Financial fraudster Sam Bankman-Fried recently received a 25-year prison sentence for his role in the collapse of the FTX cryptocurrency exchange. In that case, the U.S. government claimed a loss of $12 billion for sentencing purposes. In the aftermath of FTX’s fall 2022 collapse, media estimates of customer losses ranged from $8 billion (the worth of assets on FTX’s balance sheet that were unaccounted for) to $16 billion (the amount of funds frozen) to $32 billion (the market value of FTX prior to its implosion). The actual loss, after more than $1 billion in fees went to lawyers, courts, trustees, and liquidation managers? Arguably zero. And certainly nothing like $12 billion.
Bankman-Fried is not innocent; his misdeeds harmed many. Customers lost access to their funds for extended periods during which they may have needed the money or could have put it toward other investments. Fraud is a crime, even if the fraudster eventually pays full restitution. Nevertheless, it’s clear that media accounts often claim shockingly high damages in fraud cases rather than using consistent, rational criteria to report losses. Prosecutorial energy seems to reflect the resulting public outrage, and subsequent good news about recoveries makes little difference to public or judicial attitudes.
Federal sentencing guidelines impose additional prison time based on the intended loss from a crime. That makes sense for, say, bank robbery. The robber takes the money, the bank loses the money. Intention is the key; the crime is equally bad whether the robber is caught quickly and the money recovered, or the money is all spent before capture. But for FTX and other recent high-profile cases, it’s not clear that there was any intention to cause losses.
Bernie Madoff’s stock and securities fraud, uncovered in 2008, inspired some of the most inflated headlines. Reports suggested that Madoff masterminded a $65 billion Ponzi scheme, but much of that amount never existed. Investors entrusted his firm with about $20 billion, which Madoff deceived them into believing earned returns of about $65 billion. Many investors redeemed their shares shortly before Madoff confessed his deception and turned himself in, and investors have recovered about 91 cents on the dollar, even after the bankruptcy trustee overseeing Madoff’s firm ran up over $1.5 billion in legal fees. Perhaps it’s bankruptcy courts that evaporate the big money.
Of course, victims consider the fictitious investment gains to be their money, make decisions on that basis, and feel rightfully aggrieved when those gains are shown to be fictitious. But it’s not money the fraudster can spend or derive any other direct benefit from; it was never real.
The bankruptcy of the Lehman Brothers financial firm is another case in which media accounts proved exaggerated. Customers received all $106 billion they were owed. Secured creditors got paid in full, while unsecured creditors received 41 cents on the dollar. A much smaller case that also attracted great media attention is that of former pharmaceutical executive Martin Shkreli, who defrauded investors in a drug company and two hedge funds. His investors made a profit, but for sentencing purposes, he was tagged with causing between $9 million and $20 million in losses.
These four cases differ in many respects, but all involved some kind of malfeasance. It’s unclear, though, that any of the parties involved intended to inflict losses on investors. Madoff’s motivations remain a mystery. Bankman-Fried claimed that he was trying to build an innovative business and change the world. Shkreli seems to have been similarly motivated on a smaller scale. And Lehman Brothers ran a highly levered firm in hope of generating large returns. What links these four fraudsters is a willingness to disregard the rules, while pursuing aggressive aims, but not necessarily the intent to harm investors.
We should be skeptical of damage amounts asserted in headlines and courts. There is no simple answer to how much money investors lost in these and other fraud cases. Many sources fail to disclose methodology for their estimates, which may be based on guesswork.
Why are early loss estimates often exaggerated? It likely begins with a media bias toward sensationalism. When only a few facts are known and loss amounts are highly uncertain, it’s tempting to report high estimates to generate interest. Even when these are qualified, as in, “losses could be as high as . . . ,” the figures tend to stick in public discourse even as better information emerges to support more moderate claims.
The high early figures can also motivate prosecutors, who like the big numbers both to supercharge their press coverage and threaten defendants for stronger plea bargains. Loss-enhancement sentences often dwarf the underlying offenses. The “base level” for fraud and theft is 7, which equates to a zero- to six-month sentence for a defendant without prior convictions. Putting a $20 million figure on the intended loss adds 22 levels to a sentence, which equates to seven-and-a-quarter to nine years in prison.
Excessive estimates of fraud damages contribute to a perception that high finance is an industry rife with criminals capable of squandering unimaginable amounts of money. It drives overzealous prosecutors to search for malfeasance where sometimes none exists. All insider-trading criminal cases against Point72 portfolio managers, for example, were overturned on appeal. Public opinion and prosecution too often rest on unfounded early estimates of fraud losses.
Properly functioning capital markets require that fraud in all its various forms is identified and punished. Our point is not that any of the above-mentioned people are innocent or should not have been prosecuted. But exaggerated media accounts and overzealous prosecution can also have costs, including increased regulations. We should strive for an honest assessment of fraudulent losses and punishment that is commensurate with the scale of the crime.
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