This is Bloomberg Law with June Brusso from Bloomberg Radio. Caroline Ellison, a former top executive in Sam Bankman Freed's fallen FTX cryptocurrency empire, was sentenced to two years in prison today in order to forfeit eleven billion dollars for her role in the collapse of FTX. Ellison was the prosecution's star witness against Bankman Freed, her former boss and boyfriend.
Prosecutors called her testimony the cornerstone of the trial. The same judge Lewis Kaplan had sentenced Bankman Freed to twenty five years in prison after a jury convicted him of fraud. Ellison's lawyers asked the judge to let her off without any prison time, citing both her testimony at the trial and the trauma of her on again, off again romantic
relationship with Bankman Freed. And though Judge Chaplin said Ellison's cooperation was quote very, very substantial, he said a prison sentence was necessary because she had participated in what might be the greatest financial fraud ever perpetrated in this country and probably anywhere else. He said in such a serious case, he couldn't let cooperation be a get out of jail
free card. Joining me is Bloomberg Legal reporter Christopher Domesh, who covered the sentencing and the trial, tell us what she said in her apology.
She was very contrite and apologetic during her speech to the judge. She immediately apologized to everyone, FPX employees, Aloma employees who had lost their jobs, people who had lost money, her family, her friends. She said they abused the trust that investors had placed in them in the worst possible way, and she was deeply ashamed of what she had done.
She said she had gradually found herself drifting away from the person that she wanted to be, and that the culture that you know, promoted positivity and discouraged dissent kind of helped that along. She said, it felt harder and harder to extricate myself and do the right thing, and she apologized for not being brave. She said, lying isn't something that came naturally to her, and it's been a
relief to be completely honest about things. She said she found that meeting and just trying to be a good person in small and noble ways, talking about, you know, working for the soup kitchen and some of the other things that she's done.
The prosecution here didn't ask for any jail time at all.
Yes, that's correct. They actually didn't ask for a specific sentence at all. You know, depending on the case, prosecutors often you know, asked to set someone in light up their cooperation. They don't really go and ask for a
specific sentence like they are with most defendants. So they at no point did they really ask for anything other than you know, substantial departure downward from the guidelines, which were admittedly draconian and you know, basically one hundred and ten years in prison, which is most driven by the loss.
And it seemed like the prosecution's statement at the sentencing was almost similar to the defenses.
Yes, it was very similar. You know, they acknowledged Daniel Festoon, who is the assistant US attorney who did the sentencing today. You know, she she made it clear that this was you know, one of the most extraordinary cooperators she has dealt with. You know, she said she came clean immediately. You know that the person that they saw on the stand is the exact same person who came and talked
to them. You know, they noted the difference between Sam bankmin Freed's testimony in hers when he continually deflected and essentially said that, you know that he might have succeeded in getting away with it without her cooperation.
Yeah, it's sort of like she's in the cooperators Hall of Fame, because the judge said, I've seen a lot of cooperators in thirty years, I've never seen one quite like miss Ellison.
Yes, that's the quote. You know. He he had a lot to say in terms of praise of what she said, most notably pointing out her testimony about the seven spreadsheets that she had created at bankman Freed's behest when you know, lenders started asking questions that essentially masked the size of the fraud, and he called that really like one of the key pieces of evidence, if not the main piece of evidence, which she revealed to the prosecutors during her
proper session. So he was very you know, specific about praising her for what she had said on the stand. But you know, once he got around and he didn't think that she needed to be specifically you know, prevented from doing anything else. He certainly made a point that she would never do it again. But then he kind of turned a little bit and basically started talking about how Sam Bankman freed had her kryptonite and that she
should have known better. And while he said he didn't really think she needed to be deterred from future crimes, he said, this is one of the most serious financial frauds ever, you know, perpetrated in this country or elsewhere, and didn't think that her cooperation could get out of jail free car And at that point he pronounced sentence.
Was there any reaction from Ellison when you did that?
Allison hardly reacted. I think she had kind of realized where he was going with some of the signals he had said. In the moments before he pronounced sentence. Her parents, you know, looked shocked, and her mother closed her eyes, her sisters closed their eyes, and after the proceeding was over, they clearly were in tears, wiping it their eyes with tissue.
And so, Chris, she gets to serve this in a minimum security prison.
Yeah, that's what he recommended. It's obviously up to the Bureau of Prisons as to where she'll serve her sentence, but he did grant emotion that he would recommend him in of security and close to Boston.
And in federal prison, you serve eighty five percent of your prison sentence and then become eligible for release if you have had good time.
Something like that. You know, generally people serve about seventy five eighty five percent as long as they they have good behavior. And it's hard to believe that she wouldn't be a model prisoner, right.
I can see how though her family might have thought that it was going to end up in no prison time, since the Probation Department recommended no prison time and the judge's remarks seemed to be heading towards no prison time and then boom.
Yeah. I mean, I think a lot of people, just given you know, what we see with cooperators in general, didn't really think that she would get prison time. But there are plenty of people who thought it was a decent possibility. And you know, Lewis Kaplan is a very serious judge. He intends to punish people and he does. And in the end of the day, I guess he felt that this was just too large of a fraud to keep her out of prison.
Now, what about the eleven billion dollars in restitution?
Yeah, so a lot of that is the government intend basically said it's it's intending to seek forfeiture through the bankruptcy process withouts that have already been forfeited.
So now there are two other cooperators who are going to be sentenced FTX co founder Gary Wang and former engineering chief Mashad Singh later this fall. But their cooperation was not as great as hers, was it.
I mean, I don't think anybody cooperation possibly in the history of cooperation, maybe as serious as hers. But it's certainly not a good sign for them that he sent her to prison. I mean, she gave up the ghost, you know, and she told prosecutors more than they already knew, So it would be hard to believe that he wouldn't find some way to sentence them to prison time as well.
So this closes another chapter in the collapse of FTX, with many more chapters to come, and that includes Sam Bankmanfried's appeal, which we've discussed before. Thanks so much, Chris. That's Bloomberg Legal reporter Chris Domesh coming up next on the Bloomberg Law Show. Coinbase and the Securities and Exchange Commission fased off in a Philadelphia appellate court over rule making.
I'm Juian Grossow and you're listening to Bloomberg. Cryptocurrency exchange Coinbase and the Securities and Exchange Commission fased off in a Philadelphia appellate court, with Coinbase trying to force the SEC to create new rules that would govern digital assets and help end a long legal fight between the industry and regulators. Judges Thomas Ambro and Stefanos Biebis questioned the SEC's refusal to engage in rule making and its approach of regulation by enforcement.
Usually you can do things sucrementally, and maybe that's the argument against what rulemaking. We've got to proceed step by step, but.
It almost looks as if to an outside observer, as if you're going after the platforms in a way that will crush the industry without really getting into rule made.
It is true that this case is not directly about due process, but there are some serious notice concerns with we might hit you with serious civil penalties, but we won't tell you what will trigger the civil penalties.
Although Judge Ambro did acknowledge the newness of digital assets.
In this area, which is you know, since two thousand and eight, two thousand and nine, it is so new I can see why a lot of regulators or people considering regulation are saying we better go slow on this one.
This is a new world.
And Judge Bieba's asked Coinbase, as attorney Eugene Scalia, the big question, what's the endgame?
Eran or we are asking now that they be ordered to proceed directly to a rule making. We think they have had more than enough opportunity to answer coinbasis, workability, concerns.
Extraordinary remedy. What would we say has to be in such a.
Rule joining me? Is security law expert James Park, a professor at UCLA Law School, Jim tell us how this ended up before the Third Circuit Court of Appeals.
Coinbase filed a petition with the SEC asking it to write rules relating to crypto, and the SEC denied that petition, and so Coinbase filed the lawsuit, thing that the denial was arbitrary and capricious. That's a standard that's typically applied in administrative law. And the district court initially denied that petition, and now it was appealed to the Third Circuit Court of Appeals and they heard the oral argument on it.
The lawyer for Coinbase, Eugene Scalia, and I have to say he does sound a little like his father, so it was sort of deja vu all over again.
That right.
Wow. So he told the three judge panel that the SEC had provided no explanation for denying the request for rule making, and coinbase is complaining about the SEC's regulation by enforcement. Tell us more about its arguments.
I think their main argument is that the SEC has publicly said to various crypto organizations, come in and register, and their argument is that this is disingenuous because there is no real practical, pragmatic way for these associations to register and provide disclosure. And this reflects the decentralized nature of blockchain projects, where you are essentially creating a network community that runs itself without any central manager that is
in charge. And unlike a corporation where you have a corporate entity and a centralized management team that can collect disclosure about the corporation, put it into SEC filings and file it in theory, you do not have that with crypto projects. And their argument is that you know, these crypto projects associations cannot come in and register because there is no central issuer that can provide disclosure. And until we have a set of rules that tells us how this works,
we simply cannot move forward. I think that's the basic crux of their argument.
Is it often that agencies are asked, you know, in quarter anywhere, to make rules about things, because usually you think the less rules, the better for those who are being regulated.
It's true, and it's just an interesting example where the industry is demanding a certain amount of certainty, and because this is a industry that is still emerging, is on the border in terms of legality. I think that Coinbase others in the industry believe that a set of rules or a statute would confer a certain amount of legitimacy on crypto, because if you regulate it, it must be
permissible in some instances. And I think that there are certainly cases where you see corporations in the industry asking for more specificity with respect to administrative rules. That is something that we do see from time to time. Whether or not that happens in a formal petition for rulemaking, I think that is less common. I think that is much less common, and that this is an unusual case based just on my knowledge of the SEC.
So explain the SEC's position and maybe you should start by the Howie jest. They say, you know, we don't need to make rules here, we have enough rules.
That's their argument is that we have an established legal framework. We have the securities active nineteen thirty three. We have Howie tests that says that investment tracks the securities in certain circumstances. We have shown you through various administrative releases and enforcement actions how we think to how we test applies to crypto, and in some circumstances they are securities.
When something is a security, we have a set procedure where you have to file a registration statement if you want to sell those securities to the general public. If you are in exchange that has securities trading on it, you also have to register with us as well. And I think they would say, you know, you want this to be this centralized organization where no one is in charge. But the reality is that there is usually a central
group of individuals who basically start these crypto projects. They are developing the code, they develop the applications, They reach out to investors, they promote it, they promise high returns. They keep, you know, a lot of crypto for themselves of the price of the crit that goes up, they make a lot of money, almost like a kind of like a controlling shareholder or insider of the organization. You know,
those organizers could certainly provide disclosure. They could, you know, certainly be responsible for filing a registration statement, and that has not happened. I think that's what they would argue in response.
So you know that it's often hard to tell from the oral arguments how the judges are going to rule. So a couple of the judges did acknowledge that this was a new area and maybe you'd want to proceed slowly, But then you had some sort of accusations against the SEC. One judge said that it looks like you're going after platforms in a way that would crush the industry without getting into rulemaking, and another said, it's not that you're not interested in the area, it's just that you're interested
in picking off wrongs without giving higher level guidance. It's hard to measure which way it's going, But it did seem like they had a lot of hard questions for the SEC.
Judges are going to ask hard questions aboth sides, and it's hard to know if they're playing devil's advocate or these are arguments that they're grappling with. But I suspect it's very possible, and it's maybe probable that these questions reflect a certain skepticism about the SEC's position. And you know, the idea that the SEC is crushing the crypto industry
is probably accurate to some extent. Now, the SEC would say, well, the reason we are closely regulating this industry and preventing the schemes from flourishing and selling and distributing crypto to a lot of members of the public is because we're concerned that a lot of these projects are fraught and that investors are going to lose a lot of money, and if we don't keep an eye on it, we're
going to be blamed. People are going to ask us, you know, what were you doing, And given past experience with you know, FTX, for example, and some of the other scandals that we've seen, there is probably good reason to be very careful about allowing wide scale distributions of crypto to public investors in the United States. So I think that the judges, though, are you know, I think that probably reflects the sincere questioning of the SEC and
its regulatory approach. It has moved sometimes in contradictory ways, in ways that are ambiguous, and you've seen some shifts in their policy where sometimes they are open to passing rules, other times, you know, they seem to not be open to that, and so they have kind of shifted their position here and there. The SEC would say, well, this reflects the difficulty of keeping up with this innovative technology and understanding exactly what's going on. And we were very
careful at first. We didn't crush it right from the beginning because we just wanted to see how it would evolve, and over time, with experience, we now understand there are
some real problems in dangers. There have not been a whole lot of useful applications of crypto that we know of, other than its use as a currency to you know, make transfers of money that would not be permitted under other federal regulations like banking law, and that's that's sort of the main thing that it has been used for. So I think that, you know, the questions, I think do reflect a general frustration at the SEC, and maybe
you know the reality. I think that the SEC is not interested in creating an easy path for these crypto firms to flourish. I think that is probably accurate.
So do you think that that's the reason why they're not making rules, because it seems pretty clear under Gary Gensler that they consider digital assets as securities.
I think so. I think that it's it's complicated. I think that there are a lot of really difficult issues here, and there are no clear answers as to what sorts of regulations you would pass, and a lot of the sort of issue of whether a digital asset is a security or not is very fact intensive. So you know, to give an example, sometimes crypto is purchased for consumptive reasons. I want this digital coin because it gives me access
to this service. Sometimes it's purchased because I want to make money, because I'm speculating, I'm investing in this network. And if it's investment, it's more likely to be a security. If it's more for consumptive means, then that's less likely to be a security. How do you write a rule that tells us when something is more of a consumptive
purchase than something that is for investment. It is very difficult to do so, and you know that I think is part of the reason why the SEC is wary about getting into this process of trying to draw these distinctions. It would much rather look at these situations case by case and bring an enforcement action and maybe litigate it before a judge, as opposed to trying to answer some questions that may not be answerable. And I think that's a reason why they are not essentially writing these rules.
And I do think that FTX is still you know, and the crypto winter, as they say, is something that has really affected the SEC's view of crypto. And if you write rules that permit crypto firms to sell widely to the public and there are significant frauds, then the SEC will get blamed for that too, So it may not be in their interest to go forward with extensive specific rules.
Coming up next on the Bloomberg Lawn Show, I'll continue this conversation with Professor James Park of UCLA Law School. What's the most likely way the Third Circuit will rule. I'm June Grosso, and you're listening to Bloomberg Cryptocurrency Exchange, Coinbase and the SEC face staff. On Monday, before the Third Circuit Court of Appeals in Philadelphia, Coinbase was urging the Federal Appeals Court to force the SEC to create
new rules that would govern digital assets. The SEC contends that current rules and existing laws governing securities are adequate for the regulation of digital assets. I've been talking to securities law expert James Park, a professor at UCLA Law School. So at one point, one of the judges said to Coinbase's attorney, well, what rule would we tell them to make? I mean, do they have to say specifically or just say SEC engage in rule making on crypto?
Well, I don't think the Third Circuit at this stage would say or order the SEC to engage in rule making. I think probably the best possible result for Coinbase, which I think is feasible, is that the Third Circuit will say that your denial was arbitrary and capricious because it did explain enough as to why you are not making rules. And so I think the SEC will still get a chance, even if it loses this case to articulate the reasons
for denying coinbasis petition. Now, in the course of that exercise, the SEC could essentially conclude, hey, maybe we should be writing rules, and the NABE you could voluntarily do that. But I think just the procedural setting of this particular appeal is not one where even if the SEC loses, they're going to be writing rules on crypto, you know,
a month after the decision comes out. I think what happened is that they would look at the petition again and they might deny it again but give more extensive reasons. That's one one possibility. On the other hand, maybe they will change their mind. It's certainly possible that they could change their mind and say, hey, we will write right rules.
But I would be surprised if they did that. So for long ways from the SEC being required to write rules relating to crypto, I think that, you know, even if Coinbase wins this appeal, the process will still continue and take some time to work its way out.
So Coinbase wants the SEC to write rules. But do other players in the cryptocurrency space also want the SEC to write rules.
It's a really good question, you know. Coinbase, I think, is any unique position. They are the exchange where these various crypto digital currencies are going to trade, and their incentive is for there to be a lot of these projects coming up, a lot of these digital assets flourishing and trading on their platform. And so I think that they would like a set of rules that these digital asset creators can comply with. So more of them are
creating digital assets that can trade. And I think that, you know, because Coinbase is sort of in a position where it is, you know, it's part of the establishment of crypto and in some ways that they have one set of us that I think are probably shared by most investors and other players in the crypto industry that
they would like a set of rules. Now, is there a set of more entrepreneurial, smaller organizations that may feel like, you know, hey, maybe we can exploit this ambiguity in order to get our projects up and going and that we can avoid SEC enforcement. Maybe we don't want a lot of rules that we'd have to comply with. It's certainly possible there is a group like that, but I think the dominant establishment voices in the crypto industry I think would probably be with Coinbase on this issue.
Well, I'm wondering if it's better for the crypto industry if the SEC sues them and then in some of those lawsuits, you know, the court says, you know, this is not a security and then they might go up to the Supreme Court, maybe they'll do some revisions of the Howie test.
It's a good point, and that's certainly something coinbas is litigating right now, and the cases are working their way up through the system. You know, is the best result for the industry that we have a ruling that they're not securities? One view is maybe that that would be a good thing, because then the SEC could not bring
enforcement or regulate crypto. On the other hand, if it's not the SCC and they're not securities and people are losing a bunch of money on digital assets, then Congress will have to step in and there'll be a different regulatory regime, I think, one way or the other. If we have crypto frauds and they are widespread, then somebody will have to regulate crypto industry. Whether it's the SEC,
whether it's somebody else, I'm not exactly sure. And you know, maybe the hope of the crypto industry in litigating whether or not crypto can be a security is maybe their hope is that if the court say it is not a security, then that will spur Congress to act and pass a statue, and then they would have the sort of regulation that might confer some legitimacy on them. That might be their ultimate hope.
I mean, the best result for crypto is it that Congress passes legislation no identifying these things and it's not left up to the courts.
I think it depends on the type of legislation that is that is passed, where you have a clear set of rules that may say that we don't need disclosure for digital assets, that we will allow them to simply run by themselves and not be regulated. I think that's what they are hoping for. I don't know if that's what is good for society. I don't know if that's
what will happen. I am skeptical that, you know, we have totally decentralized associations where we are trusting that the incentives will work and will not be used to exploit smaller players and individuals. I'm skeptical that that is possible. And you know, the crypto or coinbases argue that when you you know, have found a crypto project, you have no obligation to the people who buy the crypto. There is no contractual obligation between the founders of the crypto
project and the people who buy the crypto. That's why they're saying it's not an investment contract. It strikes me as problematic. You know, if I'm a shareholder in a company, I'm protected by various fiduciary duties that prevent the managers from from exploiting me. As a crypto purchaser, I don't have that, and so, you know, is it a good idea to have these decentralized associations where there are no contractual rights that customers have that individuals who buy the
don't have. I think probably not. And I think that there will need to be some regulation in some form that will protect the general public when they are buying digital assets, whether it's securities are something else, there needs to be some regulation in order for this to work.
You know, we've talked before about agency power in the Supreme Court, trying to reign in agency power. I didn't hear anything from these judges against agency power. They talked about deference to agencies. Does agency difference or the changes in that play any part here?
I think it does. I think that one possible outcome I think is some of the judges they will want to sort of say sec when you deny a petition like this, you have to give more reasons, and that is a bit less deference to agencies and their decision making. It may be about setting up additional expectations, procedural expectations about explanations agencies have to give. So I think it
could this decision could have implications for administrative agencies. The way they denied petitions and explain their reasoning, that could have some modest impact in restraining their discretion.
Yeah, one of the judges said something to the effect of, you don't have to give much of an explanation, but you have to give some. And this is totally vacuous, was the word that he used about the SEC's explanations for this. So, now, as far as the presidential candidates, is one more than the other, you know crypto friendly? Is Trump more crypto friendly than Harris? Or they both seem to be trying to court the crypto industry.
It's what it seems like. Whether or not they will follow through on sort of their campaign promises, I think is another matter. I think because of the amount of money that has been invested in crypto, the industry has a lot to spend, and the presidential candidates are responding
to this. Whether or not they will actually want to pass the sort of legislation that the crypto industry really wants, I think is another matter, because they do not want to be blamed if the public loses a lot of money, and so I think that they're both basically remaining somewhat vague as to what exactly they would do while trying to appear like they're sympathetic to the crypto industry.
I did want to ask you about the FTX collapse for a moment, because you mentioned the concerns about it. Are the FTX customers though getting all their money back?
They are, they're certainly getting more back than we expect it, and I think that reflects the rebound in crypto that has happened over the last you know, last few years after the collapse of FTX. This is a wildly speculative market, and we will probably see other fluctuations as well. I would be surprised if crypto never sees a major correction. You know the fact that the market rallied for various reasons, you know, and that resulted in the FTX customers getting
you know, substantial amounts back. I think that does notily mean they're not dangerous to crypto and we'll see what happens in the future. I don't know, but certainly that is something that you can make an argument that, hey, you know, the problem is not so great as we thought.
But I think there may be have been a little bit of luck in that, and there's a lot of money that is flowing around our system in speculative ways, and if that reverses, though, that could have some disastrous consequences for investors.
It's certainly a lot to think about. Thanks so much, Jim. That's Professor James Park of UCLA Law School, and that's it for this edition of the Bloomberg Law Podcast. Remember you can always get the latest legal news by subscribing and listening to the show on Apple Podcasts, Spotify, and at Bloomberg dot com, slash podcast, Slash Law. I'm June Grosso and this is Bloomberg