Daniel Roberts
Published: Aug. 2, 2018
Tether, the Hong Kong-based company behind the cryptocurrency of the same name, has been the subject of fierce scrutiny in the crypto world all year. Tether, the digital token, is meant to be a 1-to-1 surrogate for the U.S. dollar, a “stablecoin” that bitcoin holders can trade into as a safer store of value. That’s why the price of tether has basically stayed at $1 for its lifetime, with the exception of a couple swings in 2017 to as low as 80 cents and as high as $1.80.
Tether, the company, insists all tether tokens are backed by U.S. dollars that Tether holds in reserve. Regulators have been skeptical of that claim.
In December 2017, the CFTC subpoenaed Tether and Bitfinex, a huge bitcoin exchange that began offering tether in 2015. Bitfinex CEO Jan Ludovicus is also CEO of Tether, but has insisted the two companies are completely separate. Major media outlets have pointed to the “mystery” of the relationship between Tether and Bitfinex, and questioned whether Tether has the reserves it claims to have.
The heat led Tether to hire Freeh, Sporkin & Sullivan (FSS), the Washington, D.C., law firm of former FBI director Louis Freeh, to conduct an investigation of its compliance and transparency, including a check of its bank balances. In June, Tether publicly posted the confidential report from FSS containing its findings.
The crux of Freeh’s report: Tether indeed holds the balance it claims to hold. On June 1, without Tether or its two banks knowing the selected date ahead of time, FSS performed an “account snapshot” and found that Tether held a total of $2.545 billion, which indeed covered the 2.538 billion tether coins in circulation at the time, plus a cushion of about $7 million.
Hiring Louis Freeh to handle a compliance investigation is akin to bringing in the big dogs. He has investigated Penn State University, FIFA, Daimler Chrysler, and others. When a large public company, small private company, government group or educational institution taps Freeh, it is an attempt to say: We are serious about this. The same is true of former FBI director Robert Mueller, currently special counsel for the Russia investigation. As Fortune wrote in 2013, “There simply aren’t many former FBI directors out there.”
Nonetheless, skeptics have questioned Freeh’s report on Tether.
In an exclusive interview with Yahoo Finance, Freeh discussed the Tether investigation, which was his first ever cryptocurrency-related work. He says his firm expects to take on more crypto jobs—and is staffing up to prepare for them.
Background: Tether and Bitfinex
The controversy over Tether went mainstream on June 13, when an academic paper out of the University of Texas concluded that bitcoin’s big price surge at the end of 2017 was partly due to market manipulation of tether on Bitfinex.
The report was widely picked up by business media, and it’s likely what led Tether, on June 20, to announce that it had previously hired Freeh’s firm. (It hired FSS in March.) In a “transparency update” on its site, Tether wrote, “Tether and related parties have been the subject of scrutiny over the course of the past several months… It is our belief that much of the speculation and negative reporting has been the result of misunderstandings of how Tether functions. To address allegations head on, we wish to make a few things clear: All Tethers in circulation are fully backed by USD reserves… Earlier this year Tether engaged Freeh, Sporkin & Sullivan LLP (FSS) to review bank account documentation and to perform a randomized inspection of the number of Tethers in circulation and the corresponding currency reserves.”
Tether also posted the June 18 FSS report, thereby waiving its attorney-client privilege.
FSS cautions that its investigation was not an official “audit” of the type that the “big four” accounting firms (Ernst & Young, Deloitte, KPMG, PWC) would conduct, since FSS is not an accounting firm. In fact, those firms have, for now, declined to take on any cryptocurrency-related work.
This is why the Next Web calls it “yet another phony audit.” In addition, some bitcoin blogs have pointed to the fact that Judge Eugene Sullivan, a partner at FSS, is on the advisory board of one of Tether’s banks, suggesting that relationship compromises the report.
In his conversation with Yahoo Finance, Freeh addresses these claims. What follows is a condensed transcript. Freeh’s son Justin Freeh, a lawyer and former Navy SEAL who is now of counsel at FSS and worked on the Tether investigation, also joined the interview.
Freeh talks Tether
Yahoo Finance: This was your first-ever cryptocurrency work. Did it require an amount of general homework before you could even dive into Tether specifically? Does your firm understand cryptocurrency?
Louis Freeh: We do. Luckily we have some in-house resources, people that have quite a bit of experience. One of our partner investigators, Walt Donaldson, has specialized in computer forensics and cryptocurrency examinations and inquiries. He was formerly the director of investigations for Bank of America. And we have another investigative partner, Mike Welch, who came out of the FBI, where he was an assistant director, ran their cyber programs. And Justin [Freeh] has quite a bit of knowledge and expertise in that area. [Justin Freeh spent two years as VP of operations and chief legal counsel to software company SAIFE.]
The first challenge was really to size and understand the scope of what we were going to do. And we wanted to make sure the client understood that we were not going to do an audit. As you probably know, the Big Four have shied away from auditing these types of businesses.
So it was not an audit, it was an examination and a due diligence. The most essential part was that on a given day of our choosing, unknown to the client, and unknown to the banks with which it is dealing, we would appear at the financial institutions and get a certified, verifiable declaration by the institutions with respect to how much cash and dollars they had on hand.
So this was a due diligence structure and scope that we hadn’t done before and we couldn’t find anybody in the industry who had done it.
Was that a turnoff for you, the fact that the big firms won’t do it? Did you care?
Certainly we care, and we took cognizance of that in terms of deciding whether we could perform a valuable and credible service for this client. We want to make sure we’re providing value, but we were also concerned about our own reputation. And we got comfortable with the idea that we’re not doing an audit, and therefore the fact that the Big Four had declined to enter the space was not a predominant factor for us.
Was checking the account balance the main thrust of why Tether wanted this investigation done, as you understood it?
Justin Freeh: I would say they were just as concerned with having a robust compliance program in place, and what that does for their credibility.
A lot of the headlines focused on the account balance snapshots, but a lot of this was going in and interviewing key personnel and reviewing hundreds of pages of documents—to include Tether’s anti-money-laundering procedures, their Bank Secrecy Act, their OFAC [Office of Foreign Assets Control] policies, all those things we would regularly do in a compliance engagement.
The account balance snapshots were very much of public interest, and that’s prominently featured in our report, but a lot of the background is the due diligence we would do on any client throughout the course of a matter.
Your report to Tether was confidential, which means they didn’t have to publish it. But they chose to. That’s different from the Penn State investigation, where you publicly released the report.
Louis Freeh: Yes. Penn State was very unusual, where upfront I said, ‘We’ve got to agree that this will become public right away, as is.’ That’s generally not the protocol. With Tether, it was the general practice where we gave them the report, and they waive the privilege if they want to make it public.
Some are naturally skeptical of your report because the finding is what the company would hope for. That is: they hired you to check them on their claim, and you found that their claim is legitimate. When your work finds in favor of the company that engaged you, do you worry about the optics of that?
Louis Freeh: That’s one of the occupational hazards of this type of practice. When I worked as the independent, court-appointed monitor for Daimler, I was paid by Daimler. And the DOJ and SEC of course take that into consideration when they allow a company to pay large amounts of funds to the monitor.
We are always asked the question, ‘You’re being paid by the client so how can you be independent?’ And our response to that is, Look, we have a reputation that we’re very proud of and very protective of. And we never want to be put in a position where we’re doing something to promote an image or facilitate a statement by a client that’s not consistent with the facts. So it’s just innate with our work that that’s always an issue for people.
Another criticism some are making is the fact that Judge Eugene Sullivan, a partner at your firm, has a relationship with one of Tether’s banks. Is that a conflict of interest?
Louis Freeh: The judge was not on site to conduct any of the interviews with the banking partners. He supervised the engagement but did not participate in the drafting of the report. We did everything we could to minimize his engagement in this matter. We’ve done things purposely to make sure this was done as objectively as we can. And the dealings with the bank that he has a relationship with were firewalled.
Wells Fargo cut ties with Tether last year. Were you able to discern why, or anything else about the two banks Tether uses?
Louis Freeh: We didn’t talk to Wells Fargo. But the two banks, which we haven’t identified publicly, are very significant and, I would say, very, very well known. We spent a lot of time with them, with their internal compliance people, really kicking the tires and getting down into the weeds.
Justin Freeh: I can tell you the banking relationships Tether has in place are very strong, and they’re with reputable players.
How much time did FSS spend on this? Was it a major engagement for you, or smaller?
Louis Freeh: It was a 90-day focus, with two and a half individuals working on it on a full-time basis for 90 days. In terms of our engagements that’s a significant one, not a huge one.
We had never done this before. We didn’t have any examples or peer practice that we could look at. And we were really very pleased with the fact that we were able to engineer the process and carry it out ourselves.
Do you expect to take on more cryptocurrency investigations as a result of doing Tether?
Louis Freeh: Yes. That’s our hope. We’re very comfortable with the procedure, and the scope of what we did, and the people who did it. We have a lot of experience in money-laundering protocols, looking at SEC guidance, FinCEN compliance requirements. So importing that into the crypto space, with maybe a little bit of innovation in terms of what we need to do to answer the essential questions investors have, we’re very excited and hopeful we can find some additional ways to perform a value service.
Would you create a specific crypto group within the firm?
Louis Freeh: We’ve talked about this at a couple of meetings. We don’t have it formally designated, but we are in the process of actively recruiting a couple of very prominent people in that area. There is one person who is super prominent. If we’re successful in that endeavor, I think we will actually form a sub-group.
We are excited about this work, we have some very good expertise in-house, there’s a lot more out there that we’d like to tap into or acquire. And we could very well spin that into a separate group.
We’ve opened an office in Rome, we’re in the process of opening one in London, and that will help us market this particular service once we get our sea legs.
Where do you see the cryptocurrency space heading? Many regulators as well as big names in finance are extremely dubious. What do you think of it?
Louis Freeh: I think it’s exciting. It’s the start of a whole new area of practice on our side. It’s innovative, disruptive. But it’s going to require the basic ingredient of transparency. Whether you’re dealing with gold commodities or cryptocurrencies, investors and government regulators want transparency, predictability, reliance.
So I think a lot of regulatory rules and concepts will ultimately be imported here, because investors will be disappointed, some will charge that they were defrauded. The government, I predict, will get much more active here in terms of regulation and rule making.
If we can zoom out: Any comment on the ongoing Mueller investigation? He’s a former FBI director, like yourself. Are you watching it closely?
Louis Freeh: Bob Mueller is a friend, a colleague. Many years before either of us were FBI directors we worked together in the DOJ. I have a lot of respect for him and his integrity. There are many people who could perform that investigation, as well as the Penn State investigation and many of the things that I’ve done. I was talking yesterday over email with Mary Jo White. [Note: White is now leading one of the two law firms investigating harassment allegations against CBS chairman Les Moonves.]
There are many good, honest, reputable, competent people who can do those investigations. Bob is certainly one of them. As a former government person, what I like to see with these types of matters, whether they’re private or government, is that the person tasked with getting the facts is honest, smart, reliable, has the moral courage to see the job through.
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