Programming note: This is the last Money Stuff of 2022. We’ll be back the first week of January. Happy holidays! Of course there will be several FTX movies, and maybe the most cinematic scene in the whole story is the meeting that Caroline Ellison, the chief executive officer of Alameda Research, FTX’s affiliated trading firm, held to tell her employees that they’d been stealing FTX customer money. Imagine! Imagine coming into the company all-hands meeting at the lucrative trading firm you work at, in the Bahamas, far away from your friends and family and competitors, in a slightly cult-like environment where your every need is catered to out of the firm’s enormous profits. And then your 28-year-old boss is like “so guys, a little bad news, actually we’re a Ponzi? Sorry if I didn’t mention that earlier.” Everyone quit immediately, but much too late. That meeting happened on Nov. 9, the day after FTX death-spiraled and tried to sell itself to Binance, and has been reported before. But now Ellison is cooperating with prosecutors and regulators, so we have their version of her version of the meeting and, oof. Here is how the US Commodity Futures Trading Commission describes it: On the morning of November 9 at approximately 10 AM ET, after the announcement of the then-contemplated Binance acquisition, Ellison held an “all-hands” meeting with Alameda staff. In that meeting, Ellison acknowledged that earlier that year, she, Bankman-Fried and other individuals had decided to use FTX customer assets to pay Alameda’s debts, and that Wang and another FTX executive were aware of this. Specifically, in that meeting, Ellison stated that, “starting last year” Alameda was “borrowing a bunch of money by open term loans” and used those assets to “make very illiquid investments.” Ellison further explained that following the widespread decline of digital asset prices most of Alameda’s loans had been recalled and, in order to meet those recalls, Alameda borrowed “a bunch of funds” from FTX, which in turn “led to FTX having a shortfall in user funds.” Ellison informed Alameda staff that FTX had “always allowed” Alameda to borrow customer assets, and did not require collateral for those loans. She also explained that Alameda could access user assets without requiring FTX’s approval as the “structure” allowed Alameda to “go negative in coins.” In response to an employee question, Ellison also acknowledged that her November 6 tweet to the Binance CEO offering to buy his FTT holdings at $22 per token was “kind of a misleading thing to tweet” and expressed remorse. Shortly after this meeting, most of Alameda’s staff resigned.
“Go negative in coins” is an incredible euphemism, really. The idea is that Alameda could deposit, say, 1,000 Bitcoin at FTX, and then it would have a balance of 1,000 Bitcoin. And then it could withdraw, say, 3,000 Bitcoin from FTX, and then it would have a balance of -2,000 Bitcoin. If you have a negative balance at your bank, bad things happen. When Alameda had a negative balance at FTX, that was just fine. Until it wasn’t. Ellison and Gary Wang, the former chief technology officer of FTX, have agreed to plead guilty to federal fraud charges for their role in the FTX implosion. (The plea agreements say that Ellison and Wang face maximum sentences of 110 and 50 years in prison, respectively, though presumably they will end up with substantial discounts for cooperating.) Last night, Sam Bankman-Fried, the founder of FTX and Alameda, landed in New York to face similar charges. There is something of a prisoner’s-dilemma situation here, in that there was in theory the possibility that everyone at FTX and Alameda could have stuck together and said “what, we never did anything wrong,” and that they might have persuaded a jury of that. The odds were always low, but it is the approach that Bankman-Fried has taken in public interviews. Bloomberg’s Zeke Faux reported earlier this month: Part of FTX’s appeal was that it was mostly a derivatives exchange, which allowed customers to trade “on margin,” meaning with borrowed money. That’s a key to his defense. Bankman-Fried argues no one should be surprised that big traders on FTX, including Alameda, were borrowing from the exchange, and that his fund’s position just somehow got out of hand. “Everyone was borrowing and lending,” he says. “That’s been its calling card.” But FTX’s normal margin system, crypto traders tell me, would never have permitted anyone to accumulate a debt that looked like Alameda’s. When I ask if Alameda had to follow the same margin rules as other traders, he admits the fund did not. “There was more leeway,” he says. … Ellison said that she, Bankman-Fried and his two top lieutenants—Gary Wang and Nishad Singh—had discussed the shortfall. Instead of admitting Alameda’s failure, they decided to use FTX customer funds to cover it, according to the people. If that’s true, all four executives would’ve knowingly committed fraud. … “So, it’s not how I remember what happened,” Bankman-Fried says. But he surprises me by acknowledging that there had been a meeting, post-Luna crash, where they debated what to do about Alameda’s debts. The way he tells it, he was packing for a trip to DC and “only kibitzing on parts of the discussion.” It didn’t seem like a crisis, he says. It was a matter of extending a bit more credit to a fund that already traded on margin and still had a pile of collateral worth way more than enough to cover the loan.
This is a story in which FTX was operating its legitimate business — extending margin leverage to traders on its exchange — and made some mistakes. The mistakes were very bad — they involved giving billions of dollars to Alameda, which it could not pay back, blowing up FTX and taking customer money with it — and also very suspicious, in that FTX gave this generous credit only to its own affiliated trading firm, secured largely by tokens that FTX had invented, and Alameda was lending a lot of that money to FTX/Alameda’s principals for their own personal purposes. And, as I have argued, even if this story was true, it is not much of a defense to fraud charges, because FTX was going around telling everyone that it had good automated risk systems that would prevent it from doing exactly this sort of dumb thing, and lying about that is itself fraud. Again, I don’t think this would have worked. But I suppose if you got a bunch of smart earnest 20-somethings up on the witness stand and they all said “yes we were extending credit to a margin customer, ordinary-course stuff, but then the market blew up and the loans defaulted,” there was a chance. But now Ellison and Wang will get up on the witness stand and, I assume, say something like “oh obviously we knew that was fraud, we were just doing it to steal customer money, we talked about that all the time.” It’s hard to see how Bankman-Fried could rebut that. Just on paper the facts are very bad, but when you add the testimony of his friends they become impossible. The other new news from Ellison and Wang’s cooperation is about the alleged manipulation of FTT tokens.[1] The US Securities and Exchange Commission explains: Beyond its “line of credit” with FTX, Ellison, at Bankman-Fried’s direction, caused Alameda to borrow billions of dollars from third party lenders. Those loans were backed in significant part by Alameda’s holdings of FTT—an illiquid crypto asset security that was issued by FTX and provided to Alameda at no cost. Ellison, acting at the direction of Bankman-Fried, engaged in automated purchases of FTT tokens on various platforms in order to increase the price of those tokens and inflate the value of Alameda’s collateral, which allowed Alameda to borrow even more money from external lenders at increased risk to the lenders and to FTX’s investors and customers, all in furtherance of the scheme.
And: In July 2019, when FTX launched FTT, Alameda received a substantial portion of the 350 million FTT tokens that were minted, including all of the “company tokens” that were allocated to FTX. Alameda did not pay for these tokens. Alameda programmed its automated trading tools (or “bots”) to conduct trades and execute transactions to purchase FTT at specific prices. On more than one occasion, Alameda and Ellison, at Bankman-Fried’s direction, actively engaged in the trading of FTT with the goal of supporting the price of the token. On these occasions, Alameda adjusted the trading parameters of its trading bots in order to support the price of FTT. For example, in 2019, there was downward pressure on the price of FTT as the token was being unlocked for early-stage investors. Bankman-Fried became concerned about, among other things, the psychological effect of the price of FTT dropping below a specific threshold, and instructed Ellison to have Alameda purchase FTT to support the price and avoid that outcome. In another instance in 2021, the price of FTT was again facing downward pressure from external events, this time related to substantial sales of FTT by a third party. Bankman-Fried again instructed Ellison to have Alameda purchase FTT on trading platforms to support the price.
Here again you might be able to get around the objective facts, which are basically that Alameda, a crypto market maker, was buying FTT tokens when other people were selling. But if the CEO of Alameda gets on the stand and says “yes Sam Bankman-Fried told me to buy FTT tokens to manipulate the price up so that we could continue to borrow billions of dollars against the inflated token we invented,” that is harder to explain away. The question I always have in situations like this is: How did they think this would go? What was the good outcome here? Why do all this? Many financial crimes have essentially the shape of Ponzi schemes, which by their nature snowball: You take some money from new customers to pay fake returns to old customers, which requires you to take even more money from newer customers to keep paying the fake returns, etc., until the hole gets too big and you go to prison. If you start by stealing $1,000, pretty soon you need to steal $10,000, and then $100,000, and then you find yourself running a billion-dollar Ponzi. And there’s rarely a way to come back from that. It is hard to make back a billion dollars at the roulette tables. You can keep this going for a while, if you are good and lucky; Bernie Madoff ran a huge Ponzi for years. But that doesn’t really help. The longer you run the Ponzi, the deeper the hole gets; being respectable and trusted for decades doesn’t really get you the billions of dollars you need to plug the hole. It is hard to grow your way out of it; growth mostly makes the problem worse. But there is something different about running a crypto exchange, taking out margin loans against tokens that you made up to invest in crypto venture capital projects. The asset that you are borrowing against is essentially confidence in you: in your exchange, in crypto generally, in your role as a leading figure in crypto. If that collapses, then your finances collapse and you find yourself in a Bahamian jail cell. But what if it doesn't? If you go on long enough, then those FTT tokens that you made up — that entitle customers to discounts on FTX trading fees and a share of FTX revenue — become more and more valuable, and your decision to lend money against them looks fine. (Your decision to manipulate them looks fine, too, because in hindsight you can say “of course we bought when people were selling, we thought they were a bargain, and we were right.”) Ultimately maybe those tokens become so valuable that they dwarf the customer money that you, uh, misplaced, and you can easily plug the hole with the tokens. Earlier this year, we talked a lot about Terra, a crypto project that collapsed when its TerraUSD stablecoin spiraled to zero. The plan, with Terra, was for it to become so popular and widely accepted that people would pay a lot of money for Luna, its native token, and then Terra’s promoters would sell a bunch of Luna to raise money to make TerraUSD a fully backed stablecoin. ““The basic structure of the trade,” I wrote, “is (1) Ponzi, (2) acceptance, (3) diversification, (4) permanence.” This did not work, because before Terra could complete its diversification it lost market confidence, and everything went to zero. But I don’t think it was a terrible plan. If Terra had managed to be widely accepted for long enough, it could have printed its own money, and then exchanged that for real money, and then everything would have been great. So close! FTX, too, printed its own money, and treated it as money. At the end, as FTX was spiraling into bankruptcy, as the Binance bailout was falling apart, as Caroline Ellison was telling employees about the missing customer money, Sam Bankman-Fried was pitching potential rescuers with a spreadsheet showing that FTX was still solvent. That spreadsheet relied on billions of dollars of tokens — FTT but also weirder things like Serum and Maps — that FTX had made up, that it owned most of, and that had no real independent market value. They were worth billions as long as everyone believed in FTX, and nothing otherwise. By the time Bankman-Fried was circulating the spreadsheet, they were worth nothing. But he only needed to find one person who believed. I keep quoting it because it is such cinematic foreshadowing, but last year Bankman-Fried said to me on a podcast: You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box. So what this protocol is, it's called ‘Protocol X,’ it's a box, and you take a token. … So you've got this box and it’s kind of dumb, but like what's the end game, right? This box is worth zero obviously. … But on the other hand, if everyone kind of now thinks that this box token is worth about a billion dollar market cap, that's what people are pricing it at and sort of has that market cap.
He went on in a cynical vein: In fact, you can even finance this, right? You put X token in a borrow lending protocol and borrow dollars with it. If you think it's worth like less than two thirds of that, you could even just like put some in there, take the dollars out. Never, you know, give the dollars back. You just get liquidated eventually.
And that is what happened: FTX got liquidated eventually, and now he’s facing fraud charges. But it was not obvious, in advance, that that was how it had to go. Maybe the box was life-changing, a world-altering protocol that was gonna replace all the big banks. Maybe you never get liquidated; maybe everyone will keep believing in the box until it becomes real. Honestly the APE thing is pretty clever. AMC Entertainment Holdings Inc. has one incredible advantage and one bizarre constraint. The advantage is that AMC is really really good at raising equity: It rode last year’s meme-stock wave more expertly than anyone else, using retail investors’ enthusiasm for its stock to sell lots of stock at attractive prices to pay down debt. The constraint is that, like most public companies, AMC has a corporate charter that limits the number of shares it can issue, and it is basically all out of shares. To get more shares, it needs to get a majority of its shareholders to approve an amendment to the corporate charter authorizing more shares, and this is hard, for two reasons: - Some shareholders seem to dislike the idea of being “diluted” if AMC issues more shares. This strikes me as misguided — if a company sells stock at a price that is too high, that’s accretive! — but people worry.
- More important, AMC has tons of retail shareholders, and retail shareholders, stereotypically, don’t vote. It needs a majority of all shares to vote in favor of the charter amendment, and it’s hard to do that if many of your shareholders don’t vote at all.
And so AMC came up with a novel idea. It couldn’t sell any more common shares, so it would sell APE shares, “AMC Preferred Equity units,” a weird new instrument designed to look like common stock. The APE shares are not common stock, so they are not covered by the cap in the certificate of incorporation, but they are like common stock in most important ways. They are listed on the stock exchange and they have the same economic rights (to dividends, etc.) as the common stock does. Also, crucially, they vote with the common stock: Anything that needs shareholder approval is submitted to a combined vote of the common and APE shares; each share, common or APE, gets one vote. AMC did not start by selling APEs; it started by giving them away. It distributed APEs to its existing common shareholders, one APE per common share; the result was basically like a stock split, where if you previously had 100 shares now you had 200, except half of them were APEs. This created a market for the APEs — now people had them, they were bought and sold on the stock exchange. And then AMC started selling APEs to raise money. It was out of common shares, but it still had APEs. In theory there were three ways this could go: - The APEs and common shares, being more or less identical, would trade at more or less the same price. It would be like any other company with dual-class shares. AMC would keep issuing more APEs to raise financing, and would get about as much money for the APEs as it would for its common stock. Nobody would worry about the small differences between APEs and common shares.
- The APEs would be worth more than the common stock, because they are funny? The ticker is APE. They are preferred stock, which you might think makes them preferable to the common stock. In this case, AMC would keep issuing APEs to raise financing, and would get more money for the APEs than it would for common stock, and would have created some value out of nothing. Or, rather, would have created some value out of leaning into the meme-stock thing, which is how it creates value generally.
- The APEs would be worth less than the common stock, because common stock is a normal obvious standard thing, while a weird preferred unit is weird. In this case, AMC would have no choice but to keep issuing APEs to raise financing — it can’t sell more common shares! — but would get less for those APEs than it would for its common stock. The APE financings would be dilutive: AMC would sell APEs for less than the price of common stock, but the APEs would have the same economic rights as common stock. This would be bad.
Option 3 was the most likely, and it is in fact what happened. When APEs started trading in August, they were worth about $6 or $7 per share, while the common stock was around $9 or $10. Yesterday the common stock closed at $5.30; the APEs closed at $0.685, an 87% discount. That’s bad. If your common stock is worth $5.30, selling basically-common-stock for $0.685 is a bad corporate finance move. But this problem comes with its own solution. AMC can still go back to shareholders anytime and ask them to vote to collapse this back into a normal single-share structure, by authorizing more common shares and converting the APE shares into common shares. If a majority of shareholders approve, then each APE will turn into a common share, closing the discount. Maybe the common shares will maintain their value and the APEs will go up to $5.30, or maybe they’ll both end up worth, say, $3, but in any case they’ll all be the same thing and trade at the same price. And, when AMC puts that proposition to a vote, the common shareholders and the APE holders will all vote together. There will be more APE shares than common shares: Originally the APEs were distributed to common shareholders 1 for 1, creating an equal number of APEs and common shares, and since then AMC has sold more APEs while the common share supply is capped. So the majority of voting shares belong to the APEs, which trade at a discount to the common. The APEs have every reason to vote to collapse their APEs back into common stock to close the discount. The bigger the discount is, the more incentive they have to vote. And, the bigger the discount is, the more likely it is that some professional investor — a hedge fund, etc. — will buy up the APEs in order to vote: You can pay $0.685 for APEs, and then vote to turn them into common shares worth $5.30. Meanwhile presumably some number of common shareholders will dislike this, because closing the discount probably means lowering the value of the common shares, so they might vote against it. But (1) there are more APEs than common shares, and (2) the APEs are much more motivated to vote — and much less likely to be held by retail — than the common. So AMC should be able to get shareholder approval to collapse the two classes of stock. Also AMC can just sell more APEs directly to hedge funds who promise to vote to collapse the structure, helping the vote along. Anyway: AMC Entertainment Holdings, Inc. (NYSE: AMC and APE) (“AMC” or “the Company”), today announced it will raise $110 million of new equity capital through the sale of APE units to Antara Capital, LP (“Antara”) in two tranches at a weighted average price of $0.660 per share. The APE unit closing price on the New York Stock Exchange on December 21, 2022 was $0.685. Under the terms of the agreement, Antara, a current AMC debt holder, will also exchange $100 million principal amount of 2nd Lien Notes due 2026 for approximately 91.0 million APE units thereby reducing AMC’s outstanding debt by $100 million. As a result of the $100 million principal debt reduction, future annual interest expense will be reduced by approximately $10 million. ... In addition, AMC’s Board of Directors is seeking to hold a special meeting for holders of both AMC common shares and APE units (voting together) to vote on the following proposals: - To increase the authorized number of AMC common shares to permit the conversion of APE units into AMC common shares.
- To affect a reverse-split of AMC common shares at a 1:10 ratio.
- To adjust authorized ordinary share capital such that, after giving effect to the above proposals if adopted, AMC would have the same ability to issue additional common equity as it currently has to issue additional APE units.
As part of the agreement, Antara has agreed to hold their APE units for up to 90 days and vote them at the special meeting in favor of the proposals.
I don’t know! It’s a very elegant trade. I suppose if you wanted to quibble, you could argue that AMC’s shareholders didn’t want it to issue more shares, so it found sort of a clever back-door way to rig the vote to allow it to issue more shares. If you are a shareholder who plans to vote no, you might be annoyed. But I tend to think that selling tons of shares into a meme-stock market was the best possible move for AMC, and its great corporate finance innovation. AMC’s management may not be giving shareholders exactly what they want, but it’s giving them what they should want, and that really is management’s job.  |
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