The collapse of cryptocurrency exchange FTX is unprecedented, and in some ways, unbelievable. As the firm seeks bankruptcy protection, at least $1 billion in customer funds is missing, according to a Reuters report. A bankruptcy court filing revealed debtors have been in contact with the U.S. attorney’s office, the Securities and Exchange Commission, the Commodity Futures Trading Commission and dozens of other agencies.
The fallout continues rippling through the cryptocurrency space and sparking debate over whether the dramatic demolition of a crypto giant will cause changes in regulation. Some are even comparing FTX to the fall of Lehman Brothers and Enron.
“I think this is actually an inflection point and we have finally reached the point where the regulation of crypto offerings and crypto exchanges is not only on the table, it’s been delivered to the diners and it’s ready to eat,” said Howard Fischer, attorney and former senior trial counsel at the SEC.
Fischer said the SEC will likely investigate what FTX told customers about the safety and segregation of its crypto. FTX founder Sam Bankman-Fried transferred $10 billion in customer funds from FTX to another company he also controlled, trading firm Alameda Research, according to Reuters sources. But he also said investigators will likely question what sort of due diligence major investors did before putting funds in FTX.
“There are investors of all kinds, all means, who are going to be damaged,” Fischer said. “One of the main purposes of government regulation is to protect investors.”
Fischer said he believes that beyond agency investigations, this case will end up being a catalyst for regulatory changes in the cryptocurrency space. In fact, he said it has to be.
“The government is concerned with the systemic integrity of how markets function,” he said. “If the FTX collapse risks the systemic integrity of those markets and has the risk of contagion to other non-crypto parts of the market, that’s a legitimate reason for the government to step in and just start regulating this.”
Complicating the case for regulation in this instance is the fact that FTX is based out of the Bahamas and there’s an element of alleged fraud that would arguably happen with or without regulation. But while fraud will happen even in heavily-regulated industries – see Bernie Madoff – Fischer still sees an ounce of prevention in regulation.
“Providing transparency into operations, which is a necessary part of regulatory oversight, is what might have prevented this,” Fischer said. “If Bankman-Fried was not segregating customer accounts, if he had a backdoor, if he was using those funds of customers to prop up his other operations, that might have been stopped if they actually had a legitimate fear that regulators would see it.”
SIMONE DEL ROSARIO: The collapse of crypto exchange FTX is unprecedented. And in some ways, unbelievable. More than a billion dollars worth of client funds missing several billion worth of assets were just tokens printed out of thin air. But will the dramatic demolition of a fallen crypto giant sparked any changes in regulation? And what charges could the FTX founder face? I’m joined now by Howard Fisher, a former prosecutor with the SEC. Howard, you have worked on some major cases in the past especially tied to the 2008 crash. It’s happening, but do you think the FTX should be compared to the fall of Lehman Brothers or Enron?
HOWARD FISCHER: Well, that’s an excellent point. And the question is, is the FTX collapse, an inflection point where we’re going to look back on it and say this is where everything changed. Now everything’s different, or is it just going to be more of the same? And I think this is actually an inflection point. And we have finally reached the point where the regulation of crypto crypto offerings and crypto exchanges is not only on the table, it’s been delivered to the diners, and it’s ready to eat.
SIMONE DEL ROSARIO: Well, according to this bankruptcy court filing, we were just looking at regulatory agencies are all over this debtors have been in contact with the US Attorney’s Office, the SEC Commodity Futures Trading Commission, and they say dozens of other agencies. I know this case is going to continue unraveling. But what are the potential violations here? If you were the SEC, what would you be going after?
HOWARD FISCHER: A couple of things first with FTX. What did they tell people, they apparently told customers that their crypto was safe, that it was segregated, and then was going to be touched or used for investment purposes, that appears to be a bald faced lie. They’re going to be looking at how they segregated customer accounts, how they dealt with the relationship between FTX and Alameda. And that’s just with respect to the investors who have crypto coins at the exchange. The other thing I think the FTC is going to look at is what FTX told to its investors, what did they tell them about their business plan about their balance sheet about how they treated customer assets? And finally, I think that the if I was going to bet, I would bet that right now there was someone at the at the SEC, preparing a series of subpoenas to the investors and FTX. asking them, What do you tell your investors about what due diligence you conducted before you made an investment in FTX? And what due diligence did you do? Because it appears that the books and records and FTX were a complete mess. And so if I’m the if the SEC or the US Attorney’s Office, or the Department of Justice, or any other handful of alphabets, you might want to toss around? What I want to know is what did the investors in FTX tell their investors they were doing? And did they do it?
SIMONE DEL ROSARIO: Here’s a question for you. Is it the government’s responsibility to protect people who are investing in what we know to be an unregulated risky environment?
HOWARD FISCHER: Oh, that’s obviously the big question. Right? What duties does the government Oh, to people who perhaps should know better? And I think there are two responses to that. Obviously, there are a lot of people who apply the caveat emptor theory, who believe that the marketplace can take care of all regulation that we don’t need, the government has come in and to put in a regulatory framework. I have two responses to that. First, there are investors of all kinds all means who are going to be damaged the purpose, one of the main purposes of government regulation is to protect investors. The second concern and the second reason why government regulation is an appropriate response here is that the government is concerned with the systemic integrity of how markets function, if the X if the FTX collapse risks, the systemic integrity of those markets, and Harris has the risk of contagion to other non crypto parts of the market. That’s a legitimate reason for the government to step in and just start regulating this.
SIMONE DEL ROSARIO: I don’t know that we’ve seen the contagion outside of the cryptocurrency sphere, but we are seeing a domino effect in cryptocurrency from the fallout. Do you think this is going to be a catalyst for actual regulatory changes? And what would that look like? I think it has to be. There are a couple of issues here. First, we have an looks like we are going to continue how continue to have a divided Congress. So there has to be some kind of bipartisan consensus for Congress to do something. In the absence of explicit congressional action, the SEC, the CFTC, perhaps the Fed are likely to step in and to propose a regulatory response. The other thing that regulators can do which is to regulate through enforcement. And that is to bring cases that apply liability. And that can include criminal sanctions as well as civil penalties in order to force behavioral changes that somewhat like regulating it. But doing it through the threat of enforcement.
SIMONE DEL ROSARIO: As far as FTX is concerned, I mean, the cats out of the bag on this one, and there’s a lot of talk right now about whether fraud is a part of this. So could regulation have stopped? What’s happening now?
HOWARD FISCHER: People always argue that you can’t prevent fraud, that people will always lie, people will always deceive other people that human beings are basically machines for deceiving other human beings. And I think that’s a little bit over simplistic. The reason why you have regulation is that it provides a system of oversight. Take a look at the normal financial system, regulated entities get examined by the by the SEC, and other agencies, government people go into those operations, make sure that they segregate customer accounts that their books and records are accurate. And it is that sunlight and operational facilities that provides a lot of the prevention aspect that we look for to regulation. It’s not necessarily saying you can do bad stuff, because let’s admit it read as a thing. People go into finance, largely because they want to make a lot of money. And that’s a pretty strong incentive. However, providing transparency into operations, which is a necessary part of regulatory oversight is what might have prevented this. I mean, if Bankman-Fried was not segregating customer accounts, if he had a backdoor, if he was using those funds of customers to prop up his other operations. That might have been stopped if they were if they actually had a legitimate fear that regulators would see it. And it is that transparency that I think is the greatest argument for regulation.
SIMONE DEL ROSARIO: Attorney Howard Fisher, thank you so much for your insight on this. We’ll be following this one closely. Thank you.