We are writing to provide you with an update in the above referenced matter. There has been progress on the appointment of an examiner in the FTX Bankruptcy cases and below we provide an analysis of the same.

Third Circuit Ruling Requiring Appointment of an Examiner.

As previously discussed, on January 19, 2024, the Third Circuit Court reversed the Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) ruling that section 1104(c)(2) mandates the Bankruptcy Court grant a U.S. Trustee’s motion to appoint an examiner. On remand at the hearing on January 24, 2023, (the “Hearing”) the Bankruptcy Court found the appointment of an examiner to be premature. The Bankruptcy Court explained, once the Third Circuit issues the requisite mandate, then, the U.S. Trustee is to conduct a thorough review of prospective examiners and submit a motion to the Bankruptcy Court to appoint the named individual as examiner. 

Third Circuit Mandate.

On February 12, 2024, the Third Circuit issued a certified judgment in lieu of a formal mandate. The mandate is LINKED here and appears on the Bankruptcy Court’s docket at D.I. 7301.

Proposed Order Directing the U.S. Trustee to Appoint an Examiner.

On February 2024, the US Trustee circulated a proposed form of order directing the appointment of an examiner to the following parties: the Debtors, the Official Committee of Unsecured Creditors, the Joint Official Liquidators “JOLs,” and the Ad Hoc Committee of Non-US Customers of FTX.com. Debtors' counsel advised that they did not agree to the form of order. Thereafter, the US Trustee filed the proposed form of order under certification of counsel providing notice to parties in interest on the same. Of note, the proposed order provides that "[t]he scope, cost, degree, and duration of the examination shall be considered on notice to parties in interest at the appointment hearing, together with the application to appoint the examiner." The US Trustee requested that the proposed form of order be entered by the bankruptcy court without notice or a hearing to effectuate the Third Circuit's letter in lieu of a mandate issued on February 12, 2024. Alternatively, the US Trustee proposed that a status conference be held at the upcoming hearing on February 22, 2024, if the court believes a discussion is required. The Proposed Order appears on the bankruptcy court’s docket at D.I. 7597.

February 22, 2024 Hearing.

During the hearing, the US Trustee and debtors' counsel addressed their disagreement over the proposed order. The US Trustee argued that it was the US Trustee's right under section 1104(d) to appoint the examiner and that the debtors' proposed order undermined that fact by proposing the Order state that the US Trustee “shall seek appointment," leaving open the issue of who appoints the examiner. Counsel to the committees each stated they were “agnostic on the order." After some discussion, the court recognized that it is the duty of the US Trustee to appoint the examiner, “subject to court approval." The court also emphasized the necessity of a hearing on the appointment of the examiner so interested parties can be heard, comment on the scope, duration, and cost of the proposed examiner's investigation, and inform the court of any knowledge they have that runs counter to the alleged impartiality of the proposed examiner. The US Trustee explained he did not have information on who the selected examiner would be; however, once an order is entered, the US Trustee's office will submit the rule 2007.1 application early next week. In determining what the application should include, Judge Dorsey and the US Trustee discussed the three-step process in In re Cred Inc., which included a court order ordering appointment, an application filed by the US Trustee, and then a court order approving the appointment of the examiner. With this, the court directed the US Trustee to submit an application that includes the scope, duration, cost, and a motion to appoint the proposed examiner. The order was entered on February 23, 2024 (the “Order”) and states that the US Trustee is directed to appoint an examiner pursuant to 11 U.S.C. § 1104(d), subject to the approval of the court. The Order also states that “the US Trustee shall file an application pursuant to Rule 2007.1(c) of the Federal Rules of Bankruptcy Procedure that identifies the examiner and, pursuant to 11 U.S.C. § 1104(c)(2), sets forth the requested scope, duration, degree, and cost of the examination (the “Application”)." Finally, the Order solidifies the rights of interested parties to be heard on the Application and states that the court will consider the Application after all parties in interest have been heard. The entered Order appears on the Bankruptcy Court’s docket at D.I. 7909.

Summary of Examiner’s Actions in In re Cred, Inc.

Because an examiner appointment could impact the FTX bankruptcy proceeding, Morris James analyzed the examination order issued by the Bankruptcy Court in In re Cred, Inc. (“Cred”), a recent and similar case in which an examiner was appointed by Judge Dorsey, to help understand what this process could look like here. This case was depended upon heavily by the US Trustee during the January 24 Hearing. Therefore, the scope of Cred provides a recent and relevant example of the parameters of an examiner's investigation, which Judge Dorsey would likely approve, given the precedent.

The Cred examination order issued by Judge Dorsey named Robert J. Stark as examiner. Mr. Stark was tasked with "investigating any allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtors or by current or former management of the debtors, and otherwise perform the duties of an examiner set forth in Bankruptcy Code Sections 1106(a)(3) and 1106(a)(4) (the 'Investigation')." The examiner order further provided: (a) the scope and conduct of the Investigation and a detailed examiner's budget needed to be outlined in the examiner's proposed work plan and (b) that such proposed work plan and budget had to be filed by the examiner within seven business days after entry of the order approving the appointment of the examiner.

Following Mr. Stark's appointment, he met with the Committee of Creditors, Debtors, and the Trustee to determine the appropriate scope of the Investigation. In the examiner's proposal to the bankruptcy court, Mr. Stark provided a list of witness interviewees, including then-current and prior executives of the corporation, and outlined a plan to use targeted searches of document custodians. The examiner proposed an initial budget of $800,000 to be completed within two months and petitioned the bankruptcy court for the appointment of an additional financial advisor, eventually retaining Ankura Consulting Group (“Ankura”) to assist with crypto-currency issues. At the conclusion of the Investigation, the final examiner's report was filed on March 8, 2021, as required by Bankruptcy Code Section 1106(a)(4) and discussed the following: the debtors' governance and business management practices; events leading up to the bankruptcy petition; intercompany transactions and potential insider transfers; key parties in this case; summary of each interview conducted; potential conflicts of interest; and investigation conclusions.

How Cred relates to FTX:

Cred and FTX both have crypto-related issues; thus, we can expect the examiner will likely request court appointment of a neutral party familiar with cryptocurrency as a financial advisor to help analyze with the crypto issues in FTX. Also, it is worth noting that the final budget used for the CredInvestigation was $925,000, a significant increase from the original projected budget of $800,000. Nonetheless, this budget aligns with Judge Dorsey's estimation of costs related to examiner's investigation in FTX being approximately "seven figures." While the outcome of Cred is a valuable reference point for this case, it is important to recognize that the similarities between these two cases are not determinative of the outcome in this case. For your reference, please see below for a chart comparing the facts of Cred to the facts in FTX:

SUMMARY OF EXAMINER’S REPORT/PROCESS RE: IN RE CRED, INC.

US Trustee's Notice of Appointment

On February 27, 2024, the US Trustee filed notice of the appointment of Robert J. Cleary, Esq. to serve as the examiner, subject to court approval. The US Trustee's application for an Order approving the appointment of Robert J. Cleary, Esq. (the “Application”) also outlines the proposed scope, cost, degree, and duration of the examination (the “Examination”), beginning with scope, the Application states the Examination shall comply with the Third Circuit's decision and the bankruptcy court's comments at the January 24, 2024 hearing – which largely established the examiner should perform a “review of the investigations already completed” (the “Initial Phase”) and once this review is complete, the examiner should have the opportunity to recommend additional investigations. Regarding cost, if there are no delays in the Examiner gaining access to all relevant information, the cost of the Initial Phase shall not exceed $1,100,000. If however, there are such delays, it should not exceed $1,600,000. The degree will vary, but should allow the Examiner to file complete and accurate public reports when the Initial Phase is complete. Lastly, for the duration, the Application provides, the report on the Initial Phase should be filed no later than (60) days from the date of entry of the court’s order approving Examiner appointment.

Robert J. Cleary, Esq. served as a federal prosecutor for almost two decades and has overseen numerous fraud investigations. Since leaving government service, he has spent over 20 years in private practice, serving in various senior management positions of a major international law firm. His private practice has encompassed white-collar criminal defense, U.S. Securities Exchange Commission (“SEC”) and related enforcement matters, internal investigations, securities litigation, complex civil litigation, and tax controversies.  If appointed Examiner, he would seek approval to retain Patterson Belknap as his principal counsel.

If you have questions or would like more information, please contact Tara Pakrouh (tpakrouh@morrisjames.com; 302.888.6836) or Eric Monzo (emonzo@morrisjames.com; 302.888.5848) or another member of our bankruptcy and restructuring practice.