A group of FTX U.S.-based employees stumbled across a backdoor for its affiliated trading firm Alameda Research months before the crypto exchange collapsed in Nov. 2022, the Wall Street Journal reported, citing people familiar with the matter.
The backdoor allowed Alameda to have a negative balance of up to $65 billion using customer funds, according to previous court filings revealing code buried in FTX’s systems. Negative balances were not possible for other FTX users, who would be automatically liquidated if they fell into the red.
The employees reportedly alerted their division boss to the discovery, who discussed it with former FTX CEO Sam Bankman Fried’s lieutenant Nishad Singh, but the issue was never resolved. Instead, the leader of the team who raised the concern was sacked, the WSJ said.
Bankman-Fried’s criminal trial relating to alleged fraud at FTX began in a New York federal court earlier this week.
The LedgerX team’s code discovery
The employees, part of a team from LedgerX, a U.S. crypto-derivatives exchange acquired by FTX's U.S. arm in 2021, were examining the compatibility of FTX's international platform code against stricter U.S. regulations when they reportedly found the backdoor in spring 2022.
"Just wanted to point out that there are currently a few places in the code base where Alameda gets special treatment in one way or another," LedgerX employee Jim Outen wrote in a May 2022 message viewed by the WSJ.
Outen's boss, LedgerX Chief Risk Officer and Commodity Futures Trading Commission veteran Julie Schoening, replied "there are less rigid rules" on the offshore exchange, adding, "but yeah we should clean up this sort of stuff."
In turn, Schoening reported the concerns to LedgerX head Zach Dexter, who discussed the discovery with FTX Director of Engineering Nishad Singh, a key member of Bankman-Fried's inner circle.
However, "Following a thorough internal investigation, LedgerX has found no evidence that any of its employees were aware of any reported code enabling Alameda to take FTX customer assets, and firmly denies any contrary allegation," a spokesman for Miami International Holdings, the company that bought LedgerX earlier this year, told the WSJ.
Backdoor left open, Schoening fired
Dexter reportedly believed the problem had been fixed after Singh removed some of the code. However, the loophole remained, and by August 2022, Schoening had reportedly been sacked, allegedly for sending "inappropriate messages" to other employees. Some of WSJ's sources said the messages were doctored or taken out of context, adding that Schoening irritated her bosses by identifying FTX's risk management issues.
Schoening's lawyer, Lisa Banks, threatened to sue over the dismissal, and the two sides reportedly agreed a $5 million settlement in a deal that failed to complete before the exchange collapsed.
Whistleblowers who threatened to expose alleged fraudulent behavior were sometimes paid off by FTX, according to a court filing in June from the management team handling its bankruptcy.
The backdoor forms a key part of the prosecution's case in Bankman-Fried’s trial. Bankman-Fried faces multiple fraud charges and could serve decades in prison. He pleaded not guilty to all charges.
Singh has already pleaded guilty to fraud and is expected to be a key witness against Bankman-Fried, with prosecution allegations suggesting Singh was complicit in creating the loophole for Alameda.
Neither FTX nor LedgerX immediately responded to a request for comment from The Block.
Disclaimer: The former CEO and majority shareholder of The Block has disclosed a series of loans from former FTX and Alameda founder Sam Bankman-Fried.
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