As we previously highlighted, Cred Inc. and its affiliates (“Cred”), operators of a global cryptocurrency transfer platform, filed for chapter 11 protection in the Bankruptcy Court for the District of Delaware at the end of last year.1 Cred’s filings are noteworthy because they are the first major bankruptcy cases entirely related to cryptocurrency and trading platforms filed in the United States. As Cred nears liquidation, a recent report filed in the case provides a cautionary tale for cryptocurrency companies and investors.
Case Background
After allegations of mismanagement and fraud surfaced upon Cred’s descent into bankruptcy, the bankruptcy court appointed an examiner pursuant to Section 1104(c) of the Bankruptcy Code, and tasked an independent third-party (the “Examiner”) with investigating allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of Cred of or by its current or former management.2 Over the course of three months, the Examiner analyzed approximately 13,000 documents and over 55 gigabytes of data, and conducted 23 witness interviews.3 On March 8, 2021, the Examiner issued a 103-page report (the “Examiner Report”).
Notable Findings of the Examiner Report
Although the Examiner Report found that the events partially responsible for Cred’s bankruptcy filing were a “flash crash” in cryptocurrency trading value in March 2020 combined with a run-up in April and May 2020—resulting in over $24 million in losses—it ultimately concluded that “the firm’s failure is more aptly attributed to dereliction in corporate responsibility.”4 Cred’s most fundamental failures, as identified by Examiner, included:
- un-systemic, chaotic and, in some instances, nonexistent diligence, accounting, and compliance functions; (ii) allowance for currency migration to non-Cred entities operating in mainland China. . . , without legal or practical capacity to repatriate capital as and when requested/needed by Cred; and (iii) allocation of important managerial and operating functions to an individual with an extremely worrisome past.5
The Examiner Report primarily found that “Cred failed to incorporate and maintain internal compliance policies, including due diligence policies.”6 Specifically, it noted that Cred’s diligence process was “informal and appeared, in places, to be cursory,”7 and that “no compliance program had been created, let alone implemented.”8 Specifically, Cred made investments in moKredit and an imposter posing as Quantcoin, and relied on James Alexander, its Chief Capital Officer, who was a fugitive in the United Kingdom unbeknownst to Cred. Each of these stunning failures is discussed in turn below.
moKredit
Part of Cred’s business consisted of the conversion of cryptocurrency received from customers into fiat currency, which was then transferred to moKredit, a Chinese microlender owned by Cred’s co-founder and 50% equity owner.9 In turn, moKredit lent out fiat currency in China and made interest payments to Cred.10 After initial arms-length dealing, the Examiner found that “Cred and moKredit soon shifted to a more casual style of business dealings, often without proper controls.”11 Meanwhile, as Cred’s loans to moKredit grew, so did Cred’s risk.12 When Cred experienced a sudden need for liquidity, it was reliant on payments from moKredit; moKredit, however, was unable to repay the $38 million it then owed Cred due to large default rates on moKredit’s microloans and the Chinese government’s unwillingness to enforce consumer loan agreements in the wake of COVID-19.13 The Examiner Report found no evidence that Cred’s Board of Directors formally approved any moKredit business dealings.14
QuantCoin
Further exacerbating Cred’s liquidity crisis was its transfer of 800 Bitcoin (now worth approximately $44,837,360 million) to an entity named “QuantCoin,” in what Cred claims was a fraudulent scheme. Ultimately, Cred lost the entirety of its investment.15 The Examiner Report found no evidence of material due diligence or written process governing transfers of funds to outside parties such as QuantCoin and noted that Cred’s General Counsel had never even heard of QuantCoin until after the alleged fraud was uncovered.16 Moreover, the Examiner Report found that Cred kept its customers in the dark on such dealings: “Cred’s culture, at least at times, appeared to promote secrecy rather than transparency when potential customers asked questions regarding their assets and the company’s investments.”17
One of the individuals tasked with performing diligence on matters such as moKredit and QuantCoin was none other than James Alexander, who “appears to have performed minimal (if any) due diligence with respect to moKredit”18 and admitted Cred “scrambled” to make initial transfers to Quantcoin.19
James Alexander
These shortfalls might be explained by James Alexander’s nefarious past: while Cred pointed the finger at Alexander for its situation, it failed to mention that Alexander was a convicted criminal who was on the lam. In fact, Cred did not know of Alexander’s past until the Examiner Report found that Alexander was convicted in the United Kingdom for crimes related to illegal money transfers, and had escaped confinement during a prison break.20 Yet, according to the Examiner Report, Cred inexplicably granted this fugitive-from-justice broad power and discretion over its investment decisions as well as the ability to transfer company assets with little oversight.21
Next Steps in Cred Bankruptcy Proceedings
On March 11, the court confirmed Cred’s modified first amended combined plan of liquidation (the “Plan”). The Plan is premised on the creation of a liquidation trust, which will succeed to all rights, interests and property of Cred, and to which Cred will transfer its assets, including causes of action of Cred’s estates. A liquidation trustee, who will be selected by members of the Official Committee of Unsecured Creditors, will be tasked with monetizing Cred’s assets and making distributions to holders of allowed claims. Undoubtedly the liquidation trustee will scrutinize the missteps outlined in the Examiner Report to determine if they support any avenue for claimholder recovery. The Cred case is certainly a cautionary tale in the burgeoning cryptoasset investment space. Customers should carefully diligence their investments, and be cognizant of the fact that they are heavily reliant on management.
Seward & Kissel LLP will continue to monitor these cases and provide updates on material developments as they occur. S&K has expertise in the issues arising in the context of these cases, which fall at the intersection of our blockchain/cryptocurrency, restructuring, and risk-based compliance expertise. If you have any questions or concerns, please don’t hesitate to reach out to Robert J. Gayda (212-574-1490), Anthony Tu-Sekine (202-661-7150), Mike Considine (212-574-1334), or your primary contact at S&K.
1In re Cred Inc., Case No. 20-12836 (Del. Bankr. 2020) (JTD).
2Cred, [Examination Order].
3Id., Dkt. No. 605 at 21.
4Id. at 3, 65.
5Id. at 3-4.
6Id. at 96.
7Id. at 35.
8Id. at 40.
9Id. at 6.
10Id. at 44.
11Id.
12Id. at 45.
13Id. at 46-47.
14Id. at 50.
15Id. at 77.
16Id. at 80.
17Id. at 51.
18Id. at 50.
19Id. at 79.
20Id. at 88-89. After the Examiner Report was filed, the UCC filed a motion seeking the arrest and detention of Alexander, which references a series of misdeeds, including “[e]scaping from prison, using multiple identities, misappropriating assets, violating injunctions, [and] withdrawing $170,000 in cash and checks [post-petition].”
21Id. at 90.
