The recent superseding indictment in the Department of Justice’s criminal prosecution of Samuel Bankman-Fried highlights how widespread FTX-related donations were to political campaigns and political action committees.
The indictment refers to 300 different political donations linked to this scheme and the possibility of more than $100 million unlawfully donated.
Some campaigns and PACs have already disposed of FTX-linked funds, and others may do the same. The indictment reveals use of FTX customer funds to make personal contributions in the names of several FTX executives.
The recent plea deal with former FTX executive Nishad Singh includes an admission to one count of criminal conspiracy to defraud the federal government via campaign finance violations.
Impact on Political Campaigns
Campaigns and PACs looking to dispose of impermissible funds must comply with Federal Election Commission rules. And, in this instance, they must also consider bankruptcy laws—fraudulent transfer statutes that allow the debtor to avoid and recover transfers of money—and demands by the FTX bankruptcy estate.
While initial recipients of FTX-linked funds consider their response, entities indirectly connected to these funds—campaign vendors, charities, and other organizations—may similarly receive a demand for the return of FTX-linked funds as part of the bankruptcy proceedings.
For example, if a campaign or PAC has already spent or disposed of the funds, and lacked the current funds to repay the amount of the initial contribution, the FTX bankruptcy estate could use avoidance statutes to demand a return of funds from campaign and PAC vendors.
Similarly, the FTX estate could turn to charities or other entities that may have received funds from a campaign or PAC as part of the initial recipient’s disposal of tainted funds. Campaign vendors, charities, or other downstream entities should start examining whether they may the secondary recipients of such funds, and start mustering available defenses.
Rules for Initial Funds Recipients
The Federal Election Campaign Act and FEC rules provide candidate campaigns and PACs several options for disposing of donations that they learn are impermissible after their initial receipt. These options include refunding the contribution, disgorging it to the Treasury, and potentially donating an equivalent amount of funds to a charity.
In the case where a straw-donor scheme is alleged, a refund should be made to the original source of the funds, although that may change subject to a current petition for rulemaking with the FEC asking the agency to require disgorgement to the Treasury.
FEC rules provide campaigns and PACs a variety of options for disposing of contributions determined to be illegal after the initial donation. But bankruptcy and state fraud statutes are not as flexible. If a campaign received funds and the funds transfer is avoided as a fraudulent transfer, campaigns and PACs must return the funds to their original source.
Unfortunately for campaigns and PACs, there is very little defense to a demand to return the funds, as campaign contributions are essentially a gift, given without a debtor receiving reasonably equivalent value in exchange.
But what happens if the PAC or campaign has already disposed of the funds, either during the election or in an after-the-fact donation to a charity? The estate of the bankrupt entity, here FTX, may pursue the funds transferred to subsequent downstream recipients.
Rules for Downstream Recipients
Vendors to campaigns or PACs might receive a demand for funds as part of a bankruptcy proceeding. But if those entities cannot or do not provide them to the estate, downstream recipients might be on the receiving end of the next wave of demands.
Unlike campaigns and PACs as initial recipients, the secondary recipients of these funds may have a better defense against a demand on them by the FTX estate.
For example, campaign vendors likely have a defense against such a claim, provided they rendered their services and received payment in good faith. However, this determination hinges on specific facts of each transaction, and is not a one-size-fits-all defense.
Charities who were secondary recipients of disgorged funds from campaigns or PACs may also be subject to clawback litigation. Although charities do not provide an exchange of equivalent value for donations, if the transfers are avoided as constructive fraudulent transfers, versus intentional fraudulent transfers, they may be able to establish that they meet the statutory defense available per section 548(a)(2) of the Bankruptcy Code.
Depending on the facts and circumstances, these types of organizations may have other defenses available, such as a claim that they received the funds in good faith. However, establishing good faith as a defense to an action to avoid a transfer is not as simple as it may sound and requires careful consideration and analysis of all available facts.
Finally, it is possible that PACs, 501(c)(4) social welfare organizations, and other political organizations also find themselves as the secondary recipient of these FTX-linked funds subject to a claw back demand in bankruptcy. These entities too may have available defenses, which will turn on the facts of each specific transaction.
Campaign vendors and other downstream recipients may have defenses available to keep these funds, and they should be ready to present them in response to any demand letter and potentially again in a court proceeding.
Clawback efforts in bankruptcy proceedings stemming from fraud previously involved charities—in the case of Bernie Madoff—and political donations—in the case of Allen Stanford. The Bankman-Fried case is the largest example of political contributions being recouped in a bankruptcy proceeding, and won’t be the last.
Going forward, vendors and charities should help insulate themselves from future claims in the event a similar situation arises. For example, contemporaneous documentation of the transaction can help establish good faith. Although risk cannot be eliminated, additional due diligence can help minimize risk in the event of a clawback action.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Chris Hughes, partner, Nossaman, is a litigator with extensive experience defending or pursuing fraudulent transfers and preferential payments.
Bill Powers, partner, Nossaman, advises nonprofits, PACs, and companies on how to leverage the legal and regulatory landscape to maximize their political and business objectives.