The FTX Meltdown – Is anything covered by insurance?

Good question. In this video and post, I’ll take a look at some of the issues at hand with FTX and Alameda Research and the meltdown that occurred this month, and how business insurance may or may not come into question.

I do want to make one strong disclaimer before I start. I have no idea what insurance, if any that these firms have or may have.

My comments are based on my knowledge of insurance in the crypto and hedge fund space.

So as of creating this video and post, I know of one proposed class action lawsuit naming certain individuals at FTX and celebrity promoters like athletes Tom Brady and Shaquille O’Neal, comedian Larry David and Shark Tank investor Kevin O’Leary.

I’m certain hundreds more will follow and involve the entities now in bankruptcy, their former directors, officers and employees, and outside entities like auditors, accounts, etc.

The first policy that I think would be triggered would be the firm’s D&O or Directors and Officers Liability Insurance.

That policy protects the company’s leaders from claims like what we’ll likely see as well as the entity for securities litigation.

If FTX & Alameda had D&O insurance, would it respond to the types of lawsuits likely to be filed?

Let’s start with the celebrity promoters, would they be covered under the firms’ D&O policy?

In my opinion, probably not, they do not fit the definition of an insured under this policy so they would need to sue FTX for protection.

Those promoters likely had some contract with FTX for the work they did for them in TV commercials, obligating some form of indemnification from FTX, so that begs the question, would the company’s D&O policy or even their general liability policy respond to those claims?

It may provide the company and directors and officers some defense from those claims, but most D&O policies exclude obligations imposed under contract, so no settlement amounts would be found here.

Also doubtful that any general liability insurance policy on FTX would respond since the allegations would revolve around contractual disputes, and financial damages and not involve bodily injury, property damage, or personal injury – the usual domain of general liability coverage.

The bottom line is possibly some limited defense coverage for the insureds to fend off claims from the promoters who are being sued, but no real coverage for the promoters. On top of that with millions of potential claimants, the promoters are going to need to get in line with everyone else.

Would any of the executives find coverage under the D&O for the claims which may arise?

If there is a D&O policy in place, coverage, if any would be extremely limited due to a key exclusion found in most D&O policies – that is, any deliberate criminal or fraudulent act, or any willful violation of any statute rule or law exclusion.

Now, all the facts of what happened, how they happened, and why they happened are not known at this time, but early reports of the circumstance surrounding the downfall of FTX and Alameda appear to fall into the criminal, fraudulent and willful violation bucket.

I think if there is insurance in place, most of the insurers will look to quickly assert this exclusion.

While there may be final adjudication wording in any possible policy, insurers will likely balk at paying much in defense costs through this litigation.

Stepping aside the coverage and exclusion conversation the other big thing here are limits of coverage – having worked on several Crypto firms I can tell you that getting D&O insurance is expensive and difficult.

A lot of folks in this space are insurance averse and would rather take potential premiums spent on things like D&O insurance and use them instead for growing their firms or investing those dollars and paying for potential claims down the road out of pocket.

The point is that FTX may not have had D&O insurance, and if they do, the potential limits of coverage will be dwarfed by the size of the lawsuits they face.

For a situation, the size of what we’re looking at, it’s impossible to get or afford the types of limits this meltdown will require.

Another bit of news coming out was that there was a potential hack from FTX alleging $370 million of crypto funds were missing.

So, would cyber insurance or crime insurance pay for this loss or any portion of it?

Maybe, but any coverage would likely be very limited. Here’s why.

The insurance industry does not love crypto, there are a handful of insurers that will entertain insuring cryptocurrency if all the right underwriting factors are in place but the capacity for theft of cryptocurrency is limited and total coverage may be limited to tens of millions not hundreds of millions.

On top of that most cybercrime policies don’t cover, unless specifically endorsed, theft of third-party funds – meaning funds you hold in escrow, which I would think most of those funds would be.

Then, of course, you’ve got to factor in the pricing of this coverage and my thought is that many crypto managers would say “thanks but no thanks…. Our security protocols are bulletproof and I’m not paying that premium for limited protection”. oops.

Here’s the bottom line on the FTX meltdown.

It looks like we’re talking about $11 billion in investor losses.

There are going to be a lot of pissed-off people looking to be made whole.

If there is some insurance in place my bet is that most of it will not come into play due to the exclusions I mentioned, and the potential limits of coverage will be so small compared to the overall claims that there’s not really going to be much recovery from insurance.

Have other questions on business insurance for crypto or hedge funds?

Reach out and let’s chat. Thanks