15/11/2022
FTXâs Failure Is Sparking a Massive Regulatory Response
A hammer is going to fall on crypto exchange FTX. The question is how heavy it might be.
The collapse of FTX will likely give rise to a number of criminal and civil actions against the exchange and its executives, like former FTX CEO Sam Bankman-Fried. Itâs also likely to push forward actual regulatory changes, either via lawmakers or through federal agencies themselves, a number of individuals told CoinDesk.
FTX filed for bankruptcy last Friday, days after halting withdrawals and a little over a week after CoinDesk first reported that the balance sheet of FTX sister company Alameda Research held a surprisingly large amount of FTT, an exchange token issued by FTX. FTX was âfine,â Bankman-Fried said in response to questions about his exchangeâs solvency, before a series of events showed otherwise.
As a result, several state and federal agencies launched or expanded investigations into the company, including the U.S. Department of Justice, the U.S. Securities and Exchange Commission, the Securities Commission of the Bahamas and the Bahamasâ Financial Crimes Investigation Branch.
Members of the U.S. Congress from both political parties are also calling for further action as a result of the collapse. Some lawmakers are even talking about holding hearings, potentially by the end of the year, said Ron Hammond of the Blockchain Association.
Rep. Brad Sherman (D-Calif.), a member of the House Financial Services Committee, said in a statement that the collapse is âa dramatic demonstration of both the inherent risks of digital assets and the critical weaknesses in the industry that has grown up around them.â
Senate Banking Committee Chair Sherrod Brown (D-Ohio) and Sen. Elizabeth Warren (D-Mass.) are among those in Congress calling for investigations into the collapse as well as Sam Bankman-Fried, who was a major party donor.
Other lawmakers, like Rep. Patrick McHenry (R-N.C.), the current ranking member on the House Financial Services Committee, Rep. Warren Davidson (R-Ohio) and Sen. Pat Toomey (R-Pa.), the outgoing ranking member on the Senate Banking Committee, said it was regulatory ambiguity in the U.S. that allowed FTX to grow as large as it had as an offshore exchange. They called for Congress or regulatory agencies to provide clearer guidelines for crypto exchanges to operate.
The fact that regulators apparently had no view into some of the major projects that fell apart this year â such as Celsius, Three Arrows, Luna and now FTX â is âprecisely the problem,â said an industry participant who works closely with policymakers.
Still, the individual told CoinDesk that they donât expect any major legislative action to occur this year. Most likely, Congress will look at bills like the Digital Commodities Consumer Protection Act, a bill that Bankman-Fried supported but was written prior to that, in the upcoming year.
Investigations:
According to an attorney who requested anonymity, the SEC may have an easier time kicking off the investigation just due to its mandate.
âThe SEC is in a much better position to go to court and get a freeze [on assets] if they believe there's a reason to do that,â the attorney said. âThe SEC also has a less cumbersome process for subpoenaing testimony and freezing documents.â
The SEC and DOJ are likely to cooperate though, to the extent that DOJ investigators may sit in on SEC interviews.
Read more: 'FTX Has Been Hacked': Crypto Disaster Worsens as Exchange Sees Mysterious Outflows Exceeding $600M
The fact that FTX is registered and headquartered in the Bahamas is not likely to impact these investigations, the attorney said. FTX has various U.S. connections, which is all the SEC and DOJ need to assert jurisdiction for their investigations.
FTX appears to be preparing for these investigations, with FTX US General Counsel Ryne Miller having already told the entire company to preserve documents.
A former federal prosecutor told CoinDesk that the bankruptcy court may also shed light on the situation, thus assisting government investigators with their probes.
"The bankruptcy court has the ability to now oversee the company and to obtain information from the company that, let's say the DOJ might not have been able to obtain as easily pre-bankruptcy, and they'll likely have access to a new trustee or an examiner and be able to learn in essentially real-time what's going on,â the former prosecutor said.
Executives like Bankman-Fried may also âbe in a tough spot with respect toâ deciding whether to cooperate or assert Fifth Amendment rights against self-incrimination, the former prosecutor added.
Tweeting exhibits:
A complicating factor â for FTX anyway â may be the fact that Bankman-Fried has tweeted his way through his companyâs collapse.
On Nov. 7, a few days after CoinDesk first reported on Alamedaâs balance sheet, the one-time crypto wunderkind tweeted that âFTX has enough to cover all client holdings.â He went so far as to say that speculation about his companyâs solvency was a rumor spurred by a competitor (Binance) but that âassets are fine.â
Later in the week, he tweeted that FTX US was also fine and fully liquid. Only hours later, FTX US warned users it might suspend withdrawals.
Within a day, Bankman-Fried agreed to a buyout/bailout of his reeling exchange by rival Binance (Binance walked away from the deal less than 24 hours later, precipitating the bankruptcy filing, including for FTX US). The tweets were deleted.
âItâs a complete nightmare,â said Ken White, a former federal prosecutor and a partner at the Brown White & Osborn law firm. âThis is a situation where all sorts of agencies are going to be looking at this, the SEC, the FTC, and probably the Department of Justice. There are all sorts of potential criminal and civil consequences â lawsuits. Civil lawsuits are a certainty. And here he is sort of tweeting out his thoughts about it. It's every attorneyâs nightmare of what a client might do.â
Read more: Washington, D.C.âs Buddy Sam Bankman-Fried Has Some Explaining to Do
Other attorneys agree, including John Sparacino, a principal at McKool Smith, who suspected Bankman-Fried did not run his tweets through a lawyer.
The former FTX CEOâs conduct is âgoing to be under a microscope,â said Sparacino, and it seems likely that some of Bankman-Friedâs tweets may come back to haunt him as litigation works its way through the courts.
Sparacino said he did not know if there were any regulatory or criminal aspects to the tweets, but would still expect them to show up in litigation.
The fact that Bankman-Fried repeatedly took to Twitter to reassure his exchangeâs users that everything was fine before the various stages of its fall could make any case against him easier, said White, calling the tweets âextraordinarily foolish.â
âIt creates new bases for criminal or civil claims against him just based on those tweets,â White said. âSo if he says that everything's fine, that their assets are real assets, and that's not true, then that can be securities fraud, and wire fraud, all sorts of other stuff, not to mention all sorts of civil causes of action ⌠It is just disastrously reckless.â
Investigators may look at what Bankman-Friedâs tweets would indicate to individual investors, as well as what FTXâs representations were. And while it is entirely possible that Bankman-Fried may have believed that his exchange was safe and stable before being proven wrong by unanticipated events, it is also possible that he tweeted inaccurate information. The exchangeâs ties to Alameda will also raise scrutiny â if Bankman-Fried was transferring user funds into Alameda and losing those investments, that may become a liability during litigation.
Asked what advice heâd give Bankman-Fried, White said, âMy advice is shut the f*** up or I quit.â
âEven if the money is good, sometimes you just don't as a lawyer,â he said. âYou don't want to be attached to someone who's deciding to self-immolate.â
