The New York Attorney General is investigating the iFinex companies — who you’ll know as crypto exchange Bitfinex and dollar-substitute stablecoin Tether.

The NY AG thinks there’s been considerable funny business with the Tether reserve — and want to get to the bottom of this. iFinex have bitterly resisted even being investigated.

The investigation started in late 2018. By April 2019, iFinex had been sufficiently uncooperative that the NY AG filed to compel discovery of documents from them. The case dragged on, as iFinex tried to block discovery, and claimed the investigation itself was illegitimate and should be stopped.

In August 2019, the court finally ruled that iFinex had to cooperate — “Fundamentally, Respondents misperceive the respective roles of the Attorney General and the Court.”

iFinex appealed — and yesterday, the NY AG’s office filed its response.

The filing contains nothing really new — but the useful thing it does is to state the NY AG’s problems with Tether concisely, in one place. If you were having problems getting your head around this case, this is a useful read.

The Martin Act

The Martin Act gives New York broad powers to head off possible securities or commodities fraud — “to defeat all unsubstantial and visionary schemes in relation thereto whereby the public is fraudulently exploited.”

Specifically, the Martin Act — and considerable precedent in its past enforcement — gives the Office of the Attorney General (OAG) broad powers of investigation — even when they’re not sure there’s a solid case yet.

The OAG first sent Bitfinex and Tether a Martin Act subpoena in November 2018.

Bitfinex and Tether

Bitfinex is a cryptocurrency exchange. It’s one of the few such exchanges that lets you deposit actual money. These deposits are held with various banks and “payment processors.”

Bitfinex claims to have barred customers from the state of New York since January 2017 — but they didn’t. Bitfinex claims to have barred all US customers since August 2017 — but they didn’t do this, either. US and New York customers continue to have access — and Bitfinex knows they do.

Tether is owned and run by the same people as Bitfinex. Tether offers tethers, a cryptocurrency “stablecoin” that is worth one dollar — their main use is in crypto trading. Tether has long claimed that every tether was backed by a US dollar in a bank account.

There were 2.6 billion tethers in circulation when the OAG brought its action. Another two billion have been issued since then.

Tether claims to have stopped serving US customers in November 2017 — but the OAG has found New York investors buying tethers from Bitfinex up to December 2018.

Bitfinex’s liquidity troubles

This is the good bit — starting on p13 of the filing. This section is why the OAG is deeply concerned.

Bitfinex needs banking to handle its customer deposits and withdrawals of actual money. Unfortunately, US banks don’t want to risk dealing with unregulated offshore companies that touch cryptos.

After multiple failed financial relationships, Tether announced in November 2018 a relationship with Deltec Bank and Trust in the Bahamas. Bitfinex also hooked up with Deltec.

Tether still stated that all tethers were “fully backed by US dollars that are safely deposited in our bank accounts.”

But this wasn’t the case. Tether and Bitfinex were also entrusting funds to third-party payment processors — such as more than $1 billion by mid-2018 to Crypto Capital Corp, who were supposedly an intermediary to wire funds to and from customers.

This was despite Bitfinex and Tether having no contractual relationship with Crypto Capital. If anything happened, Bitfinex and Tether customer funds were at risk. They did not disclose this to their customers.

In mid-2018, Crypto Capital stopped processing Bitfinex’s withdrawal requests — they claimed that (unspecified) governments had seized $850 million of Bitfinex funds from banks around the world.

Despite withdrawal requests piling up … Bitfinex didn’t tell anyone. In fact, they claimed that reports of problems were “based on nothing but fiction” — “All cryptocurrency and fiat withdrawals are, and have been, processing as usual without the slightest interference.”

In November 2018, Bitfinex grabbed $625 million from a ready source of cash — Tether’s account at Deltec. In return, they transferred $625 million from Bitfinex’s account at Crypto Capital to Tether’s account at Crypto Capital.

That is, Bitfinex got money they could use, in return for money they couldn’t use — and that Tether couldn’t use either.

Which shell is the reserve under?

Bitfinex produced a small quantity of documents for the OAG. In February 2019, they finally told the OAG that Crypto Capital had $850 million of Bitfinex money they weren’t giving back.

Bitfinex didn’t mention to the OAG the $625 million transaction from November. In fact, they told the OAG they were contemplating a new transaction, to give Bitfinex a $600-700 million line of credit on the Tether reserve — the money that was supposed to be the one-to-one backing for tethers.

The OAG was concerned by this — it sounded like Bitfinex needed hundreds of millions of dollars urgently, just to keep going, and Tether would lose its backing. And this transaction would never be disclosed.

The OAG asked for more information on the loss of funds to Crypto Capital, and on the line of credit transaction. Bitfinex dragged its feet on submitting more documentation.

In March 2019, Bitfinex told the OAG the line of credit had gone through — for $900 million. Bitfinex also finally told the OAG about the earlier $625 million shuffle.

Thus, Tether’s backing now included $625 million at Crypto Capital that wasn’t accessible, and a $900 million IOU from Bitfinex — $1.5 billion had been taken from the Tether reserve to pay out Bitfinex withdrawals.

This finally drove the OAG to file its action in April 2019.

The New York Supreme Court told iFinex to produce documents, and not to make “transactions outside the ordinary course of Tether’s business that would result in Bitfinex or other affiliated parties having claims on the U.S. dollar reserves being held by Tether” — that is, no more nonsense like the $900 million line of credit.

No New York

iFinex objected (so far) on three grounds — that the OAG’s subpoenas had not been properly served; that the Martin Act didn’t apply to tethers (so the OAG had no subject matter jurisdiction); and that iFinex didn’t do business in New York (so the OAG had no personal jurisdiction).

The judge asked iFinex for documents to back up the jurisdiction claim.

The OAG says that these documents established “respondents’ purposeful direction of activities toward the State at various stages of the trading process”. Among other examples:

Phil Potter, then an executive at Bitfinex and Tether, lives in and works from Long Island, New York. But he didn’t just happen to live in New York while working for a foreign company that didn’t do business in New York — Bitfinex was reassuring customers in January 2018 that Potter “lives in New York as you do and will be glad to help you with anything related to your trading activity.”

Bitfinex’s lawyer, Stuart Hoegner, told one New York customer to work via a “UK vehicle” to avoid New York regulation.

In 2019, iFinex loaned tethers to “a New York-based virtual currency trading firm.”

iFinex entities opened bank accounts in New York.

The Supreme Court found in August 2019 that all three grounds were invalid — the order and subpoenas stood, and the investigation could proceed. iFinex appealed.

iFinex responds

Just as I was finishing this post, iFinex put in its response to the OAG’s filing.

This is mostly an extended “nuh-uh” to anything the OAG said.

The best argument I can see in iFinex’s response is that the Crypto Capital issue, the $625 million shuffle and the $900 million line of credit didn’t happen in New York — so the OAG has no business even asking about any of this.

What happens next

@lex_node suggests that the personal jurisdiction issue is the only one iFinex has any hope on — “If I had to, I would guess the court sides with NYAG and allows continuing discovery process against Bitfinex/Tether. The fraud allegations are so strong that a judge should be loathe to do otherwise. But can’t exclude that court finds insufficient basis for personal jurisdiction.”

iFinex general counsel Stuart Hoegner tweeted in response that “There’s nothing particularly new” in these allegations, which they dispute. Bitfinex CTO Paolo Ardoino replied, “But but but things were too quit [sic] lately, better raise some FUD” — which I think must be short for “Facts U Dislike.”

The appeal is to be heard in early 2020.