Crypto Market manipulation lawsuit against FTX Trading seeking $150M contains more words than substance

Link to lawsuit

A couple of preliminary thoughts. First, just because a lawsuit is long doesn’t mean it’s a “serious” lawsuit. Second, just because a lawsuit asks for $150 million doesn’t mean it’s a “$150 million lawsuit.” Or as one wag on twitter put it:

Yes, OK, that wag was me. Still, let’s just start by stipulating that the fact that someone has demanded a ton of money simply means that they have … demanded a ton of money.

Where is the wisdom coming from, Palley? I am writing this after reflecting on a new lawsuit against FTX Trading and a bunch of people associated with it by a company called Bitcoin Manipulation Abatement LLC. In fact, the reason why my Genesis essay is coming to you late in the week is that the lawsuit contains 366 numbered paragraphs, is badly written and over 89 pages long and I had to read the damn thing several times to make heads or tails out of it. A long and badly written lawsuit doesn’t bode well for the Plaintiff, no matter how much money they are asking for.

The lawsuit is filed in federal court in San Francisco. It contains 13 counts — Counts 1 and 2 are for RICO violations (more on that below), Counts 3, 4 and 5 are for violation of the Commodities Exchange Act. Count 6 alleges a violation of a California state that is similar to federal Commodities Exchange Act. Count 7 alleges negligence. Count 8 alleges fraud. Count 9 alleges civil conspiracy. Count 10 alleges violation of a California’s unfair business practices statute. Counts 11, 12 and 13 seek equitable relief and include claims, seriatim, for unjust enrichment, constructive trust and an accounting. The lawsuit also includes a picture of Bart Simpson, to explain “[b]art patterns”, described as a type of “pump and dump” scheme that creates a chart that roughly matches the size of Bart’s head. Plaintiff asks for $150,000,000 in damages.

Trying to summarize the factual allegations of this long and frankly overwritten complaint into a couple of sentences is a challenge, but the nubbin seems to be contained in a single paragraph at the outset:

"Defendants, and each of them, were caught red-handed when, at about 21:00 EDT on September 15, 2019, and acting in furtherance of the manipulative and deceptive scheme as alleged hereinabove, Defendants, and each of them, made two illicit unsuccessful attempts to manipulate prices of bitcoin futures listed on Binance cryptrocurrency futures exchange. One such attempt was perpetrated by dumping futures contracts for about 255 bitcoins, valued at approximately $2,626,500, on to the newly opened Binance’s SAFU futures market, at market prices, in two minute time interval, with the specific purpose to cause a calculated artificial price move that would trigger cascading execution of stop loss orders and liquidations of bitcoin futures long positions on Binance and propagate to other exchanges (“liquidation cascade”). In furtherance of the alleged manipulative and deceptive scheme, Defendants, and each of them, deliberately chose the newly opened and thinly traded derivatives exchange and the time of the lowest global bitcoin and bitcoin futures trading liquidity (21:00 EDT on Sunday) to maximize the impact of their illicit and unlawful manipulation attempt on the price of bitcoin futures. Both times, Defendants, and each of them, were caught by Binance’s market surveillance functionality and their manipulation attempts were thwarted. Plaintiff BMA is informed and believes and thereon alleges that Defendants, and each of them, have continuously engaged in the same type of illicit and unlawful conduct on Binance and dozens of other exchanges during the Relevant Period. Therefore, Defendants, and each of them, conspired to participate and participated in a long-running, continuing enterprise engaging in a pattern of racketeering activity as alleged hereinbelow."

Basically, if you take out the hereinbelows and hereinbelows and wherefores, AND EACH OF THEM, plaintiff says that the defendants have been involved in a long-running systemic market manipulation involving cryptocurrency.  Is there any meat on the bones of this whale-sized Complaint? My conclusion is that it is mostly fat and a tiny bit of gristle.

The first 15 pages of the complaint are background information on who the parties are, what Bitcoin is and a description of general types of market manipulation. For example, the Complaint explains that a

"Liquidation cascade is an extreme case of the stop loss hunt, when the perpetrator pushes the price of the asset or derivative to reach position liquidations levels for multiple traders and the resulting multiple market liquidations take place in a very short time interval moving the price even further. This triggers additional liquidations causing a cascading execution of a large number of liquidation orders. Similarly to the stop loss hunt, the perpetrators place their buy or sell orders such as to have them filled at the bottom or at the top of the resulting liquidations cascade, at artificially below or artificially above market prices, respectively."

Plaintiffs also allege that “a manipulative price action on one cryptocurrency exchange results in a substantially similar price action on all other exchanges.”

This is riveting stuff, but, nothing actionable yet. (Pro tip — a lawsuit has to contain actual factual allegations about specific wrongs that the defendants committed.)

The complaint does include RICO claims which only sounds interesting or dangerous if you don’t know much about RICO. It’s a federal statute that was originally created to go after organized crime — think mob families in the 1970s and 1980s. A tool of federal prosecutors in criminal cases, it can also be used by civil litigants. But without going down a law treatise rabbit hole, RICO claims have a lot of elements, are hard to plead properly, harder to prove, and can get taken apart by a decent defense lawyer if you don’t have the meat.

In order to plead a Civil RICO claim, you have to (among many other things) establish underlying criminal conduct. No criminal conduct, no RICO. After slogging through 23 pages of the Complaint we finally get to an allegation of criminality for RICO purposes. Specifically, Plaintiff says that the Defendants violated the Bank Secrecy Act by operating an unlicensed money transmitting service:

"It should be noted that the sheer magnitude of Defendants’ unlicensed money transmitter operation is truly staggering. According to Defendants’ own Whitepaper, FTX turnover was over $100 million per day in addition to $ 30 million per day turnover for Defendant Alameda unlicensed OTC money transmission business. Thus, Defendants’ illegally transmitted over $130 million per day without the required state money transmitter license and the required registration with FinCEN in violation of 18 U.S.C. § 1960(a)."

I have no idea if this is true or not of course. It’s just an allegation. I am sure if it is true FinCEN is interested too. If so, this lawsuit is the least of the defendants' problems. More to the point re: this lawsuit -- it’s also not entirely clear to me what the connection is between this MSB allegation and … well, the specific damages Plaintiff says it suffered.

Beyond the initial specific allegations about two unsuccessful attempts to manipulate prices on Binance on Sept. 15, I was surprised to see no other specific references to actual manipulative trades. To the extent that any part of this lawsuit requires proof of fraud — and a wire fraud predicate to a RICO claim would — you have to plead facts with specificity. That is, you have to allege who, what, where, when, why — not just that you are pretty sure something happened, but what it was exactly.

One of the problems with the RICO and fraud claims in this lawsuit is that, well, it’s not entirely clear that the Plaintiff has the goods.  Here’s an example:

"Plaintiff BMA is informed and believes and thereon alleges that the alleged fraudulent electronic wire transmissions were performed by Defendants on a daily basis during the Relevant Period and were carried out from Defendants’ Berkeley, California office and to respective offices or computer servers of the 35 exchanges that Defendants used to perpetrate their manipulative and fraudulent scheme alleged hereinabove. Plaintiff BMA is informed and believes and thereon alleges that each of Defendants FTX, Alameda, Alameda BVI, Bankman-Fried, Wang, Croghan, CWang, Wong and Ellison issued the alleged fraudulent electronic wire transmissions on a daily basis during the Relevant Period."

Now that sounds bad, I suppose, but there’s a problem. The Plaintiff doesn’t actually say which exchanges received wires and the pleading is on “information and belief” — in other words, Plaintiff asks you to believe or assume that this happens but doesn’t have actual knowledge of the events for purposes of alleging fraud, I’m not convinced this is gonna be enough. And I suspect that this is what a motion to dismiss is going to argue.

The meat of Plaintiff’s claim, is that on September 15, 2019 they tried to “manipulate prices of bitcoin futures listed on Binance’s newly opened SAFU futures trading platform by dumping about 255 bitcoins, valued at approximately $2,626,500 on to the Binance futures market at market prices in two minute time interval.” They failed to do so and then told exchange CEO Changpeng Zhao that it was just a mistake. The plaintiff says that the claim “was in fact a fraudulent statement made with a purpose to avoid closure of Defendants’ account on Binance and to continue Defendants’ illicit price manipulation on that exchange[.]”  Gotta be honest -- this sounds like a stretch to me as a predicate to an underlying criminal act necessary for a Civil RICO claim.

There are a bunch of other elements to a civil RICO claim, not just the underlying predicate criminal acts. If you are dying to learn more, there’s a nice treatise here, from the Jenner and Block firm. My thousand-foot view/assessment, is that this plaintiff is probably quite vulnerable to dismissal of Counts I and II, just not enough on the criminal violations. A lot of bad-smelling smoke, not enough fire to make it past a motion to dismiss in San Francisco federal court.

As to the other claims, my suspicion is also that a decent law firm will make similar mincemeat out of them.  Maybe one or two make it past a motion to dismiss. Maybe. Plaintiff claims, for example, that it was damaged by market manipulation in violation of the Commodities Exchange Act when it “sustained a loss of at least 10 bitcoins on or about June 26, 2019, due to a liquidation cascade, which, on information and belief of Plaintiff BMA, was caused by” the Defendants. The problem here again is that “information and belief” means (in essence) we don’t actually know but it might be true. I’m not sure that is going to be good enough to get past a motion to dismiss as this allegation is based on fraud, and you have to (when pleading fraud) allege facts that you actually know, with specificity -- information and belief doesn't get past Rule 9 of the Federal Rules of Civl Procedure.

The balance of the lawsuit has similar infirmities.  Negligence -- where's the duty?  Fraud -- again, failure to plead facts with specificity. Civil conspiracy? Why not throw in the tort of outrage and some myofacial pain disorder for damages while you are at it? The only way this case will have any teeth is if the Plaintiff can survive a motion to dismiss and do some discovery that actually gives weight to what is now a lot of surmise. Assuming the Defendants hire decent defense lawyers, this thing will linger in motion to dismiss land for a while and even if it isn’t dismissed immediately, I have serious doubts it’ll ever see a trial.

Bottom line — a long lawsuit asking for a ton of money doesn’t necessarily mean it’s going to be a successful lawsuit. It may be that the defendants did in fact engage in massive market manipulation. If so, this lawsuit is probably not the thing that will bring them down.