A Miscarriage of Justice?

Ian Ayres

Barbara Fried’s recent post on Substack, to my mind, lays out a devastating critique of the prosecution’s misappropriation theory of criminal liability in the trial of her son, Sam Bankman-Fried.  If you think the evidence is open and shut that SBF stole client money, you should think again.  Margin accounts like those offered by FTX are very different from traditional (spot) brokerage accounts at, say, Vanguard or Fidelity.  As John Donohue and I emphasized in a comment we posted to SSRN:

The whole purpose of a margin exchange is to permit customers to finance a portion of their purchases on the exchange with assets borrowed from other customers. FTX’s terms of service authorized such loans with regard to its margin account customers who opted for FTX margin accounts. A substantial majority of the funds deposited on FTX came from customers who opted into the margin trading program. To do so, they had to agree to Section 16.4 of the terms of service, which governed margin traders. The provision clearly stated that:

“Under certain market conditions, it may become difficult or impossible to liquidate a position [and] there is no assurance or guarantee that any such program activities will be sufficient or effective in liquidating your position. As a result, you may lose all of your Assets or incur a negative balance in your Account. In addition, even if you have not suffered any liquidations or losses, your Account balance may be subject to clawback due to losses suffered by other Users.”

Donohue and I emphasized this provision because FTX didn’t misappropriate client funds if the margin account holders gave FTX permission to loan their funds to other clients, including Alameda.  The final clawback provision is especially relevant because it warns margin clients that they may be subject to risk of loss due to losses suffered by other users, which only makes sense if the assets of margin users could be loaned to other account holders.

So what is the best interpretation of Section 16.4?  John and I pointed out:

The terms of service were expressly governed by English law. But the judge refused to admit expert testimony about what was permissible under FTX's terms of service. A defendant's expert, Lawrence Akka, was prepared to testify that under UK law, the loans to Alameda—and the uses that Alameda made of the funds—were permissible. To quote Akka: “FTX was obliged to honour customer withdrawals (i.e. to repay the debt of fiat currency that it owed), but was not constrained to use fiat currency for any particular purpose in the interim.” This doesn’t rule out the possibility that FTX breached its civil duty to its margin customers by allowing for excessive lending to Alameda—albeit now satisfied by the full payments in bankruptcy—but it does refute the idea that any borrowing of customer funds was blatant theft under criminal law.

As Fried points out, the fact that the prosecution sought to bar admission of Section 16.4 of the Terms of Service in a pretrial motion might be taken to indicate that they, too, believed that interpretation was at least plausible. 

Kaplan justified his ruling blocking Lawrence Akka from testifying about the meaning of the Terms of Service under UK law by stating that he (Kaplan) was competent to instruct the jury on foreign law himself.  Fried’s Substack post details what happened next: 

At the charge conference Kaplan announced he was going to instruct the jury [on the meaning of the Terms of Service] under US law instead. . . . His stated reason was that the defense had failed to introduce any evidence concerning UK law [!]

But then he gave the jury no instructions [under US or any other law] on the most important legal issue in determining whether the funds in question were misappropriated (stolen): whether the Terms of Service authorized the loans from FTX to Alameda. . . . 

Instead, as Fried states, he “invit[ed the jury] to conclude that the terms of the contract were irrelevant because this ‘is a criminal wire fraud case. It is not a civil case for breach of contract.’” (Transcript, p. 3155)  The fact that the crime was charged under a federal wire fraud statute has no relevance to whether an underlying crime was committed.  It merely states the method of communication used in its alleged commission.  The contract at issue here, on the other hand, has everything to do with whether a crime was committed.  Contracts can authorize one party to use another party’s assets and thereby change what would otherwise be criminal conversion into a commonplace, perfectly lawful transaction.  When I drive Avis’s car off the rental lot, I am not stealing it, because my contract with Avis authorizes me to do so.  The jury’s instruction should have allowed the jury to conclude that the terms of service authorized FTX to lend the funds of margin account holders to Alameda.  Indeed, the judge might have reached such a determination as a matter of law.

In seeking to justify his decision not to instruct the jury on the legal import of the express provisions of the terms of service, the judge dismissed them as an “idle communication.” (Transcript, 2853-54)  Fried appropriately concludes:

In a single sentence, Kaplan negated the legal relevance of contract terms, inviting the jury to supply the terms of a private contract from—what? general principles of law? customs of the trade? their own beliefs about what these parties ought to have agreed to? 

There are still important questions about whether SBF might be criminally liable for representations that FTX and he made at various points in time.  (In an earlier post, Fried questioned whether the alleged misrepresentations could plausibly support a criminal conviction, let alone a 25-year prison term.)  But in my view, she lays out a devastatingly persuasive case that the prosecution should not have been allowed to argue to the jury, dozens of times during the trial, that the defendant stole billions of dollars of client funds – at least without much more careful attention to whether the terms of service allowed those funds to be lent.

Before ending, I should mention there are ad hominem reasons why you might discount the foregoing.  As I have disclosed before, I am a friend and coauthor of both Barbara Fried and Joe Bankman, the parents of Sam Bankman-Fried.