How much legal trouble do Celsius and Three Arrows Capital execs face? Possibly a lot

July 22, 2022, 12:11 PM UTC
Alex Mashinsky, Celsius CEO
Alex Mashinsky, founder and CEO at Celsius.
Bruno de Carvalho—SOPA Images/LightRocket/Getty Images

The sudden bankruptcies of crypto lender Celsius Network and hedge fund Three Arrows Capital left many investors in a state of shock—and fury, as they realized not only that their money was gone, but that top executives may have behaved recklessly or worse when it came to customer funds. Investors burned by the bankruptcies are demanding to know whether they’ll recover any of their money, but also whether the executives responsible will face any consequences. Will the leaders at Celsius and Three Arrows face criminal justice or some other form of punishment? Or will the fallout echo the 2008 financial crisis, when top banking executives gambled away investors’ money and wrecked their companies, but no one went to jail?

The crypto executives certainly face the possibility of serious consequences, lawyers tell Fortune, including civil liability for actions such as “fraudulent transfer” and “insider preference”—a situation that could expose them to fines or court-ordered repayments. What’s more, they could face criminal prosecution and even jail time at the hands of various governments if it comes to light that they’ve misrepresented their actions to investors or lied during bankruptcy proceedings. But before any of this happens, angry investors and government investigators must clear a number of legal and practical hurdles.

Following the money

When the stablecoin known as TerraUSD—once one of the 10 most valuable cryptocurrencies—lost its $1 peg in May, the coin and its sister cryptocurrency Luna entered a death spiral that wiped out $60 billion of combined market value. By June, the collapse spawned a contagion as companies that had borrowed to the hilt during the bull market rushed to shore up their balance sheet. Many could not.

Those included Celsius and Three Arrows, which were deeply exposed to Terra and badly over-leveraged. Even worse, the companies appeared to have increased their leverage via dodgy business practices. In the case of Celsius, the platform reportedly used the deposits of small retail investors to make outsize bets on the markets. The Three Arrows founders, meanwhile, took out billions of dollars of uncollateralized loans from some of the biggest players in the crypto space to buy a $50 million yacht, among other things.

The dominoes fell quickly: Celsius paused its withdrawals on June 12; a British Virgin Islands court ordered Three Arrows into liquidation on June 27. A few days later, both filed for bankruptcy.

Now, the question remains whether Three Arrows’ founders, Su Zhu and Kyle Davies, and Celsius CEO Alex Mashinsky will be held accountable—and end up repaying investors who were victims of their companies’ collapse.

According to lawyers, the first thing courts will want to know is whether the executives in charge of Three Arrows and Celsius, as they teetered on bankruptcy, shifted their companies’ remaining assets to themselves or those close to them. If they did, bankruptcy law has mechanisms to stop that—and while cryptocurrency represents a new type of asset, the traditional legal regime very much applies to it.

A court may find that the executives committed what’s known in the parlance of bankruptcy law as fraudulent transfer and insider preference. As the names suggest, they refer to what happens when a debtor—or in this case, the company founder or executive—attempts to devalue the company before a bankruptcy proceeding, paying themselves or “insiders” one year or less before filing bankruptcy.

The goal of shuttling assets around in this way is, of course, to stash them outside of the collective pool that is distributed to other creditors under the terms of a bankruptcy law agreement.

If investigators find that Zhu, Davies, or Mashinsky conducted any fraudulent transfers, they could be liable for breaching their obligations to the company and its creditors, bankruptcy attorney Carlos Martinez told Fortune. Liquidators for Three Arrows, for example, could then try to reverse the transfer of the fund’s property and use it to pay back those the founders owe.

But even if a bankruptcy judge issues such an order for the crypto executives to transfer assets back to the creditors’ pool, that may not help investors due to a simple reason. Namely, Zhu and Davies are currently in the wind, likely overseas, making it hard or impossible to force them to comply with any court order.

It’s possible, of course, that even if the executives are hiding out overseas, they’ve left assets in the United States, which can be seized whether or not they’re here. If they did, though, the process is likely to be complicated since many of the assets are unusual even by crypto standards—Three Arrows, for example, has about 1,000 non-fungible tokens (NFTs). It’s anyone’s guess how a bankruptcy judge would handle disposing of those.

“The thing regarding crypto legal issues is, even though there are definitely already laws in place that very clearly can be applied to crypto effectively, the legal questions for crypto and how the law will be applied to it are unanswered, and things rarely go the way people—even the smartest ones—predict,” attorney Joshua Lida told Fortune.

Possible criminal charges

The executives at Celsius and Three Arrows likely face major headaches in U.S. civil courts, but based on the facts of the case, they could conceivably face more serious legal woes in the form of criminal charges.

According to Martinez, Three Arrows’ founders could face such charges in the event they falsified information regarding their fund to authorities and investors, concealed assets after filing bankruptcy, or committed perjury while in bankruptcy. “If any criminal charges are brought, it would be up to the U.S. attorney general’s office to prosecute.”

Meanwhile, the Manhattan bankruptcy judge presiding over Three Arrows granted liquidators permission to subpoena Zhu and Davies. If they fail to respond to the subpoena, Three Arrows can be denied a bankruptcy discharge—or even have its case dismissed for bad faith and be found to be in contempt of court, Martinez said.

Lida also noted that such contempt charges can be civil or criminal, and can result in fines or even jail.

Celsius’s Mashinsky may be in an even “dicier” situation than that of the Three Arrows founders, notes Martinez, “since it seems that he has already been questioned by the FBI, and Celsius is being investigated by state securities regulators from New Jersey, Texas, Alabama, and Washington.”

Unlike with the Three Arrows bankruptcy, there have been allegations and lawsuits filed regarding Mashinsky and Celsius for fraud, mismanagement, and misappropriation of funds, Martinez explains. “If what is being alleged against Celsius is true, then the Office of the Trustee would report any criminal action by Mashinsky and Celsius to the Department of Justice and Attorney General’s Office in order to bring criminal charges against Mashinsky and any other executive involved.”

Even if the crypto executives did break the law, however, it’s far from a slam dunk that they would be charged or detained. This is due to the fact they are wealthy and able to flee to areas beyond U.S. legal jurisdiction, but also because, as recent books have noted, the U.S. Justice Department has shown itself increasingly unable or unwilling to prosecute white-collar crimes.

Lawyers for Zhu, Davies, Three Arrows, Mashinsky and Celsius did not respond to Fortune‘s requests for comment.

The upshot, for the companies and thousands of small investors burned by Celsius and Three Arrows, is that justice, in the form of accountability for the men who lost their money, is uncertain at best.

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