United States: NY Attorney General Files Fraud Claims Against Bitfinex And Tether

Last Updated: May 22 2019
Article by Matthew F. Miller and Michael J. Fluhr

A showdown is underway between the New York Attorney General's Office and the companies that own and operate the cryptocurrency exchange Bitfinex and issue the stablecoin tether. In short, after months of investigation, the AG's office has filed a lawsuit under New York's Martin Act (the NY laws regulating securities and commodities fraud) against the Bitfinex and Tether companies alleging that they may have defrauded Bitfinex customers and tether owners. At the commencement of the lawsuit on April 24, 2019, the AG's office obtained a court order compelling the Bitfinex and Tether companies to produce documents and information necessary for the AG's Martin Act investigation and prohibiting the companies from continuing to engage in certain transactions with each other. The companies have responded, disputing the AG's allegations and asking the court to vacate the order. At a hearing on May 6, 2019, New York Supreme Court Justice Joel Cohen upheld the order compelling Bitfinex and the Tether companies to produce certain documents and information as well as the injunction. But Justice Cohen expressed concern about the injunction's breadth and clarity, and he gave the parties a week to negotiate a new injunctionThis dispute has crucial implications for both the regulation and market perception of cryptocurrency, so the industry will watch it closely.

In greater detail, Bitfinex is a cryptocurrency exchange that services both crypto- and fiat currencies. Tether is a stablecoin. Tether coins were sold by a group of companies (the Tether companies) for $1, which the Tether companies promised they would keep in reserve for tether holders to redeem at a 1:1 ratio, thus maintaining stable parity of tether with the U.S. dollar. For months the AG's office has been investigating the Bitfinex and Tether companies, including via subpoenas for production of documents and other information and through in-person meetings. According to AG's filings, while the companies that run the Bitfinex exchange are separate from the companies that issue the tether stablecoin, the companies are under common management, control, and ownership. The AG alleges that in 2018, Bitfinex ran into difficulty securing banking services necessary to service customer deposits and withdrawals of fiat currency. Unable to find large banks willing to meet its needs, Bitfinex allegedly placed over $1 Billion in deposits with an overseas entity called Crypto Capital, which Bitfinex used as an intermediary to wire U.S. dollars to its traders. By mid-to-late 2018, Bitfinex executives allegedly began to suspect that Crypto Capital had lost or absconded with the funds, and the companies have been unable to locate or recover approximately $850 Million of funds deposited with Crypto Capital. To ensure Bitfinex could meet its customers' fiat withdrawal requests, Bitfinex entered into various transactions with the Tether companies, under which the Tether companies loaned their dollar reserves to Bitfinex. The Bitfinex and Tether companies do not dispute the broad strokes above.

The dispute between the AG's office and the companies centers around three main topics. First, the AG's office alleges that the loans weren't on commercially reasonable terms but were instead intended only to keep Bitfinex afloat to the detriment of the Tether companies and tether holders, specifically, that tether is no longer backed 1:1 by dollar reserves but by a combination of dollar reserves and what the AG's office characterizes as risky loans. The AG's office claims that the Tether companies agreed to these loans only because they are under common ownership, operation, and control with the Bitfinex companies. The Bitfinex and Tether companies dispute this, arguing that the loans were arm's length transactions made under commercially reasonable terms that included a 6.5% interest rate and securitization of the loans with Bitfinex stock. The companies also argue that tether holders haven't suffered any harm as tether is still backed 1:1, albeit by a combination of dollar reserves and loan interests, and that even the remaining dollar and "dollar-equivalent" reserves, which the companies estimate at 74% of all reserves, suffice to back tether; the companies note that banks keep far less than this in reserve without issue. Second, the AG's office alleges that the companies did not disclose and even misrepresented both Bitfinex's ability to secure banking services and tether's reserve backing. The AG's office claims for years the Tether companies stated that "[e]very tether is always backed 1-to-1, by traditional currency held in our reserves." The Tether and Bitfinex companies dispute this, noting that in February 2019, Tether updated its website to disclose that its reserves "may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities." Third, the AG's office claims that the companies have failed to adequately respond to various pre-suit subpoenas for documents and other information. The companies dispute this.

On April 24, 2019, the AG's office filed a lawsuit in New York Supreme Court against the companies under the Martin Act, New York's laws that regulate securities and commodities fraud. In the filing, the AG's office sought and obtained an order from the court compelling the companies to produce certain documents and refraining from continuing to engage in certain transactions with each other. On April 30, the companies responded, asking the court to vacate this order. At a hearing on May 6, 2019, New York Supreme Court Justice Joel Cohen upheld both the order compelling the companies to produce information and documents as well as the injunction. But he stated that "the preliminary injunction that we have right now is vague, open-ended and not sufficiently tailored to precisely what the AG has shown will cause imminent harm. I think it's both amorphous and endless." Accordingly, Justice Cohen gave the parties a week to negotiate an agreed-upon scope of the injunction. Also at the hearing, Justice Cohen left open the issue (recently raised by the companies) of whether Tether constitutes a security or commodity subject to Martin Act regulation (the companies have argued it does not).

The dispute carries great weight in the digital asset industry. From a legal perspective, the dispute demonstrates the growing interest state and federal governments have in regulating the cryptocurrency industry. From a market perspective, the resolution of and facts exposed during the dispute could have tremendous impact on the public perception and trust of Bitfinex and Tether as well as the market as a whole. We along with the rest of the industry await the next step in this showdown.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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