Fueling the Fire? Professional Athletes Face Suit Following the Fall of FTX
In November 2022, investors filed a class action lawsuit in Florida against a slew of professional athletes, including Tom Brady, Steph Curry, Shaquille O’Neal, and Naomi Osaka, after FTX, a leading centralized cryptocurrency exchange, filed for Chapter 11 bankruptcy protection. The lawsuit also named the Golden State Warriors as defendants due to the team’s promotional partnership with FTX and unveiling of the company’s logo on the court at their home arena, the Chase Center. Additionally, the Warriors were named as defendants in another lawsuit filed in San Francisco on behalf of the non-U.S. investors who traded on FTX’s platform. Although not named in either suit, the Miami Heat publicly terminated their relationship with FTX, which held the naming rights to the team’s arena.
Founded in 2018 by Samuel Bankman-Fried, FTX was a cryptocurrency platform that offered investors a wide range of trading products, including derivatives, options, volatility products, and leveraged tokens. Cryptocurrency is a decentralized form of digital currency that secures and self-records transactions using encryption algorithms. This allows cryptocurrencies to be transferred between parties without the need for a bank or central governing system, unlike transactions involving traditional currencies, such as the U.S. dollar or the Euro. At the same time, the absence of regulatory oversight can make cryptocurrencies a risky investment.
Despite the speculative nature of the asset, some investors built substantial fortunes by taking on the risk of investing in early-stage cryptocurrencies, such as those offered by FTX. By July 2021, FTX was the world’s third-largest cryptocurrency exchange, valued at approximately $32 billion. As a result of the company’s initial success, professional athletes and teams promoted and endorsed FTX, which allegedly prompted unsophisticated consumers to invest in the platform as well. Now, the defendants listed above face an $11 billion lawsuit for their alleged involvement in FTX’s scheme to defraud investors by enlisting celebrities to influence the public and drive investment in the company.
The legal merits of the suit ultimately depend on whether or not the cryptocurrencies the defendants promoted are deemed securities. If investors can prove the defendants failed to disclose that they were being paid to promote the cryptocurrency or had invested in FTX, or were selling or buying unregistered securities, they could be liable for damages. The Securities and Exchange Commission (SEC) has historically taken the position that cryptocurrencies are not securities until September 2022 when SEC Chair Gary Gensler stated his belief that cryptocurrencies should be considered securities, and thus regulated by the agency.
To determine whether a given item constitutes a security, courts tend to refer to the Howey Test, which stems from a 1946 U.S. Supreme Court decision defining a security as “an investment of money in a common enterprise with profits to come solely from the efforts of others.” If courts determine that FTX’s cryptocurrency meets this definition, then it does not matter “whether the enterprise is speculative or nonspeculative, or whether there is a sale of property with or without intrinsic value.”
While some courts have ruled that certain cryptocurrencies may fit the legal definition of a security, the issue remains unsettled. FTX is a particularly complicated case because the company is headquartered in the Bahamas, and U.S. securities laws generally only apply to domestic transactions. Thus, there an open threshold question of whether U.S. securities laws apply to the interest-bearing cryptocurrency accounts offered by a non-U.S. based crypto platform.
Regardless of the legal outcome, experts surmise that the pending lawsuits will generate substantial amounts of money because most defendants will end up settling. Even though there is no evidence yet to suggest the defendants knew of FTX’s purported scheme or intentionally engaged in deceptive business practices to defraud consumers, their wealth and prominence as professional athletes makes them desirable targets for investors looking to recoup some of their losses. This is especially true given the fact that Bankman-Fried is now judgment proof and FTX itself is shielded from suit while it undergoes bankruptcy proceedings.
Only further investigation will reveal the truth behind FTX’s alleged scheme and whether the defendants had any involvement in perpetuating it. Nevertheless, the fall of FTX and the lawsuits filed thereafter raise important questions to consider going forward. Given the novelty of cryptocurrencies and the inherent risk that comes with investing in them, it is at least questionable as to whether the defendants should be held liable for an investor’s poor business decisions, especially if discovery reveals they had no knowledge of the company’s fraud or wrongdoing.
At the same time, celebrities must be careful about encouraging the public to purchase stocks and other investments. Endorsing a risky financial asset is not the same as endorsing sneakers or a clothing brand--endorsements of financial instruments may be unlawful if the defendants do not disclose the nature, source, and amount of any compensation paid, directly or indirectly, by the company in exchange for the endorsement. Going forward, professional athletes and teams may want to think twice about what they promote to their fans, and until the SEC and other regulatory bodies and lawmakers enact rules for the crypto sector, it is essential to be extremely cautious.
References:  Photo: Jaguars QB Trevor Lawrence Among Famous Names Sued in FTX Crypto Collapse, News4Jax (viewed Jan. 22, 2022) https://www.news4jax.com/sports/2022/11/17/jaguars-qb-trevor-lawrence-among-famous-names-sued-in-ftx-crypto-collapse-report-says/  Photo: Why Did FTX Collapse? Here’s What to Know, N.Y. Times (viewed Jan. 22, 2022) https://www.nytimes.com/2022/11/10/technology/ftx-binance-crypto-explained.html  Timothy Smith, FTX: An Overview of the Exchange and its Collapse, Investopedia (Jan. 5, 2023) https://www.investopedia.com/ftx-exchange-5200842  Minyvonne Burke, Tom Brady, Larry David, and Other Celebrities Named in FTX Lawsuit, NBC News (Nov. 16, 2022) https://www.nbcnews.com/business/business-news/ftx-crypto-investors-sue-founder-sam-bankman-fried-celebrity-promoters-rcna57453  Jody Godoy, ‘Wave’ of Lawsuits Over FTX Expected, But Investors Will Face Legal Hurdles, Reuters (Nov. 17, 2022) https://www.reuters.com/legal/wave-lawsuits-over-ftx-expected-investors-will-face-legal-hurdles-2022-11-17/  Steven Taranto, FTX Collapse: Tom Brady, Stephen Curry, Shohei Ohtani Among Sports Figures Named in Class-Action Lawsuit, CBS News (Nov. 16, 2022) https://www.cbssports.com/nfl/news  Smith, supra.  Jake Frankenfield, Cryptocurrency Explained With Pros and Cons for Investment, Investopedia (Sept. 26, 2022) https://www.investopedia.com/terms/c/cryptocurrency.asp  Kate Ashford, What is Cryptocurrency?, Forbes (June 6, 2022) https://www.forbes.com/advisor/investing/cryptocurrency/what-is-cryptocurrency/  Frankenfield, supra.  Id.  Smith, supra.  Nathan Reif, The Collapse of FTX: What Went Wrong With the Crypto Exchange?, Investopedia (Jan. 4, 2023) https://www.investopedia.com/what-went-wrong-with-ftx-6828447#:~:text=FTX%20collapsed%20in%20early%20November,below%20a%20%241%20trillion%20valuation  Burke, supra. See also Ken Sweet, Tom Brady, Larry David, Other Celebrities Named in FTX Suit, AP News (Nov. 16, 2022) https://apnews.com/article/entertainment-technology-sports-celebrity-business-24690dec0c1541a911f4d201e568ebee  Zija Song and Joe Schneider, FTX Investors Go After Brady, Shaq: Here Are Their Legal Chances, Bloomberg Law (Nov. 23, 2022) https://news.bloombergtax.com/crypto/ftx-investors-go-after-brady-shaq-here-are-their-legal-chances  Id.  Frankenfield, supra.  Song and Schneider, supra. See also S.E.C. v. W.J. Howey Co., 328 U.S. 293, 301 (1946).  Song and Schneider, supra. See also W.J. Howey Co., 328 U.S. at 301.  Godoy, supra.  Id.  Id.  Song and Schneider, supra.  Id.  Id.  Investor Alert: Watch Out for Fraudulent Digital Asset and “Crypto” Trading Websites, U.S. Securities and Exchange Commission (Apr. 24, 2019) https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_fraudulentdigitalasset  Jennifer Korn, Why Tom Brady, David Ortiz, Jimmy Fallon, and Other Celebrities are Getting Sued Over Crypto, CNN (Dec. 14, 2022) https://www.cnn.com/2022/12/14/tech/celebrity-crypto-lawsuits/index.html#  Id.  Jack Kelly, Should Sports Stars and Other Celebrities Endorse or Accept Crypto Pay After Entanglement in FTX Scandal?, Forbes (Dec. 13, 2022) https://www.forbes.com/sites/jackkelly/2022/12/13/will-sports-stars-and-celebrities-continue-to-endorse-or-accept-pay-in-crypto-after-being-entangled-in-the-ftx-scandal/?sh=4db3d99e1b1a