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New York AG accuses crypto firms of $1B fraud, citing risky loans to Bankman-Fried’s hedge fund

New York state prosecutors sued a pair of crypto firms for a billion-dollar fraud on customers by over-concentrating their loans in Sam Bankman-Fried's hedge fund, which he's accused of using to loot $10 billion from FTX customers.

MANHATTAN (CN) — While FTX founder Sam Bankman-Fried’s criminal fraud trial in New York federal court rolls through its third week, the New York attorney general sued cryptocurrency firms Digital Currency Group and Gemini for lying to investors and failing to adequately manage the risks associated with exposure to the crypto hedge fund at the center of Bankman-Fried’s federal trial.

The 58-page civil complaint, filed in Manhattan state court, accuses Genesis and Gemini of defrauding more than 230,000 investors, including at least 29,000 New Yorkers, of more than $1 billion.

According to the New York attorney general’s investigation, Gemini lied to investors in a program it ran with Genesis and repeatedly assured them it was a low-risk option.

The program, Gemini Earn, promised interest rates as high as 4.29% on cryptocurrency deposits. Gemini and Genesis would then lend out those funds to other investors.

Gemini’s internal analyses of Genesis showed the company’s financials were not sound and it was at risk of being unable to repay its open-term liabilities — including to Gemini Earn investors — according to state investigators.

Even though Gemini knew Genesis’ loans were under-secured, and at one point highly over-concentrated with one entity, Sam Bankman-Fried’s Alameda did not reveal this information to investors, the investigation found.

“From July 6, 2022, through August 16, 2022, these reports showed that Genesis Capital’s loans were heavily concentrated in a single counterparty, cryptocurrency trading firm Alameda, which was the borrower for nearly 60% of all outstanding loans from Genesis Capital to unaffiliated counterparties,” the state's complaint says.

Gemini was founded by the Winklevoss twin brothers, Tyler and Cameron Winklevoss, who were made famous as jilted investors in the movie "The Social Network" about the origins of Facebook.

Genesis, a subsidiary of the Digital Currency Group, ended up declaring bankruptcy in January 2023, a few months after FTX's abrupt collapse in November 2022 following the cryptocurrency equivalent of a bank run on deposits.

The Securities & Exchange Commission sued Gemini and Genesis in January for selling unregistered securities to retail investors through the Gemini Earn crypto asset lending program.

Federal prosecutors have accused Bankman-Fried of directing FTX coders to grant unlimited withdrawals for Alameda, regardless of whether it carried a negative balance, and ultimately plundering more than $10 billion of customers’ trading funds for risky investments, publicity, and real estate purchases.

New York Attorney General Letitia James brought the civil suit under New York State’s Martin Act, an expansive 1921 state law that broadens prosecutorial power to fight financial fraud.

The lawsuit also charges Genesis, its former CEO Soichiro Moro, its parent company, DCG, and DCG’s CEO Barry Silbert with defrauding investors and the public by trying to conceal more than $1.1 billion in losses, which were borne by investors.  

The state seeks to bar Gemini, Genesis and DCG from the financial investment industry in New York, as well as restitution for investors and disgorgement of ill-gotten gains.

“These cryptocurrency companies lied to investors and tried to hide more than a billion dollars in losses, and it was middle-class investors who suffered as a result,” James wrote in a statement Thursday.

“Hardworking New Yorkers and investors around the country lost more than a billion dollars because they were fed blatant lies that their money would be safe and grow if they invested it in Gemini Earn. Instead, Gemini hid the risks of investing with Genesis and Genesis lied to the public about its losses. This fraud is yet another example of bad actors causing harm throughout the under-regulated cryptocurrency industry.”

During the relevant period of the complaint, from Feb. 2, 2021, through Nov. 16, 2022, Cameron Winklevoss served as Gemini’s president and Tyler Winklevoss served as its CEO. They famously battled with Meta CEO Mark Zuckerberg over the creation of Facebook, which the twins claimed copied their own now-defunct social media website ConnectU. Zuckerberg would eventually settle out of court, and the twins went on to become investors in numerous tech startups.

Federal prosecutors have accused Bankman-Fried of gambling in his own casino by directing his Alameda Research hedge fund to secretly funnel and illegally commingle billions of dollars of customers’ deposit funds from his FTX exchange platform as loans for cryptocurrency futures trading on the FTX exchange he also co-founded and controlled.

Alameda co-CEO Caroline Ellison — Bankman-Fried’s on-again, off-again girlfriend and the cooperating star witness of Bankman-Fried’s federal trial — testified last week that when Genesis asked to see an updated Alameda balance sheet, she and Bankman-Fried brainstormed ways to make the company’s financial position look stronger so that Genesis wouldn't ask for more money back.

She testified that she prepared a variety of different balance sheets to show Genesis, and Bankman-Fried ultimately selected a ginned-up balance sheet that concealed the reality that Alameda was taking some $10 billion from FTX's customers’ deposits. By October 2022, she said, Alameda had taken $14 billion from the platform’s users and Bankman-Fried was trying to raise money to fill the enormous financial deficit.

For the last three weeks, Attorney General James has been attending her office’s civil fraud trial against former President Donald Trump in Manhattan Supreme Court, which is directly next to the Manhattan federal courthouse where Bankman-Fried’s six-week trial is underway.

Prosecutors in Bankman-Fried’s trial are expected to rest their case next Thursday following a short break.

Bankman-Fried’s defense attorneys have not indicated whether or not he will take the stand to testify in in his own defense.

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Categories / Financial, Securities, Technology

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