FTX Probe to Test Whether Law Giant Is Tainted by Conflicts (1)

An investigation into Sullivan & Cromwell’s relationship with FTX will test the elite Wall Street firm’s assertion that its pre-bankruptcy connections with the crypto exchange were limited.

US Bankruptcy Judge John Dorsey cleared former Unabomber prosecutor Robert Cleary to examine whether the law firm’s work for FTX and its former leader Sam Bankman-Fried created any conflicts of interest when it began leading the exchange through Chapter 11 proceedings. The firm has since billed more than $170 million to the FTX estate during the bankruptcy.

“A lawyer is obligated to provide the beneficiary of the work with undivided loyalty and disinterested advice,” said Georgetown Law ethics counsel Michael Frisch. “Did the lawyer have some interest either disclosed or not that impairs the ability to provide that disinterested advice? That is really the overarching question.”

Cleary’s investigation adds to scrutiny Sullivan & Cromwell faces due to its FTX work. A February investor lawsuit accuses the firm of aiding FTX schemes ahead of the crypto exchange’s collapse, and a pair of law professors in a paper last week questions Sullivan & Cromwell statements in the days ahead of the bankruptcy.

The firm may have used “deceptive tactics” to seize control of FTX from Bankman-Fried, Temple University law professor Jonathan Lipson and University of Pennsylvania law professor David Skeel claim in the paper, which draws on emails produced by Bankman-Fried in his criminal case.

Sullivan & Cromwell has previously said that it never served as primary outside counsel to any FTX entity. “The firm had a limited and largely transactional relationship with FTX and certain affiliates prior to the bankruptcy,” Sullivan & Cromwell said in January 2023.

FTX said Wenesday that “certain academics and others have parroted, in obvious coordination” Bankman-Fried’s “false narratives in an attempt to elevate his standing and image before the court that is about to sentence him.”

“In fact, but for the work of a large team of committed advisors, including Sullivan & Cromwell and others who have been unfairly maligned as part of Mr. Bankman-Fried’s defense strategy, billions of additional dollars would have been lost or stolen, and the recoveries to customers would be a fraction of what we can now expect” FTX said. “It’s time to put blame where it rightfully belongs.”

FTX and more than a hundred of its affiliates filed for bankruptcy in November 2022, listing at least $10 billion in assets and liabilities. A jury in Manhattan convicted Bankman-Fried a year later of seven charges, including wire fraud and conspiracy. US District Judge Lewis A. Kaplan in New York is scheduled to sentence Bankman-Fried on March 28.

Cleary’s Investigation

Dorsey, the bankruptcy judge, said Wednesday he will enter an order “as soon as possible” allowing Cleary, a New York-based litigator at Patterson Belknap, to conduct his investigation. Cleary will be required to submit a report summarizing aspects of the investigation within two months.

The US Trustee, an arm of the Justice Department that monitors corporate bankruptcies, has pushed for the outside probe since the onset of the bankruptcy. Dorsey originally rejected the request, saying such a probe would likely cost creditors more than $100 million. However, the Third Circuit reversed the ruling in an opinion that cited some of the conflicts questions raised by Sullivan & Cromwell’s role.

The Trustee later tapped Cleary to conduct the probe. Cleary served as the US Attorney for both the District of New Jersey and the Southern District of Illinois and was lead prosecutor of Ted Kaczynski, known as the Unabomber, who killed three people and injured 23 with bombs across 17 years last century.

Cleary’s investigation will examine whether there are conflicts of interest involving Sullivan & Cromwell “which were not adequately addressed” when the firm applied to be lead counsel, according to a proposed Justice Department order. A central feature of the review will likely be whether the firm intentionally or recklessly omitted things about its FTX relationship, Frisch said.

The Trustee has also asked Cleary to look at past investigations by FTX’s new management team, its creditors and government regulators, and to scrutinize if additional employees of Bankman-Fried’s failed crypto exchange were involved in fraudulent activity before its collapse in November 2022. Cleary will also review any investigations conducted around FTX’s use of its native token, FTT, to inflate its value, and make recommendations if further inquiries are needed.

Sullivan & Cromwell’s Work

Sullivan & Cromwell has acknowledged beginning to work for FTX after a former partner, Ryne Miller, joined FTX US as its general counsel. The firm earned over $8 million for work on 20 FTX matters in the 16 months before its downfall.

The firm has said in prior filings that Bankman-Fried handed over control of the company to restructuring expert John Ray after consulting with his father, the Stanford law professor Joseph Bankman, and three personal lawyers.

Judge Dorsey previously dismissed attacks from Bankman-Fried and others against the firm as “hearsay and rumors.” “There is no evidence of any actual conflict here,” Dorsey said during a January 2023 hearing approving the firm’s role.

Sullivan & Cromwell has defended the high fees since taking FTX into Chapter 11, arguing the costs will be modest compared to the recoveries. Andy Dietderich, the firm’s bankruptcy practice leader, said in a January hearing that customers and creditors who can prove their losses will likely get back all of their money.

Sullivan & Cromwell and the Silicon Valley law firm Fenwick & West are among several institutions with an FTX link that have been hit with a lawsuit from a proposed class of investors. Sullivan & Cromwell, represented by Hunton Andrews Kurth managing partner Samuel Danon, is due to file its first response in the case by May 13.