Senator Warren demands answers from Silvergate Bank regarding its business relationship with FTX

When it comes to offering banking services to the cryptocurrency community, Silvergate Bank holds an ace card: the endorsement of none other than Sam Bankman-Fried, the famous founder of FTX, a large and popular cryptocurrency exchange.

“Life as a crypto firm can be divided into pre-Silvergate and post-Silvergate,” Bankman-Fried said in a recent and prominent statement on Silvergate Bank’s website. “It’s hard to overstate how much blockchain has revolutionized banking for companies.”

Now, with billions of dollars missing from the bankrupt FTX’s coffers, Bankman-Fried’s tributes have disappeared from San Diego-based Silvergate’s website. Silvergate’s banker role at FTX and other Bankman-Fried entities raises questions for its CEO, Alan Lane, and headaches for the institution’s public shareholders.

Late Monday, Elizabeth Warren, Democrat of Massachusetts and a member of the Senate banking committee, and two of her Republican colleagues subpoenaed Lane and Silvergate for information about the bank’s ties to FTX and Bankman-Fried.

“In the weeks following FTX’s shocking bankruptcy, new and troubling allegations about the company’s business practices continued to emerge,” the letter said, “including reports that Mr. Bankman-Fried secretly moved $10 billion of client funds into his own trading.” . vehicle, Alameda Research’, to finance ‘risky bets’ in violation of both US securities laws and FTX’s own terms of service. We are concerned about Silvergate’s role in these activities due to reports that Silvergate facilitated the transfer of FTX client funds to Alameda.

The letter, co-signed by Sens. John F. Kennedy, R-Louisiana, and Roger Marshall, R-Kansas, also questioned Silvergate’s vigilance in flagging suspicious activity on customer accounts in compliance with banking regulations.

“Your bank’s involvement in the transfer of FTX customer funds to Alameda demonstrates a serious failure of your bank’s responsibility to monitor and report suspicious financial activity by its customers,” the letter said. Silvergate has until December 19 to respond to MPs.

Silvergate is one of the few US banks that allows customers to transfer dollars or other so-called fiat currencies to cryptocurrency exchanges. FTX and related companies, including Alameda Research, its hedge fund and private trading firm, have 20 different accounts at Silvergate, according to FTX’s bankruptcy filing. According to the lawsuit filed against Bankman-Fried and its senior executives, billions of dollars were transferred to FTX Group through Silvergate in recent years.

It is not yet clear what happened to FTX, Alameda and other related entities, or where the billions of dollars in missing client funds went. However, in a conversation with an investment manager, a former FTX employee said that Silvergate is a major banking partner of FTX. In a conversation whose transcript was shared with NBC News, the former employee described transfers of money between FTX’s Silvergate account, which contained FTX client money, and accounts belonging to other entities believed to be controlled by Bankman-Fried, including Alameda. Research, separate crypto trading operation. The investment manager told NBC News that he shared some of the former employee’s testimony with members of the Senate banking committee.

FTX’s bankruptcy filings, disclosures and reports from Bankman-Fried raise questions about the possible mixing of customer money and wire transfers between FTX and Alameda.

“Silvergate appears to be at the center of the improper transfer of billions in FTX client funds. Americans need answers. Those guilty of wrongdoing must be held accountable,” Senator Warren said in a statement.

In response to the lawmakers’ letter, Silvergate issued this statement: “We received Senator Warren’s letter and look forward to answering his questions in an open and transparent manner. Like many others, Silvergate was a victim of FTX and Alameda Research’s apparent misuse of client assets and other errors of judgment, and we believe our full cooperation will help set the record straight about our role in the digital asset ecosystem.

Citing client confidentiality and Silvergate’s status as a federally regulated financial institution, Lane declined to answer questions from NBC News about the bank’s ties to FTX, Alameda or other Bankman-Fried companies.

Late Monday, Lane issued a new statement outlining the bank’s extensive due diligence process on FTX and Alameda, saying: “If we discover any unexpected or potentially suspicious activity on any account, we conduct an investigation and, when requested, make a confidential inquiry. suspicious activity report in accordance with federal regulations.

‘Duty of due diligence’

Silvergate’s clients are all institutional and include cryptocurrencies, hedge funds, venture capital firms and other entities that trade digital currencies, its website and securities filings show. Silvergate has over 1,300 digital currency and fintech customers using its platform every day. In 2017, it launched a 24/7 instant money transfer system called Silvergate Exchange Network, or SEN. The bank reports that during this period, SEN provided assistance of $1 trillion in US dollar transfers.

In a recent news release addressing the FTX mess, Lane said his institution’s exposure to the FTX failure was nominal, with FTX deposits accounting for less than 10% of the bank’s roughly $12 billion in digital deposits as of September 30. “As a well-capitalized federally regulated banking institution, we maintain a strong balance sheet with sufficient liquidity to support our customers’ needs,” Lane said.

Still, Silvergate’s potential exposure to the FTX crackup goes beyond the deposits it holds for the company. Silvergate’s securities filings disclose the potential risks posed by associations with troubled clients. “If one of our customers (or, in the case of digital currency exchanges, their customers) engages in, or is accused of engaging in, illegal activity using digital currency, a filing states, “We may be subject to various fines and sanctions. , including restrictions on our operations, which could harm our reputation and adversely affect our business, financial condition and results of operations.”

Silvergate is overseen by the Federal Reserve Bank of San Francisco and California, and its deposits are guaranteed by the Federal Deposit Insurance Corporation, its securities filings show. As a regulated bank, Silvergate has an obligation to monitor customer accounts for suspicious activity that may signal fraud, money laundering or tax evasion. Such crimes may be possible through the use of digital currencies, the bank acknowledged in its filings, but Silvergate said its risk management and compliance framework was “reasonably designed to detect any illegal activity by our potential or existing customers.” ” Still, the bank acknowledged in those filings that it cannot guarantee the ability to detect all such activity, should it occur.

Silvergate’s use of Bankman-Fried as a pitchman could also pose potential legal risks, one of the securities law experts said. “If they advertise it on their website, they have a more important duty of due diligence,” said Lewis D. Lowenfels, a prominent securities lawyer and co-author of the nation’s leading securities law treatise. “They have a duty to make sure they don’t encourage fraud.”

Crypto based deposits

Fifteen years ago, long before the cryptocurrency craze, Silvergate Bank was a small industrial loan company in San Diego with four branches, 40 employees and $300 million in assets, Lane said in interviews. The bank avoided the subprime crisis of 2008, and other troubled lenders had no trouble attracting borrowers. Gathering deposits was more difficult, and as larger and more established institutions battled for share, in 2013 Lane said he began to see the promise of cryptocurrency.

Lane acknowledged that bitcoin trading was taking off, but other banks were shying away from the cryptocurrency business because the risks of money laundering and other financial crimes worried the arena. In a 2019 podcast, he agreed when asked if Silvergate’s goal was to fill the crypto banking vacuum and “manage deposits.”

He drove them. Silvergate’s deposits rose to $13 billion in the September quarter, and its shares, which went public at $12 in 2019, rose to $217 in early November 2021, when bitcoin’s price peaked near $69,000. Then, Lane’s Silvergate holdings were worth an estimated $87.5 million, according to regulatory filings. Now, with Silvergate’s stock down 89%, Lane’s stake, smaller as a result of some stock sales, is worth $6.1 million.

Almost 40% of Silvergate’s deposits are from foreign entities whose documents are sovereign, without specifying the countries. This is not surprising in the cryptocurrency arena. Only 2% of FTX exchange customers were in the US, a recent bankruptcy filing shows. A full third of FTX’s clients were from the well-known tax havens of Cayman and the Virgin Islands, while clients from China, which bans cryptocurrency transactions, accounted for 8% of FTX’s clients.

As a regulated entity, Silvergate must monitor its customers’ accounts for illegal activities such as money laundering or tax evasion and notify regulators of suspicious transactions. “A bank should be alert to unusual transactions after establishing contact with a customer,” says guidance issued by the Office of the Comptroller of the Currency, one of the nation’s top banking regulators. Among the activities banks should watch out for, the guidance says, are “unusual transfers of funds between related accounts or between accounts covering the same or related basis.”

Banks must submit suspicious activity reports to the Financial Crimes Enforcement Network (FinCEN) when they detect problematic transactions. However, such documents are confidential and it is not possible to determine whether Silvergate provided any of these reports to FTX. The lawmakers’ letter specifically asks whether Silvergate should file suspicious activity reports with FTX, adding that failure to do so could constitute a violation of the law.

According to a former FTX employee with direct knowledge of the operations, FTX frequently used the Silvergate Exchange Network. Among the transactions described by the former employee were transfers from FTX’s client account at Silvergate to accounts belonging to Alameda Research and other entities the employee believed to be controlled by Bankman-Fried.

Bank compliance experts say large institutional clients, such as those banked at Silvergate, are very complex and require close scrutiny because ownership can be murky. For example, several analysts may be required to service just one large account, such as FTX, to provide anti-money laundering protection, one expert said.

As the cryptocurrency craze cooled and several crypto exchanges filed for bankruptcy, Lane issued statements assuring investors that none of these setbacks would hurt their operations.

The bank has also made recent changes to internal risk controls. On November 7, just days before FTX’s collapse, Silvergate appointed a new chief risk officer: Kathleen Fraher, formerly the bank’s vice president in charge of compliance and the Bank Secrecy Act. Fraher replaces Silvergate CEO Lane’s son-in-law Tyler Pearson in the role. Pearson is currently deputy chief risk officer at the bank. A Silvergate spokeswoman said the change reflected the new president’s role at the bank.

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