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Sen. Warren demands answers from Silvergate Bank about its business dealings with FTX

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When it came to pitching banking services to the crypto community, Silvergate Bank held an ace card: an endorsement from none other than Sam Bankman-Fried, the celebrity founder of FTX, a large and popular crypto exchange.

“Life as a crypto firm can be divided up into before Silvergate and after Silvergate,” Bankman-Fried gushed in a testimonial featured recently, and prominently, on Silvergate Bank’s website. “It’s hard to overstate how much it revolutionized banking for blockchain companies.”

Now, with billions of dollars missing from a bankrupt FTX’s coffers, Bankman-Fried’s tribute has vanished from San Diego-based Silvergate’s website. Silvergate’s role as a banker to FTX and other Bankman-Fried entities is raising questions for Alan Lane, its chief executive, and creating headaches for the institution’s public shareholders.

Late Monday, Elizabeth Warren, the Massachusetts Democrat and member of the Senate banking committee, and two Republican colleagues sent Lane and Silvergate a request for information about the bank’s relationship with FTX and the Bankman-Fried entities.

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“In the weeks since FTX’s shocking collapse, new and disturbing allegations about the company’s business practices have continued to surface,” the letter said, “including the reports that Mr. Bankman-Fried ‘secretly transferred some $10 billion of customer funds to his trading vehicle, Alameda Research,’ to fund ‘risky bets,’ violating both U.S. securities laws and FTX’s own terms of service. We are concerned about Silvergate’s role in these activities because of reports suggesting that Silvergate facilitated the transfer of FTX customer funds to Alameda.”

The letter, co-signed by Republican Sens. John Kennedy of Louisiana and Roger Marshall of Kansas, also questioned Silvergate’s vigilance in flagging suspicious activities in client accounts as it is required to do under banking regulations.

“Your bank’s involvement in the transfer of FTX customer funds to Alameda reveals what appears to be an egregious failure of your bank’s responsibility to monitor for and report suspicious financial activity carried out by its clients,” the letter said. Silvergate has until Dec. 19 to respond to the lawmakers.

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Silvergate is one of only a handful of U.S. banks allowing customers to move dollars or other so-called fiat currencies onto crypto exchanges. FTX and related companies, including Alameda Research, its hedge fund and proprietary trading firm, held 20 different accounts at Silvergate, according to a recent FTX bankruptcy filing. Billions of dollars in wire transfers sluiced through Silvergate to FTX Group in recent years, according to a lawsuit filed against Bankman-Fried and his top executives.

It is not yet clear what transpired at FTX, Alameda and other affiliated entities or where the billions of dollars in missing customer funds wound up. But in a conversation with an investment manager, a former top FTX employee said Silvergate was FTX’s primary banking partner. In the conversation, a recording of which was shared with NBC News, the former employee described transfers of funds between FTX’s Silvergate account, which included FTX customers’ money, and accounts belonging to other entities believed to be controlled by Bankman-Fried, including Alameda Research, the supposedly separate crypto trading operation. The investment manager told NBC News he shared some of the former employee’s statements with members of the Senate banking committee.

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FTX’s bankruptcy filings, public statements by Bankman-Fried and news reports raise questions about possible commingling of customers’ money and transfers of funds between FTX and Alameda.

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

In response to the lawmakers’ letter, Silvergate provided this statement: “We received Senator Warren’s letter and look forward to answering her questions openly and transparently. Like many others, Silvergate was the victim of FTX’s and Alameda Research’s apparent misuse of customer assets and other lapses of judgment and we believe our full cooperation will help set the record straight about our role in the digital asset ecosystem.”

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

Late Monday, Lane put out a new statement describing the bank’s extensive due diligence process on FTX and Alameda, saying: “If we detect activity that is unexpected or potentially concerning in any account, we conduct an investigation and, when required, confidentially file a suspicious activity report in accordance with federal regulation.”

‘Duty of due diligence’

Silvergate’s customers are all institutional and include crypto exchanges, hedge funds, venture capital firms and other institutions that buy and sell digital currencies, its website and securities filings show. Silvergate has over 1,300 digital currency and fintech customers using its platform daily, it says. In 2017, it launched an instant money transfer system that operates 24/7, called the Silvergate Exchange Network, or SEN. Over that time, SEN has facilitated $1 trillion in transfers of U.S. dollars, the bank states.

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In a recent news release addressing the FTX mess, Lane said his institution’s exposure to the FTX debacle is nominal, with FTX deposits totaling less than 10% of the bank’s almost $12 billion in digital deposits as of Sept. 30. “As a federally regulated banking institution that is well capitalized, we maintain a strong balance sheet with ample liquidity to support our customers’ needs,” Lane said.

Still, Silvergate’s potential exposure to the FTX crackup extends beyond the deposits it held for the company. Silvergate’s securities filings spell out the potential risks posed by associations with problematic clients. “If one of our customers (or in the case of digital currency exchanges, their customers) were to engage in or be accused of engaging in illegal activities using digital currency,” a filing states, “we could be subject to various fines and sanctions, including limitations on our activities, which could also cause reputational damage and adversely affect our business, financial condition and results of operations.”

Silvergate is overseen by the Federal Reserve Bank of San Francisco and the state of California and its deposits are guaranteed by the Federal Deposit Insurance Corp. fund, its securities filings show. As a regulated bank, Silvergate has a duty to monitor clients’ accounts for suspicious activities that could signal fraud, money laundering or tax evasion, the filings note. Such crimes can be enabled through the use of digital currencies, the bank acknowledged in its filings, but Silvergate said its risk management and compliance framework “is reasonably designed to detect any such illicit activities conducted by our potential or existing customer.” Still, the bank conceded in those filings that it could not ensure its ability to uncover all such activities were they to occur.

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Silvergate’s use of Bankman-Fried as a pitchman may also create potential legal risks, one securities law expert said. “If they’re advertising him on their website, they would have a more substantial duty of due diligence,” said Lewis D. Lowenfels, a prominent securities lawyer and co-author of the leading treatise on the nation’s securities laws. “They have a duty to make sure they are not stimulating a fraud.”

Crypto-driven deposits

Fifteen years ago, well before the crypto craze, Silvergate Bank was a small industrial loan company in San Diego with four branches, 40 employees and $300 million in assets, Lane has said in interviews. The bank dodged the mortgage meltdown of 2008, and with other lenders in disarray had no trouble attracting borrowers. Amassing deposits was harder, though, and as it battled larger and more established institutions for its share, in 2013, Lane said, he began to see the promise of crypto.

Buying and trading bitcoin was taking off, but other banks were avoiding the cryptocurrency business because risks of money laundering and other financial crimes had plagued the arena, Lane has acknowledged. In a 2019 podcast, he agreed when asked if Silvergate aimed to fill the crypto banking vacuum and “drive deposits.”

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Drive them he did. Silvergate’s deposits had grown to $13 billion in the September quarter, and its stock, issued to the public in 2019 at $12, soared to $217 in early November 2021 when the price of bitcoin hit a peak of almost $69,000. Then, Lane’s Silvergate holdings were worth an estimated $87.5 million based on data in regulatory filings. Now, with Silvergate’s stock down 89%, Lane’s stake, smaller as a result of some stock sales, has a value of $6.1 million.

Almost 40% of Silvergate’s deposits are from foreign entities, its filings state, without specifying the countries. This isn’t surprising in the crypto arena. Only 2% of FTX exchange customers were U.S.-based, a recent filing in the bankruptcy court shows. Fully one-third of FTX’s customers were from the Cayman Islands and the Virgin Islands, known tax havens, while customers from China, which has outlawed crypto transactions, totaled 8% of FTX customers.

A regulated institution, Silvergate must monitor its clients’ accounts for illegal activities, such as money laundering or tax evasion, and alert regulators to suspicious transactions. “Once the bank has established a customer relationship, it should be alert for unusual transactions,” states a manual published by the Office of the Comptroller of the Currency, one of the nation’s top bank regulators. Among the activities banks should watch for, the manual says, is an “unusual transfer of funds among related accounts, or accounts that involve the same or related principals.”

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Banks are supposed to file what are known as suspicious activity reports with the Financial Crimes Enforcement Network (FinCEN) when they spot problematic transactions. But such filings are confidential and it could not be determined whether Silvergate had filed any of these reports regarding FTX. The lawmakers’ letter specifically asks if Silvergate filed suspicious activity reports about FTX, adding that a failure to do so may constitute a violation of the law.

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

Bank compliance experts say large institutional clients like those that bank at Silvergate require intense due diligence because they are so complex and ownership can be obscure. For example, one expert said that multiple analysts would have been required to service just one large account like FTX’s to ensure against money laundering.

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As the crypto craze has gone cold and several crypto currency exchanges have filed for bankruptcy, Lane has issued statements assuring investors that none of those failures will hurt its operations.

The bank also made a recent change in its internal risk oversight. On Nov. 7, a few days before FTX filed for bankruptcy, Silvergate named a new chief risk officer: Kathleen Fraher, previously the bank’s vice president, compliance and Bank Secrecy Act officer. Fraher replaced Tyler Pearson, a son-in-law of Silvergate CEO Lane who had been in that role. Pearson is now deputy chief risk officer at the bank. A Silvergate spokeswoman said the change reflected a shift in functions taken on by a new president at the bank.

This article was originally published on NBCNews.com

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