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Life as a crypto firm can be divided up into before Silvergate and after Silvergate — it’s hard to overstate how much it revolutionized banking for blockchain companies. — Sam Bankman-Fried

Silvergate Bank, of La Jolla, California, was the main US dollar bank for crypto exchanges from 2017 to 2022. The Silvergate Exchange Network (SEN) operated 24/7 — not just during normal banking hours — and was essential to US dollar crypto and inter-exchange liquidity. By 2021, 58% of Silvergate deposits were from crypto firms.

After crypto crashed in May 2022, Silvergate got broker and broker. FTX crashed in November 2022, and panicked Silvergate customers withdrew $8.1 billion. The bank had to unload assets, realizing ghastly losses. In March 2023, Silvergate finally announced it would be unwinding.

The assorted regulators promptly dived in to work out what on earth had happened here. They’re finally applying penalties. Also, they’re all still extremely annoyed about FTX.

The SEC rap sheet

The SEC is suing Silvergate for making false or misleading claims to investors — the bank’s holding company, Silvergate Capital Corporation, was publicly traded (NYSE:SI) — about Silvergate’s anti-money-laundering compliance on the SEN. [Press release; Complaint, PDF; Docket]

The complaint also names former CEO Alan Lane, former COO Kathleen Fraher, and former CFO Antonio Martino as defendants.

Silvergate has agreed to pay the SEC $50 million in civil penalties for misleading investors post-FTX.

Lane and Fraher also agreed to settlements — $1 million and $250,000 respectively — and a five-year ban on serving as officers or directors of a public company. 

Martino was accused of lying to investors about the bank’s solvency. He maintains his innocence. He has not agreed to settlements and plans to challenge the SEC in court. [Bloomberg, archive]

The Fed and DFPI rap sheet

The Federal Reserve and California’s Department of Financial Protection and Innovation (DFPI) have also brought state and federal charges against Silvergate. [DFPI; Consent order, PDF]

The only detail in the consent order of the Fed and DFPI’s concern is regarding Silvergate’s SEN:

An investigation by the Department identified deficiencies with respect to Silvergate’s monitoring of internal transactions.

Silvergate has agreed to pay $63 million to settle — $20 million to the DFPI and $43 million to the Federal Reserve Board. The $50 million SEC fine will be offset by this settlement — if Silvergate pays these penalties, it won’t have to pay the SEC as well.

What happens in the SEN stays in the SEN

Crypto firms flocked to Silvergate for its Silvergate Exchange Network. Unlike bank wires, SEN let crypto exchanges move dollars between exchanges at all hours of the day, including nights and weekends.

From 2017 to 2021, deposits from crypto customers grew from $770 million to $14.1 billion. Between April 2021 and September 2022, SEN processed more than $1 trillion of transactions.

Silvergate claimed in its original 2019 S-1 filing that it had “proprietary compliance capabilities,” which constituted “policies, procedures and controls designed to specifically address the digital currency industry.”

Before April 2021, Silvergate had an automated monitoring system (ATMS-A) that was part manual. The system would trigger an alert for suspicious activity, and the bank’s compliance staff would review and track transactions on a spreadsheet.

But in April 2021, the bank switched to a new system, ATMS-B, that was fully automated. ATMS-B just … didn’t bother checking transactions on the SEN!

The coverage assessment concluded that ATMS-B had not been monitoring SEN transactions “as expected because [ATMS-B] does not consider internal transfers as risky activity within any financial crime typologies.”

SEN was a speakeasy, a money laundromat. Just what FTX and the wider crypto bubble needed!

Silvergate’s previous BSA compliance officer warned Fraher repeatedly that the Federal Reserve Board would likely be unsatisfied with the bank’s AML monitoring system, or lack thereof. The Fed and the DFPI told Lane and Fraher that Silvergate’s AML monitoring was indeed inadequate.

In its 2021 SEC 10-K filing, the bank touted “the enhanced procedures” of its compliance program. The same statements were repeated in its 2022 10-Q — even though Silvergate’s SEN hadn’t had automated monitoring in 15 months. 

Silvergate and FTX

FTX declared bankruptcy on November 11, 2022. Rumor had it that FTX had been laundering customer money via Silvergate — which it indeed had — and a bank run ensued.

Just after FTX collapsed, a Silvergate compliance staff analysis found 300 suspicious transactions by FTX-related entities from January 2022 until November 2022:

Most troubling to the BSA staff was the trend of funds that flowed from FTX’s custodial accounts — which held FTX customer funds — to a series of non-custodial FTX-related entities’ accounts, followed by transfers of these funds to other third parties — either through the SEN or to accounts external to the Bank. 

Despite knowing that FTX alone had run up $9 billion in suspicious transfers, Lane continued to assure the public that everything was just fine and Silvergate had a robust AML system. On November 30, 2022, he told CNBC Squawk on the Street:

Again, we built this business compliance first. We satisfy all the regulatory requirements. And we have also, in the past, we have offboarded customers if we see activity that is inconsistent and if they can’t correct it or can’t explain it, then we offboard those customers. 

On December 5, 2022, Lane posted a letter, which Fraher approved, on Twitter and LinkedIn, stating:

Silvergate conducted significant due diligence on FTX and its related entities including Alameda Research, both during the onboarding process and through ongoing monitoring, in accordance with our risk management policies and procedures and the requirements outlined above.

All of these claims were false. What’s more, the SEC says Lane and Fraher knew the claims were false.

Senators Elizabeth Warren, John Kennedy, and Roger Marshall issued a public letter demanding a better explanation of Silvergate’s role in FTX. 

Silvergate’s CEO Alan Lane replied that the bank monitored transactions for every account and had “conducted significant due diligence on FTX and its related entities, including Alameda Research, both during the on-boarding process and through ongoing monitoring, in accordance with our risk management policies and procedures.” 

All of these claims were false too.

Whoops, liquidity!

On September 30, 2022, Silvergate had approximately $12 billion in deposits. By December 31, 2022, deposits had dropped to $3.9 billion.

By the end of 2022, the regulators told Silvergate it needed sufficient cash to cover its crypto asset customers’ deposits. Silvergate borrowed $4.3 billion from the Federal Home Loan Bank of San Francisco (FHLB).

Silvergate also issued brokered certificates of deposit (BCDs). By December 31, 2022, Silvergate reported $2.4 billion in BCD liabilities.

But interest rates were going up. This pushed many of Silvergate’s securities into an unrealized loss position. From September 30 to December 31, Silvergate’s securities holdings plummeted from $11.4 billion to just $5.7 billion. 

Borrowing to cover debts

We wrote before about how Silvergate was unable to file its 2022 10-K on time and that its auditor had refused to sign off on the Q4 2022 accounts. This complaint fills in some of the gaps.

The SEC says that Martino understated Silvergate’s losses and misrepresented that the bank remained well-capitalized at the end of 2022. According to the complaint, he “engaged in a fraudulent scheme to mislead investors about the bank’s dire financial condition.” 

Martino knew that the bank had borrowed billions of dollars in 2022 via BCDs, which were due in January and February 2023.

Martino approved a January 17, 2023, earnings release stating that Silvergate expected to sell $1.7 billion of securities in Q1 2023 — of which it had already sold $1.5 billion. This would leave just $200 million more to sell by March 31. But Silvergate sold another $1 billion in that quarter — because there was no other viable source of funding to cover the previous quarter’s BCDs.

The SEC alleges that the earnings release “falsely reported” how the $1.7 billion was calculated, understated losses on the sales, and overstated a leverage metric. It also alleges that Martino made “false or misleading” statements on Silvergate’s Q4 2022 earnings call, falsified financial statements, and failed to maintain accounting controls.

What does this mean?

The SEC suit is about lying to investors. The Federal Reserve and the California DFPI action is about money laundering. But it’s all really about FTX.

The message for other banks is: don’t pull any more SEN-like arrangements without close monitoring. Don’t set up a money laundromat for your high rollers. Don’t let in customers like FTX. Beware of crypto.

You might have thought Silvergate was already scorched earth — but with a sufficiently awful public disaster, there’s always room for more scorching.

Also, don’t lie to your investors. Remember: everything is securities fraud.