Companies associated with Bitfinex and Tether obtained an order from a New York court requiring the NY Attorney General to “show cause” during a hearing on May 6 why the firms should not be excused from providing over four years of documents required by an April 24 order of the same court. 

Previously, the NY court required the associated companies to produce a multitude of documents by May 24, 2019, as well as prohibited the companies from accessing, loaning or encumbering in any way US dollar reserves supporting tether stablecoins. The NY AG had applied for such order without giving respondents notice or having an opportunity to object, claiming such emergency action was necessary because of the potential danger of respondents compromising tether’s supporting balances to help fund Bitfinex’s operations. (Click here for background in the article “NY Attorney General Sues Stablecoin Issuer and Related Companies for Purportedly Misusing Tethered Fiat Currency Without Customer Disclosure” in the April 28, 2019 edition of Bridging the Week.)

Last week, the defendants vehemently objected to the NY AG obtaining the order against them on an ex parte basis, claiming that the lawsuit was “riddled with factual and legal errors.” Among other things, defendants claimed they (1) had voluntarily cooperated with the NY AG’s investigation as soon as they learned about it; (2) had no obligation to maintain a 1:1 ratio of fiat currency to the value of each tether stablecoin; and (3) had not committed fraud or failed to disclose a potential conflict of interest. This is because, argued the defendants, Tether had expressly disclosed to customers on its website in February 2019 that tethers could be backed by ”other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.” 

According to the NY AG, Tether extended to Bitfinex a US $900 million line of credit that closed in March 2019. Subsequently, Bitfinex drew down US $625 million of this amount to replenish funds that previously Bitfinex had transferred to Tether in accounts at Crypto Capital, a payment processor, in return for Tether transferring an equivalent sum from Tether’s reserves to Bitfinex at a different financial institution. At the time, said the NY AG, Bitfinex was apparently having difficulty meeting customers' demands to withdraw money because of its inability to access funds maintained at Crypto Capital. Beginning in late December 2018, said the NY AG, the defendants expressed specific concerns about US $850 million of their funds at Crypto Capital that the settlement firm claimed had been “restrained” by governmental authorities in Poland, Portugal and the United Sates.

In papers filed in the NY court, the defendants claimed that the court’s grant of the NY AG’s requested ex parte order denied it due process. Moreover, claimed defendants, nothing is fundamentally wrong with tethers not being backed 1:1 by fiat currency; a “fractional reserve” system underpins commercial banking, said the defendants. Moreover, even after the companies posted their February 2019 disclosure, tethers traded on marketplaces close to their US $1 face value. The companies claim that, currently, all tethers are supported 74 percent by fiat money reserves and 100 percent by fiat money reserves and other assets, including a loan repayment obligation from Bitfinex.

Separately, two individuals were charged by the US Attorney’s Office in New York City with bank fraud and operating an unlicensed money transmitter business in connection with their activities on behalf of the Crypto Companies. The US Attorney’s office claimed that the individuals made false and misleading statements to open accounts at US banks and financial institutions, claiming they were to support real estate businesses, when they were, in fact, to support crypto exchanges’ activities. In the indictment against the two individuals – Reginald Fowler and Ravid Yosef – the government requested forfeiture of certain funds it had seized that had allegedly been obtained by defendants in connection with their alleged offense. The funds currently are frozen at HSBC Bank and HSBC Securities accounts in the US. (Click here for the relevant indictment.)

Memory Lane: In September 2018, the NY AG issued a report claiming that trading platforms for cryptocurrencies often (1) engage in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. Moreover, the report alleged that three cryptocurrency platforms may be operating unlawfully in New York and referred these platforms to the NY Department of Financial Services for possible further action. 

The AG’s report followed a voluntary request for information sent to 13 cryptocurrency platforms earlier in 2018. (Click here for background in the article “New York Attorney General Seeks Information From 13 Cryptocurrency Exchanges Even If No State Connection” in the April 22, 2018 edition of Bridging the Week.)

Among specific findings, the NY AG claimed that few trading platforms restrict or even monitor “bots” or algorithmic trading on their systems. Moreover, many venues offer special pricing and other features, including preferential trading access, to professional traders. These circumstances could negatively hurt retail investors, said the NY AG.

The NY AG also raised potential conflict of interest concerns at cryptocurrency trading platforms. The NY AG said it is unclear why trading platforms list certain cryptocurrencies, suggesting that sometimes payments to a platform may drive listings. The NY AG also said that the owners and investors in several trading platforms are large holders of cryptocurrencies trading on their platform, and trading platforms themselves, as well as their employees, are often investors in virtual assets and trade against customers.

(Click here to access the full NY AG Report.)