FTX Violated Its Own Terms of Service and Misused User Funds, Lawyers Say

Sam Bankman-Fried’s embattled cryptocurrency exchange FTX may have misused customer funds in violation of its own terms of service, lawyers have told CoinDesk.

FTX’s downward spiral, which began after a CoinDesk article last week about its sister company Alameda Research’s financials, prompted the exchange to halt customer withdrawals on Tuesday, indicating it did not have the required funds to cover all the crypto locked on its platform.

But the exchange’s terms of service states that none of the crypto in customer accounts are “the property of, or shall or may be loaned to, FTX Trading,” and that the platform “does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading.” In other words, FTX cannot use the funds for purposes other than just holding them on customers’ behalf.

Citing people close to the matter, the Wall Street Journal reported Thursday that FTX had placed billions of dollars worth of customer funds on risky bets, with some suspecting customer funds were used to help bolster Alameda.

“Using customers’ investments to support Alameda Research is a serious problem and could amount to claims for fraudulent breach of trust,” said Louise Abbott, a disputes solicitor in the U.K. who deals with cryptocurrency and asset recovery at Keystone Law.

Speaking with CoinDesk, three other lawyers are in agreement with Abbott, saying FTX’s actions appear to point to a misappropriation of customer investments.

“If you were an FTX customer, you should have felt very safe because they were telling you that they weren't going to do anything with your belongings,” said Matthew Nyman of the digital assets and Web3 practice at the law firm CMS. “And if it turns out that they breached their word, using those funds to lend to Alameda or anyone else, then that's even worse, because they held themselves to a higher standard.”

Twitter user @wassielawyer, who was one of the first to flag the Terms of Service, went even further, saying, “FTX was literally stealing customer funds.”

Although FTX’s quick collapse following the CoinDesk article and a Twitter-spat between Bankman-Fried and rival Changpeng Zhao of Binance suggests the exchange had misused user funds, Nyman says it may not constitute actual theft. He added that it is a technical difference and a serious wrong either way.

The provision made in the terms of service stipulating that customers retained title to their assets will be particularly important if the company ends up facing insolvency, Nyman said. With Binance backing out of a buyout and Alameda winding down services, FTX could file for bankruptcy in Antigua and Barbuda, where it was incorporated.

But there might be a silver lining, Nyman said. Because the terms of service specify that customer funds do not belong to FTX, those funds cannot be used to pay back creditors or other stakeholders in the event of insolvency. The lines may blur, however, for those customers who opted into a yield-earning program, because those funds were not subject to the same retention of title provisions and can therefore get caught up as assets in a bankruptcy case.

Beyond any civil actions taken by FTX users who cannot access their funds, misappropriation of customer funds could lead to criminal charges. The U.S. Department of Justice is already investigating FTX, the Wall Street Journal reported Wednesday.

FTX’s Japan unit was ordered by regulators to suspend all operations after it halted withdrawals without specifying a date for reinstatement and without stopping the onboarding of new customers.

"It is necessary to take all possible measures to prevent a situation in which [Japanese customers' assets] are leaked to a [foreign] affiliated company," Japan’s Financial Services Agency said in its suspension order.

Read more: Sam Bankman-Fried Says Alameda Winding Down, Promises FTX US Customers' Funds Are 'Fine'

Camomile Shumba contributed reporting.

Update (07:54 UTC, Nov. 11, 2022): Updates Matthew Nyman's title in seventh paragraph and adds additional comments throughout.