I am an attorney in a public-sector position not associated with EA, although I cannot provide legal advice to anyone. My involvement with EA so far has been mostly limited so far to writing checks to GiveWell and other effective charities in the Global Health space, as well as some independent reading. I have occasionally read the forum and was looking for ideas for year-end giving when the whole FTX business exploded . . .
Jason
Employers, suppliers, etc. should be safe. Although the underlying law is complex, at a high level a clawback is possible when (as Wikipedia describes “constructive fraud”) the transfer “took place for less than reasonably equivalent value at a time when the debtor was in a distressed financial condition.” If I sell my labor (or widgets) to Charity X and receive a fair market wage or price in return, then the transfer took place for reasonably equivalent value and all creditors can generally pound sand.
It can get more complex, though. Let’s say I am a supplier of products to a charity and let them pay me 90 days after delivery, or maybe they are late in making payments. I’m now a creditor, and if the charity is insolvent, then paying back my loan could lead to a clawback because it’s seen as the charity favoring me over other creditors. That’s why vendors often demand cash on delivery to supply financially distressed companies. It’s possible for payments to employees to become problematic—if you’re insolvent and hand out certain bonuses, you can expect some extra scrutiny as to whether the business received reasonably equivalent value in exchange.
To underscore the complexity this stuff can reach, Irving Picard and his firm have spent something like $1 billion in legal fees and over a decade going after money for net losers in the Madoff scheme using similar theories.
It seems clear this morning anyone who received FTX-aligned monies is on notice that those monies may be (to make up a term) morally tainted in some fashion. Without attempting to fully delineate moral taint or establish that it exists, I submit that monies generated through fraudulent business practices that caused financial harm to identifiable victims would qualify. And gambling with customer deposits that you had promised not to gamble with would qualify in my book.
In that case, there’s an argument that the monies transferred out of the business (including through insiders or their foundations) should be treated as equitably belonging to the victims, as opposed to belonging to anyone who received the transfers without giving reasonable equivalent value. (Although I am using some legal metaphors, I am attempting to ask a moral rather than legal question in this comment.)
I am wondering how the community feels about the argument that—under some factual scenarios that are looking increasingly likely—some FTX-aligned monies should be returned to the victims under such a theory, irrespective of whether a clawback can legally happen. My initial reaction is that there are some circumstances under which that would need to happen because the monies were never properly the transferor’s to grant away.
To use a more concrete analogy, suppose that my grandmother gives me a car, and I later learn that it was stolen. Do I have a moral obligation to return the car? I would submit that I have such an obligation in some circumstances and not others.
I think anyone who provided reasonably equivalent value for funds received does not need to worry about taint. Next, I suggest that the taint dissipates if a transferee spends or irrevocably commits the transferred funds in good faith and without actual or constructive knowledge of the moral taint. I am not sure whether I think there is also a requirement that the transferee would not have spent or committed the monies absent the donation.
Most fundamentally, I submit that there has to be a sufficient causal and temporal nexus between the source of the taint and the specific monies for the monies to be tainted. So it would generally be morally OK to keep donations from (say) Harvey Weinstein, because his crimes were independent of the genesis of any funds he donated. Also, if the monies were clean at the time of transfer, I would submit that the transferor’s subsequent actions could not taint them. So if FTX was clean until the end, then any transfers it irrevocably committed to charity prior to the onset of any fraud would generally be untainted in my book. They might cause an optics/PR problem, but that’s another story.
All that is to say, however, that there’s a good chance there is significant money out there whose origin story is analogous to Grandma stealing a car and giving it to me under circumstances where I should give the car back.
There is wisdom in this comment: for many people, following this story closely as it rapidly develops doesn’t add any value to their lives or their work.
However, I suspect it will be many months before we have a truly “final outcome.” At least as of this morning, people have enough knowledge of the situation (and the range of likely outcomes) that it should be affecting—or at least causing them to delay—decisions that need to be made in the next weeks to months. I think it is extremely likely that FTX is done for and that the bulk of Bankman-Fried’s assets are gone. It wouldn’t be responsible to ignore that likelihood in making any decisions from this time forward, unless and until the probabilities change.
People involved in managing EA organizations, people who were considering sizable donations in the near term, and people who are employed at organizations highly dependent on FTX-affiliated funding probably shouldn’t wait for a more final outcome before assessing their situations. But for those who don’t have any decisions to make in the next few weeks to months (including decisions not to change funding or operations) that could be affected by the breaking news, I think you’re absolutely correct.
From the looking bad in court perspective, the CEO of a capsizing corporation has a tough rope to balance on. Because saying nothing, or not even giving the appearance of try to save the customers and the company, poses risks too. That is not to suggest that lying about factual matters is a good idea for any corporate executive, but in some cases a heavy dose of spin might be the least bad path from a legal-risk perspective. And the amount of permissible spin may be higher if ordinary depositors/investors are not in a position to take any actions in reliance on the spin.
“Fraudulent transfer” under 11 USC 548 is a bit of a misnomer. Subsection (a)(1) explains what makes a transfer “fraudulent.” One option, subparagraph (A), requires intent to mess over creditors. But subparagraph (B) does not require any ill intent at all—it only requires that the debtor “received less than a reasonably equivalent value in exchange” for the transfer (check), and that one of four criteria concerning the debtor’s financial condition is met (e.g., that the debtor “was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital”). The underlying idea is that if a company that is insolvent, on the brink of insolvency, etc. has no business handing out money to favored entities or persons in preference to the claims of its creditors.
For the curious, the shorter “preference” period is more about favoring creditors close to the bankruptcy filing date. So, e.g., if I owe my friend and the bank 100K each, I can’t make a big payment to my friend and then file for bankruptcy, because that violates the bankruptcy norm of treating like creditors alike.
A trustee can also seek clawbacks under 11 USC 544(b) if allowed under applicable state law, which can sometimes look back up to six years.
Of course, the relevance of this discussion is dependent on whether a US bankruptcy court would apply US law if an FTX debtor filed in US bankruptcy court (for which the standards are low—https://www.skadden.com/insights/publications/2021/06/quarterly-insights/international-companies-turn-to-us-restructurings) or sought ancillary proceedings under Chapter 15 (which I know very little about). If the target of a clawback isn’t in the US, there is also a question of whether the target is effectively beyond the reach of a US court order.
Complicated stuff, and I’m not qualified to offer an opinion beyond “consult with your lawyer if you think you have exposure.”
As I commented to Cate, I would also think about whether any transfer could fall under 11 USC 548(a)(1)(B) which does not require actual intent to defraud creditors for something to be a “fraudulent transfer.” That is not an opinion on whether there are fraudulent transfers here, which (although a lawyer) I am not qualified to give.
Since people are discussing the legal situation: one practical thing the EA community could potentially do is make it clear that if a bankruptcy trustee came after smaller grantees, the community would arrange for the grantee’s legal representation. Maybe this offer would be limited to grantees who offered to return grant funds that were not spent or irrevocably committed as of this week (or some later date when the community feels that grantees should know to stop commiting grant funds). Litigation is expensive, which means (1) smaller grantees could be at risk of being bullied into giving back monies they should not have to, but also (2) a credible commitment by the community to fund legal defense would make it unprofitable to litigate against certain smaller grantees (meaning the community shouldn’t even have to spend money on their representation at all).
(I cannot represent anyone due to the nature of my employment, by the way.)
Expecting a non-profit to be so “robust” or “isolated” as to be invulnerable to potential clawback claims that all of its funding was the proceeds of recent fraudulent activity by insiders isn’t realistic. Maybe the FTX Foundation’s setup is more fragile than advertised in other ways, but I can’t imagine that any lawyer advising the Foundation would tell them it was OK to keep paying out on grants at the moment. If their in-house or outside counsel had researched in advance what should happen to this specific foundation if all the donations appeared to be linked to fraudulent activity . . . that attorney’s licensing authority would have some pointed questions about what the attorney knew and when! So the pause on payouts doesn’t really tell me anything useful.
As for the donor advised funds mentioned in the linked post, the monies legally belong to the DAFs and any potential clawback liability would be against the DAFs (not just against the FTX-aligned person’s account at the DAF). If I’m running a DAF in which an FTX-aligned person has an account, I am not releasing any money until I am absolutely sure I don’t have any clawback exposure. The admin fee on a large DAF account is a very low percentage of assets, and one cannot reasonably expect a DAF to justify running even a small risk of clawback.
Assuming fraud occured: the harder question is whether those who received funding have an obligation to return it, at least under some circumstances. Verbally condemning fraud is a rather low bar; presumably few would openly defend any fraudulent behavior that occured. But some people may be holding grants funded by fraud, and any future avoidable spending of those funds could be seen as condoning the fraud.
Bahamian authorities have obtained a court order to begin provisional liquidation proceedings for “FTX Digital Markets and related parties.”
Looking dumb is an acceptable risk. If the team prematurely resigned and there is still usable money . . . the usable money is presumably locked in the FTX Foundation and in DAFs, it is not lost.
Premature send, ETA: As far as “questioning the ethics at FTX,” it would be very easy for FTX to have denied raiding customer funds if they didn’t do it as reported. It’s appropriate to draw the obvious inference that they did, and that alone is more than enough to “question[] the ethics at FTX” which is a pretty mild response to the news in my book.
The PR attention is at its height this week, the risk of “looking dumb” (which I think is very unlikely) is outweighed by the need to engage in damage control. No one will be listening if EA waits a few weeks to start distancing itself....
The losses are likely in the billions. Even assuming we could come up with (say) $100MM, that might move the needle from a reported 9.4B shortfall to . . . 9.3B. That’s not going to change the narrative in any meaningful way.
One could argue for the EA community returning every dollar ever received from FTX-aligned sources . . . but I’m just not sure how much even that would move the needle of public opinion. Especially because the bad PR will be heaviest in the next few weeks to months, and it would seem exceedingly difficult to come up with that amount of money that fast.
One could also argue for prioritizing funding for work that has already been done over work that has been approved but not yet done. If someone was going to receive a grant to do certain work and has it been pulled, that is unfair and a loss to them . . . but it’s not as bad (or as damaging to the community / future incentives) as denying people payment for work they have already done.
How this logic translates to a prize program is murky. But unless you believe that the prize’s existence did not cause people to work more (i.e., that the prize program was completely ineffective), its cancellation would mean people are not going to be paid for work already performed.
Of course, it might be possible to honor the commitment made for that work in some fashion that doesn’t involve awarding full prizes.
FTX had received several billion dollars in funding from major investors. One was a province pension fund, so it wasn’t just crypto folks. That generally involves having the investors’ accountants do substantial due diligence on the target firm’s financials. That tells me that either the books were fairly clean at the time of investment or they were cooked in a way that even the due dilligence specialists didn’t detect. It’s not clear to me how the Future Fund people, who to my knowledge are not forensic accountants or crypto experts, would have had a better ability to pick up on funny business. So I don’t see why it would be unreasonable for them to have relied on third-party expert vetting.
I don’t think staying on would add to what the insolvency trustee, regulatory authorities, and likely criminal prosecutors will uncover. The court has already appointed a liquidation trustee whose mission is preserving assets and does not include working with EA. Its unclear to me whether the trustee is in control of the FTX Foundation now, but the statement did say related entities. The FTX principals are doubtless preoccupied and are presumably attuned enough to legal exposure to not be having unnecessary conversations.
The nature of insolvency and fraud is that someone ends up getting hit with pain. The question is who should have to bear it. I don’t think it is correct to say that the community was the beneficiary of any ill-gotten funds; the true beneficiaries were the public. “The community” is even further removed from FTX than grantees, and the people who won’t be getting bednets (or whatever) because we diverted funds from effective charities are at an even further remove. I do not like the idea of diverting the pain from FTX depositors to bednet recipients unless that is morally obligatory. Without suggesting that the depositors are to blame, they are both better off and were more connected to the incident than the bednet recipients.
And I don’t see a moral obligation to return spent funds; the grantees were contracted to perform certain work that FTX-aligned people wanted done and they did it. We didn’t expect ordinary employees at Enron to give back their earned wages because their payor was a massive fraud.
However, the Enron employees were not morally entitled to unearned wages when that money could have gone to fraud victims. So too here. Because I think there generally is a moral obligation to return unused funds if those were the product of fraud, I am more inclined toward the idea of the community replacing those funds on behalf of grantees. But I would conceptually frame that a bit differently: we would be providing a grant to former FTX grantees to allow them to meet their obligation to refund unspent grant funds, so that their charitable work can continue. Maybe it’s just a matter of optics, but that feels subtly different than seeking monies to clean up the messes created by FTX.
I think your metaphor is a good one, but doesnt entirely get you where you want to go.
Insolvency is all about distributing pain. I agree that non-executive employees (including indirect employees through grants) have a high priority moral claim for work already performed and should not be clawed back. There are also practical utilitarian reasons for this rule more generally.
However, I don’t think they have this moral superpriority status for work performed after the insolvency became known. Taking away the expectation for future compensation for future work that does not benefit those with high-priority moral claims on the insolvent entity is better than the alternative of foisting more losses on depositors than absolutely necessary. Depositors have actual losses, not losses of expectancy, and there are utilitarian reasons to grant them special protections over ordinary claimants.
Moreover, most individuals funded by grant work can find alternative employment in a fairly short period of time. So they are in a much better place to mitigate loses than depositors..which is another reason I think their claims are weaker.
I’d vote for an algorithm that is transparent and has limited if any discretion. Maybe the end result would be somewhat suboptimal to discretionary independent-panel vetting, but it would be critical that the process be seen as fair.
Plus, a complicated procedure will eat up a lot of the funds intended for victims, unless you think the EA community should both return any FTX money and pay for an involved claims process. That goes beyond mere disgorgement.
I think the class of issues that would make it inappropriate to accept donations is much narrower than the issues that would and should make a public investor (like a province pension fund) decline to invest.
Few private businesses are going to let an outsider come in on a regular basis, conduct a hard look at sensitive internal documents, and potentially publish derogatory information to the public. Even for investors, this kind of stuff is generally done under a heavy NDA and for good reason. That would make it extremely difficult to do this on a regular basis—so any scrutiny would at best catch fraud that existed at the time of scrutiny.
Obviously this is very breaking news, but depending on the ultimate facts, I would be nervous about the risk of a clawback action if I were an organization that had received funding from an FTX-aligned source in the past few years. It’s been a while since I took bankruptcy law, but the trustee can have pretty significant clawback powers when the debtor was actually insolvent at the time of transfer and the transfer was not for value. Of course, we do not know at this juncture whether the insolvency is of recent origin or existed for a while before this week.
I would also consider deferring any sizable donations to an organization I thought might be at risk for a crippling clawback, stick those monies in a DAF or similar entity for the time being, and ask the DAF to slowly regrant to the at-risk organization over time depending on the circumstances until it became clear there was no clawback risk. If a charitable organization is subject to a large clawback, it might be more efficient to move the charity’s operations to a new charity (paying FMV for any assets, of course). In that case, it would be better to have not given money to the exposed charity as that money would end up in the hands of FTX’s creditors. For instance, a number of charities had to pay clawbacks in the Madoff scandal despite not having committed any wrongdoing—despite the name, there does not have to be any evil intent to have been involved in a fraudulent conveyance.
None of this is intended to be in the least bit authoritative—it is merely a suggestion to stop and assess risk before taking certain significant actions in the short run.