the from their perspective, union contracts. But people don't think, well, first of all, they don't say airlines or airplanes are an obsolete industry, right? If the whole industry is becoming obsolete, then there isn't going to be much left and it's going to be kind of spiraling down to heat death to use that earlier. But air travel is, at least for the foreseeable future, is here to stay. And often the airlines have good, they have the confidence continuing of their customers. So American Airlines, even if it goes through a Chapter 11, which it did, well, in the last 15 years, it still can sell tickets and people will still say, I'll fly on this airline. So part of the confidence in the product is related to confidence in the brand. And so the brand can be one of the most valuable assets to protect in a chapter 11 reorganization. Now, financial firms require a degree of confidence in their solvency in particular. To a large extent, what they're selling is solvency or what they're selling is financial trustworthiness in a way that, for example, an airline isn't. What's the main thing I care about when I buy an airline ticket? I think, well, obviously I want the plane to arrive safely. And we see that the biggest pullbacks when customers are buying airline tickets is not the bankruptcy of the airline, but it's a plane crash, specifically with that airline, but also any actually plane crash and any airline can affect a whole industry because people are saying, well, this isn't so safe anymore. Short of that, heaven forbid that occurs anytime soon, and let's hope it continues to be a very rare event. It's concerns like am I gonna get there on time and so on? Do I have a comfortable flight? So the factors that make the airline continue to be viable as a going concern are not strictly related to its financial solvency. It can become bankrupt and still be considered to be trustworthy. Most financial firms, though, because you're actually entrusting them with your money, the threat of insolvency are being kind of this is this goes to the core of their business. And so it's very hard for the brand to survive. When Lehman failed, uh, there is the Lehman brand, but there's no major firm out there who's repackaging itself as the new Lehman, as opposed to Pan Am. Pan Am fail, liquidated, but then another firm said, hey, there's still some confidence in this brand, right? So the question for me would be, is the FTX brand worth anything? To me, it seems pretty badly tainted. The other thing that FTX was selling, I mean, putting aside the brand, I should say the underlying product it's selling is an exchange. Now, exchanges are fairly interchangeable, I think. The main thing that's beneficial about an exchange is there are other people on the exchange, kind of economies of scale and so on. So there's other exchanges out there. I think they could be built pretty quickly. So I'm not seeing an underlying product there that's likely to continue to be attractive. So I could be wrong, but my sense is that Ray's trying to be optimistic, and I, and you know, he is the CEO now of the company, and he wants to say there's something valuable here, putting aside the misbehavior and the fraud of the past, whether he's right about that is something that I must say, I'm skeptical that he's right about that. It would be unusual, to say the least, for a firm in a financial services industry, and that's ultimately what crypto exchanges are, would be able to survive like that.

SPEAKER_00 25:32

Okay, so let's go from optimistic to pessimistic. Right. What can customers of FTX expect, creditors, in terms of getting their money back, seeing a payout?

SPEAKER_02 25:43

So it's a great question. And there is, I think, room for some optimism. If we look at what happened at FTX, optimism meaning that they won't, the customers won't be completely wiped out. They will get some payout. Whether they'll get 100 cents on the dollar, I was gonna say I can't say for sure. I think I can say for sure, they're probably unlikely to get 100 cents on the dollar. But whether they're completely wiped out is another question. There was some uncertainty with FTX at the beginning. Actually, there's tremendous uncertainty about where are the assets. FTX was unprecedented as far as John Ray was, as you mentioned, in terms of how bad the internal accounting is and so on. So nobody knows where the money is, where it went. I think this kind of notion of we're casual and you know, we don't worry about these conventions was part of the appeal, at least to some people. I mean, Banger Fried himself was like he was very casual in the way he dressed and the way he kept his hair. So it was a surprise that he was casual in the way he kept accounting. You know what I mean? It was all part of almost of the image, right? So maybe in the future we should say, no, that's actually there's good some things you shouldn't be casual about. But initially there was panic and they say there's no money here, we don't know where it is. But over time, we have started to locate not only some accounts that were frozen, it was hard to locate, but we found them, but also some better tracing of the money. And there are mechanisms in bankruptcy to recall money that has been given away or spent in certain ways. There is other avoidance actions, and this is a legal term. It's not what it sounds like to me, avoidance action sounds like some kind of Freudian defense mechanism, but what it actually is is a way to render void or null a previous transaction, to reverse it. We reversal actions might be more descriptive. And so, very specifically in this case, FTX and its affiliates were giving a lot of money to charity. Well, you can only give money to charity if you are solvent when you do it. It's not illegal to do it, or at least in the absence of fraud, but that money can be recalled. They can say, sorry, you have to be just before you're generous. Uh, if you don't have enough money to pay your creditors, you can't give it away to all the charity. That would be called a fraudulent transfer. Not fraud here in the sense of intentional deception, but it's an older term, denoting some idea that you're you're not treating your creditors as you should. And so I think a lot of charitable giving was done by IFTX. We'll be, will be, they'll be able to get that back. Also, there were a lot of political donations, not just only done by the officers themselves, like free, but maybe by the firm as well, and maybe by its affiliates. Some of that's going to be able to come back. The bankruptcy court will have the power to say, again, that was done at a time when the company couldn't pay its creditors, and so it has to go to the creditors first. Now, a lot of money also was, it seems that there is this, there was this affiliated entity, Alameda, affiliated with FTX, which is also now in bankruptcy, that was making investments, risky investments. And when it couldn't cover the investments, when the investments were losing, some of them because they were crypto investments, and then the bubble burst, FTX money was transferred from FTX out of customer accounts to Alameda to cover those losses. Now, if the argument can be made at Alameda that that FTX itself, if they're treated as separate entities, didn't receive any benefit, right? That was just one legal entity helping out the other, kind of from FTX's perspective, it's another charity, right? Alameda is just another charity. Yours, from Bankman Fried's perspective, it's all the same, but from a legal perspective, it's one company just gratuitously helping the other. Again, that money could be recalled. Now there is a question of where is it at this point? Alameda was making investments. Some of those investments may be difficult to recall because they were, at the time they were made, they seem like bona fide investments. So the recipient of the investment money may say, look, I don't have to give this back. I sold you something that was worth at the time what you paid for it. So it's not clear how much money that can come back there. But I think some of it will be recallable. There is a tendency, and here I think history is illustrative, there is a tendency when a financial services firm initially fails, and especially if there's some sense of wrongdoing that occurred. And I think the clearest parallel in my mind is what happened with the Madoff fund with Bernie Madoff, initially to think all the money is gone. People are going to get nothing back. But actually, in that case, it took a while. But the trustee in that case was able to use the avoiding powers that are there in bankruptcy law to recall a lot of the money. It took a long time and people suffered. And sometimes they were elderly people. A lot of them were elderly people, and they waited so long that they never saw it in their lifetimes. It was very tragic. But a lot of money was recovered. And so the ultimate losses weren't nearly as bad as what was initially estimated. Now, a lot of it was bad because Madoff was paying himself huge amounts of money and spending that money on houses and yachts and just high living. Some of that could the houses were seized. His wife and now widow ended up homeless. I mean, it's all it's an ugly story.

SPEAKER_00 30:13

Trevor Burrus, Jr.: Well, you see that they are looking at Sam Bankman Freed's investments in Robin Hood shares. He's got something like 700 million.

SPEAKER_02 30:20

Right, right. So he overpaid himself or he took money fraudulently. That could maybe be recalled as well. So a lot of money did come back. With Lehman, again, so here's another parallel. It took a very long time, another big collapse. Lehman, I don't think, is tainted with the allegations of fraud, nearly to the extent that, of course, that Madoff was, or even maybe Bankman-Fried. But it was also a spectacular financial services failure that ended up liquidating, and people thought, oh, people aren't going to get anything back. And there ended up being non-trivial payouts, even to the unsecured creditors who are the most at risk. So I think that there's reason to think here that the losses won't be as big as initially feared. But it does take some time to kind of unscramble all of the eggs or to, but you can't unscramble eggs, but you can sort out the spaghetti maybe, but it does take a long time. And that is an expensive and protracted process. But there are mechanisms that bankruptcy law does make available to make that possible.

SPEAKER_00 31:12

Yeah, particularly in these crypto bankruptcies, because there's a lot of firms, crypto firms, that have admitted that their own failures are kind of a result of being intertwined with FTX's collapse. So isn't it the case that they will have to wait for the FTX bankruptcy to be resolved before their creditors can see any payout?

SPEAKER_02 31:30

Aaron Powell Yes. And I think that's a really good point because in these avoidance actions where money is recalled back to the estate, so FTX gives money away through various things, through charitable giving through political donations, through imprudent investments. The imprudent investments could be in other crypto firms. And the degree to which the FTX estate and that bankruptcy proceeding can recall money from those other crypto entities, those crypto businesses that FTX gave money to or invested in, will of course, in turn, affect their own kind of degree of solvency. That's right. So the protracted legal process casts a shadow of uncertainty over all of these firms. I think that these firms would be best served, many of them, by being able to say this is our maximum exposure to FTX. If we have to give back all of this money, or if they have, they in turn, now the connections can go both ways, right? They also might have some investments in FTX or any of its affiliates, and they say, okay, so the maximum amount that we would give back is this, and the maximum amount that we would lose in our own kind of investments with FTX-related entities is this. Even with that, we're solvent, right? So if they can say that and present this is our maximum exposure, that should be able to rebuild some confidence in the market. And I'm sure that some firms are figuring out, okay, what is our maximum exposure here? And then over time, they might be able to say that was our maximum exposure. And it turned out that we didn't lose nearly as much as we hoped.

SPEAKER_00 32:56

Right. We saw recently BlockFi, who is intertwined with FDX. Right. They inadvertently, in a court filing, admitted that they have a billion dollar exposure to FDX and Alameda. Yes. So they inadvertently told everyone what their exposure is. Right. But I want to get your thoughts on investors who are trying to jump out of this scheme. Now there's markets emerging where you can buy and sell some of these claims. So this enables you to recover some money much faster than you would if you had to wait for bankruptcy to be resolved. Sure. So what do you think of those markets? And are they specific to crypto or do you see that happening in other bankruptcies?

SPEAKER_02 33:29

No, this is actually very common in bankruptcy now. It's called claims trading. And it's in many ways, it's a benefit, I think, of having free trading or a free market because it allows people to solve a problem. So if you are, let's say you were a short-term investor in a company, let's say you were a trade creditor and you would deliver goods and services on 60 days credit. So you would deliver and then you get expect to be paid 60 days later. You're not expecting or hoping to have a long-term period when you're out of pocket, when you've when you've spent some money, you're not gonna, you know, you're not trying to make a 10-year loan. But if the firm that owes you the money and that you thought you get back, be paid back in 60 days is going through a bankruptcy and it's going to take a very long time for these creditors to get paid. 10 years might be an exaggeration, although with Lehman to take that long for some claims, five years, whatever, you might say, okay, look, I want liquidity. In other words, I want to convert this legal claim, which is a debt, to cash. And there's another person who says, you know, I have liquidity and I'm willing to make a long-term investment in the bankruptcy proceeding. So I'll buy your claim from you. Now it's going to be discounted, it's going to be pennies on the dollar or dimes on the dollar, meaning or quarters on the dollar, depending on what how it's valued. But in a sense, there is a kind of a mutual gains from trade. The person who needs cash right away gets it. And the person who doesn't need cash right away but wants to make a longer-term investment and get a positive return, he or she can do that as well. So claims trading is just like trading in any other type of investment, if you think about it. It is people who want to get out now and they need cash, and other people want to get in now. So this is common in bankruptcies. It's not prohibited by any stretch, and certainly it will happen in crypto bankruptcies as well, to the extent it isn't happening already. And I'm sure to some extent it is.

SPEAKER_00 35:11

Interesting. Okay. So it sounds like you're saying with the combination of these exchanges and clawing back some of the money in the estate, that the creditors won't be, I mean, they won't totally lose their shirts.

SPEAKER_02 35:23

So I don't think every single one of them will lose everything. I do think that because not everyone in a bankruptcy proceeding gets the same percentage payout. It depends on whether you're secured or unsecured, or whether you have other types of uh way that the bankruptcy proceeding law can privilege certain claims over others. Also, there are different legal entities here, and some of them may be more solvent than others. As you said at the beginning, FTX was actually a complex of businesses and legal entities. And so I don't want to say that because there will be, I think, significant clawbacks, and therefore some creditors will do okay. Maybe they won't lose their whole shirts, that there won't be some that really suffer. I mean, there may be some kind of at the bottom of just the way that things shake out, that at the end they do lose their shirt and all they have is one sock or something. I mean, it could be, it could be, it could be some that are losing basically everything. But I don't think everyone will lose everything. There will be many creditors who see a meaningful, if still relative to initial expectations, disappointing payout.

SPEAKER_00 36:20

Right. And despite FTX and the bankruptcies in particular, the crypto winter will not last forever. So that's the good news.

SPEAKER_02 36:28

So you do you want me to say summer is coming? Summer is coming. I I don't, or at least a a thaw, a spring, yes. Now, if I'm completely wrong about the underlying technology and that blockchain just doesn't do anything that you can't do more effectively with other, with other technologies that are now in existence or will be invented, then yes, maybe spring and summer will never come. But I have reason to think that things will get better over time for some firms. I think this is a shakeout. I think there were too many firms that came in. And I think that that was a natural byproduct or a natural consequence of a new technology being introduced and people not knowing what it is. And then it was massively exacerbated by all the money printing by our central bank, the Federal Reserve. But that doesn't mean there isn't a nugget in there, an acorn that can be planted that will bloom in the spring.

SPEAKER_00 37:18

Spring blooms eternal. Well, we really certainly hope you're right. And I think you are, I suspect you are, because you have such valuable and wonderful, wonderfully helpful.

SPEAKER_02 37:27

I mean, the way you're you're you're talking about hope and kind of you know, you want reassurance. I hope you're not too exposed. Are you are you just I'm in at least a billion to FDX. Yes. Okay.

SPEAKER_00 37:38

No, not at all.

SPEAKER_02 37:39

Well, I'd be happy to buy your claims off of you for the dollar.

SPEAKER_00 37:44

Well, thank you so much for being here. This was very informative. Thank you for your insights, and we hope you enjoy being the very first guest on Bite Side Business.

SPEAKER_02 37:51

I enjoyed it and it was an honor, and this was a great pleasure. Thanks for having me on.

SPEAKER_00 37:55

Thanks, Richard.

unknown 37:56

Bye.

SPEAKER_00 38:00

Thanks to everyone at Fordham Law School, especially the Dean's Office and our corporate law center donors for supporting this podcast. Bite-sized Business Law is produced by We Edit Podcasts. Listen and subscribe to Bite-Sized Business Law on Spotify, Apple, or wherever you get your podcasts. The information in this podcast is for educational, informational, and entertainment purposes only, and does not constitute legal advice, nor is it intended to promote the organizations with which our guests are affiliated. For more information, check out our show notes, and thanks for listening.