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Today the Commodity Futures Trading Commission (CFTC) announced the filing of a complaint in the United States District Court for the Southern District of New York against Stephen Ehrlich. Ehrlich was the co-founder and CEO of three companies bearing the name Voyager Digital (Voyager).
According to the complaint, Voyager offered its customers a high-yield return—as high as 12%—on digital assets stored on its platform under the terms of a rewards program. Voyager promised customers a “safe haven” in a volatile market.
Contrary to that marketed image, Voyager and Ehrlich are alleged to have approved loans valued at hundreds of millions of dollars worth of customer assets to numerous third parties that, for example, made prominent disclaimers that investing with them had a “high degree of risk” that could result in investors losing all their money.
Voyager is alleged to have conducted insufficient due diligence on these counterparties, and to have wrongly determined that they were of low risk despite evidence to the contrary. When one of the counterparties defaulted on repaying a Voyager loan of roughly $650 million of customer funds, Ehrlich concealed from customers Voyager’s precarious financial position, omitted mention of the default, and continued to solicit deposits from new and existing customers, whose assets Voyager then used to repay earlier-in-time customers’ withdrawals. Voyager went bankrupt.
This case exemplifies intersecting layers of certain risks inherent in our markets. For the last several months, I have frequently underscored one of these risks for customers: asymmetries of information.[1]
Consumers of all kinds are at an inherent disadvantage when trying to evaluate investment opportunities. Asymmetries become increasingly imbalanced as the product becomes more complicated. An average retail investor has no independent ability to evaluate, for example, the health of a company offering shares of securities. And not only are the asymmetries more pronounced in the financial sector, but they are more critical and thus more problematic because financial assets have no intrinsic worth to investors beyond how their value will change in the future.[2]
To level the playing field, legislators and securities regulators have developed decades of laws and regulations to define the classes of material information that market participants must disclose to the public as well as the timing and frequency of disclosures. Increasing transparency increases the efficiency and fairness of market transactions, and mitigates the risk of fraud and manipulation.
Digital assets are currently in a uniquely opaque market with inherently more information asymmetries. Customers entering digital asset transactions in the current market have exceptionally limited information about the assets that they purchase or the individuals and firms that customers may rely on to offer advice or execute transactions. As a result of the lack of transparency, the marketplace for retail investors can be exceptionally risky.
What makes this case particularly concerning is that Voyager itself served as an intermediary and was best positioned to overcome these asymmetries on behalf of their retail customers.
At the height of its success, Voyager managed billions of dollars of customer assets. Voyager frequently extended nine-figure loans to third parties as part of its business strategy to generate high-yield returns on behalf of its customers.
It is astounding that Voyager failed to exert pressure on the firms where it invested its customers’ assets. Instead of demanding that investment firms that received customer assets offer greater levels of transparency, Voyager shirked the long-established expectations for custodians and simply dispatched customer funds with little effort to preserve the same.
As set out in the complaint filed today, Voyager conducted bare-bones due diligence, and then seemingly ignored the results of that process even when counterparties failed to return the minimal materials they requested.
Instead of seeking audited financial statements from the company the complaint calls Firm A, Voyager is alleged to have sought merely a net asset valuation, and then accepted in response a letter consisting of a single sentence asserting Firm A’s valuation with zero supporting documentation. What was the benefit of pooling customer assets if the terms negotiated regarding protection and preservation of customer assets were no better than those each retail customers could have achieved alone?
Because of Voyager’s failures, the company became no better than a house of cards.
Firm A, seemingly impacted by the collapse of the Terra Luna blockchain ecosystem and resulting cratering price of terraUSD, became unable to make payments on Voyager’s loan. Firm A defaulted on the loan, and because Voyager had overinvested after failing to conduct proper diligence, Voyager became insolvent itself. And left holding the bag, so to speak, were Voyager’s retail investors, who believed that they had put their digital assets in a “safe haven” amidst a volatile crypto market environment.
Regulations that improve disclosure and transparency of course do not prevent all fraud. Indeed, in this case, Voyager Digital Ltd. is a public company that traded on the Toronto Stock Exchange, and thus was subject to robust disclosure obligations overseen by the Ontario Securities Commission. Ehrlich and Voyager nevertheless made numerous statements, as laid out in the complaint, that obfuscated the company’s financial condition and the quality of the counterparties to whom they would be loaning customer assets. But one firm’s violation of disclosure obligations does not detract from the clear proposition that regulations are a necessary step.
I also note that the Federal Trade Commission (FTC) has announced today that it filed an action against Voyager and Ehrlich for violations of the Federal Trade Commission Act and Gramm-Leach-Bliley Act. Continued coordination with our cooperative enforcement partners is a credit to excellent work being done by the Division of Enforcement, and the dual actions send a strong message to the crypto industry that fraudulent behavior will be met with severe consequences.
Finally, I commend the Division staff responsible for investigating and charging this fraud, in particular Alan Simpson, Rachel Hayes, Stephen Turley, Christopher Reed, and Charles Marvine.
[1] See, e.g., Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC Resolving Charges Against Three Decentralized Finance Companies: The Need for Oversight (Sept. 7, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement090723b (pointing to asymmetries of information as a major risk of DeFi protocols); Kristin N. Johnson, Commissioner, CFTC, Taking Action to Prevent Fraud By Digital Asset Services Firms (July 13, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement071323 (citing information asymmetry as a root cause of the bankruptcy of the digital asset lending company Celsius Network)
[2] See Kristin N. Johnson, Decentralized Finance: Regulating Cryptocurrency Exchanges, 62 WM. & MARY L. REV. 1911, 1977 (2021), https://scholarship.law.wm.edu/cgi/viewcontent.cgi?article=3901&context=wmlr (citing Noah Smith, The Dirty Little Secret of Finance: Asymmetric Information, BLOOMBERG (Aug. 11, 2016), https://www.bloomberg.com/opinion/articles/2016-08-11/the-dirty-little-secret-of-finance-asymmetric-information.
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