Sam Bankman-Fried (ex FTX) - when lawyers stop representing their clients
The news just keeps getting worse for Sam Bankman-Fried (SBF) after the collapse of his cryptocurrency exchange FTX. Last Friday, Sam Bankman-Fried's lawyer, Paul Weiss, announced that, due to conflicts of interest, he has stopped representing SBF, the troubled cryptocurrency magnate. For this article, we focus on the topic of lawyers removing themselves from representing their clients and the regulatory obligations they have to their clients.
Background
If you don’t follow the cryptocurrency industry or haven’t heard of FTX and Alameda Research, here’s a quick background.
There are essentially two entities embroiled in the current situation. First, there is FTX, a leading centralized cryptocurrency exchange specializing in derivatives and leveraged products. FTX was founded by Sam Bankman-Fried (SBF), an MIT graduate and former trader on Wall Street. What are derivatives? These are essentially financial products that originate from other financial products or an underlying asset. For example, if you want to trade crude oil but you’re not an oil company that wants the physical asset, you can buy contracts on the public market that can be traded without me having to actually take possession of a barrel of crude oil. Through its trading structure, the trading of derivatives is often seen as having high volatility but potentially high returns. Another aspect of derivatives is the ability to leverage borrowed funds to amplify the returns.
Second, there is Alameda Research, a quantitative trading firm that was also founded by Sam Bankman-Fried. Quantitative trading uses computer algorithms and programs that are based on sophisticated mathematical models to find and take advantage of trading opportunities. In January of 2018, SBF organized an arbitrage trade, moving up to $25 million per day, to take advantage of the higher price of Bitcoin in Japan compared to the price in America. The quantitative trading algorithms that SBF setup found small arbitrage opportunities in Bitcoin but amplified them on a massive scale, which made them extremely profitable. Between 2021 and 2022, Alameda Research amassed $60 million worth of crypto tokens, believing there would be an arbitrage opportunity prior to those tokens being listed on their FTX trading platform. Unfortunately, due to various circumstances, the arbitrage opportunity did no pan out, and Alameda Research suffered significant losses in May and June 2022. It is alleged that this resulted in FTX lending Alemeda Research more than half of its customer funds to cover its losses. If this is found to be true, it would put FTX and their executives in a really bad position as it would be considered co-mingling of investor funds, which ironically, was explicitly forbidden by FTX's terms of service. According to anonymous sources cited by The Wall Street Journal, FTX executives did know about this, which dispels any suspicion of a rogue trader or disgruntled employee at FTX making these transactions.
Events leading up to trouble
The cryptocurrency market has been on a downward spiral this year. After the hype and craze of the cryptocurrency market in 2021, it has taken significant losses for most investors in 2022. At the peak in 2021, Bitcoin was trading close to $65,000 per coin and as of November of 2022, Bitcoin was trading at $16,000, representing a staggering 77% drop in its value. As Bitcoin fell, so did all the other cryptocurrencies. This is where things got messy because amongst the trading products available at FTX was their own token, FTT. On 2 November 2022, CoinDesk, a large crypto market publishing and news outlet, published an article alleging that Alameda Research had significant holdings in the FTT token and that FTX essentially used part of these tokens to leverage debt to fund its business operations. After the article from CoinDesk was published, Binance, a competing cryptocurrency exchange that had previously invested in FTX, said it would sell all of its FTT holdings. This caused the market price of the token to drop significantly overnight. Within 2 days of the article, the value of FTT would go from $23 dollars down to $4.50, an 86% drop in value. The move also triggered a spike in customer withdrawals from FTX, causing the exchange to freeze withdrawals due to an inability to meet withdrawal demands. Only US$4.5 billion out of the original US$32 billion worth of crypto assets remained on the FTX network before withdrawals abruptly ceased to be accepted. On November 8, Binance signed an offer to acquire FTX pending due diligence but later withdrew the offer, citing reports of mishandled customer funds and U.S. government investigations.
FTX submitted a Chapter 11 bankruptcy petition on November 11, and SBF resigned as the company's CEO. This also affected100s of other affiliates within the FTX and Alameda Research ecosystem, causing a massive ripple effect across the broader cryptocurrency market. The business is currently being run by restructuring lawyer John J. Ray, who previously oversaw Enron Corp.'s bankruptcy. FTX itself has retained Wall Street law firm Sullivan & Cromwell to provide outside legal support as it goes through the bankruptcy proceedings. FTX’s assets and liabilities, including its large network of linked companies, are estimated to be between $10 billion and $50 billion. It is alleged that the $16 billion worth of assets owned by Bankman-Fried have disappeared. Last Thursday, a class action lawsuit was also launched, alleging Bankman-Fried and other well-known social media influencers and celebrity advocates defrauded investors.
The trouble with SBF
Obviously, SBF is running into a lot of legal headwinds. In the last couple days, word has gotten out that SBF has personally been let go by his law firm because, in the words of the platform's US counsel, SBF is obstructing restructuring efforts by "incessant and disruptive tweeting." Since Twitter is a public platform, most have seen these “tweets” and can understand where his counsel is coming from. Bankman-Fried has sought to explain the implosion of FTX and disparaged government regulators in posts on Twitter and conversations with reporters, which seems to have hampered his legal counsel’s efforts to represent him properly.
Martin Flumenbaum, partner at law firm Paul, Weiss, Rifkind, Wharton & Garrison, informed SBF that due to an undisclosed conflict, the firm would no longer represent him. Mr. Flumenbaum is quoted as saying “we informed Mr. Bankman-Fried several days ago after the filing of the FTX bankruptcy, that conflicts have arisen that precluded us from representing him.” When asked about what specific conflicts have arisen, Mr. Flumenbaum did not disclose. In another report, Reuters did note that Mr. Flumenbaum is currently defending Christian Larsen, the founder and chair of crypto payment and exchange company Ripple Labs Inc, in a high-profile lawsuit filed by the SEC. His law firm represents many other financial industry clients, and it may seem that getting mixed up in the newly created FTX situation with SBF may have put the law firm in conflict or at least made it extremely difficult for them to create a winning defence for their other clients.
What by-laws are available for lawyers to stop representing clients?
The quick answer is no, but it’s not as straightforward as one would think and is different across jurisdictions in North America. In Alberta, Canada, according to The Law Society, when withdrawing, a lawyer must avoid causing prejudice to the client and others, including witnesses, the court, jurors, and opposing counsel and parties. Essentially, if the action of withdrawing from the representation of a client causes harm or injury that results or may result from some action or judgment, then a lawyer would be obliged to continue regardless of the client relationship. It’s interesting because The Law Society also points out that, for example, a client intent on committing perjury poses an ethical dilemma. If a lawyer fires the client in the midst of trial, he or she risks painting the client as a liar. Soldiering on, however, would be a breach of the lawyer’s duty of candour to the court.
The American Bar Association also indicates in rule 1.16.7 that a lawyer may withdraw from representation in some circumstances. The lawyer has the option to withdraw if it can be accomplished without material adverse effect on the client's interests. Withdrawal is also justified if the client persists in a course of action that the lawyer reasonably believes is criminal or fraudulent, for a lawyer is not required to be associated with such conduct even if the lawyer does not further it. The lawyer may also withdraw where the client insists on taking action that the lawyer considers repugnant or imprudent objective with which the lawyer has a fundamental disagreement.
Essentially, the rules for lawyers indicate that courts granting their request to fire a client is difficult and is only granted under exceptional circumstances. At the same time, there is no obligation for the lawyer to represent the client in a new case, especially if a conflict is to arise.
What’s interesting is that SBF’s lawyers cited both rules that would grant them leave from representing him in the current situation. Their request included both SBF obstructing their ability to represent him properly AND that a conflict has arisen. Perhaps they were requesting as many arguments as they could to cover all the potential bases where it would be reasonable to stop representing a client.
Final takeaway
The final takeaway is that yes, lawyers can “fire” their clients but under only under extraordinary circumstances and as long as it doesn’t bring adverse effect and damage on your client by doing so. One consideration for lawyers needing to do this is the need to carefully consider the communication and PR strategy behind this action. Careful handling of any potential concerns from current clients would need to be addressed as lawyers wouldn’t want to lose the confidence of other clients. Lawyers wouldn’t want to portray themselves as cutting ties whenever a case runs into hardship. Carefully planned and strategically laid out communication will help guide a lawyer and their firm’s reputation on a more positive note rather than a negative one.
