Washington’s watchdogs are outgunned in the crypto Wild West

The oversight gaps that enabled the disastrous failure of FTX – which just weeks ago was one of the world’s most respected crypto firms before being exposed as a house of cards – point out the profound risks of trading on unregulated digital currency exchanges. That prompted policymakers in Congress and federal agencies to consider new laws and more aggressive penalties to stave off a future meltdown. Crypto has thrived in a regulatory gray zone, where even activities that resemble traditional financial products have escaped scrutiny.

A big question is whether regulators have enough authority or need more power. Two key financial market agencies – the SEC and the Commodity Futures Trading Commission – are under scrutiny over why they haven’t done more to protect consumers.

“What we’re seeing is partly a sign that the financial regulatory system isn’t able to evolve as quickly as needed to deal with emerging threats,” said Columbia Law professor Kate Judge. School.

FTX’s bankruptcy filings include harrowing allegations from top executives – including Bankman-Fried, a former political mega-donor – treating FTX and its 130 affiliates as a slush fund. Behind its sleek exterior, FTX was actually a loosely organized network of investment firms, crypto firms, and holding companies with no centralized accounting system, little staff oversight, and few internal controls to prevent Bankman-Fried and other employees to tap into the business.

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of reliable financial reporting as has occurred here,” wrote FTX’s new CEO, John Ray III, who previously managed the restructuring of Enron, in a bankruptcy filing on Thursday. “This situation is unprecedented.”

Because the Bahamas-based parent company of FTX has never registered with the SEC or the Commodity Futures Trading Commission – and has spent tens of millions of dollars on an influence campaign in Washington to push back against any argument according to which it was required to do – the internal operations of FTX were never examined. like Wall Street banks or traditional exchanges.

The SEC and CFTC have the authority to launch investigations into companies that are not registered with them, but there must be an indication of potential fraud or manipulation impacting the securities and commodities markets derivatives they regulate.

“You can never stop fraud,” CFTC Chairman Rostin Behnam said in a Nov. 14 interview. “A regulated entity will certainly be in a much better position to avoid problems related to illegal activities or the use of customers’ money for illegal purposes.”

This is one of the reasons SEC Chairman Gary Gensler has requested that crypto exchanges register with his agency, according to sources familiar with the committee’s thinking. Registered scholarships must disburse their books upon request.

Gensler, who headed the CFTC during the Obama administration, argued for two years that securities laws covered most crypto activity.

But the SEC’s efforts to probe unregistered digital currency firms are often met with fierce resistance, including costly legal battles from industry and whistleblowing from pro-crypto lawmakers in Congress.

In March, Gensler even spoke with Bankman-Fried, other FTX executives and exchange operator IEX about IEX’s plans to enter the crypto market, according to people familiar with the meeting. The US subsidiary of FTX then announced an investment in IEX.

Before the executives could go any further with their presentation, Gensler interrupted and spent the rest of the meeting talking about how crypto exchanges should meet exchange standards, the people said, asking not to be named in private conversations.

“I don’t think — within our framework — there was an opportunity for the SEC to intervene in this matter,” the rep said. Stephen Lynch (D-Mass.), who chairs the House Financial Services Committee’s fintech task force, said in an interview.

President of Senate Banks Sherrod Brown (D-Ohio) said the SEC chief “thinks he has the power to do a lot of things, but Gensler’s problem was that he inherited an agency that basically opened the door for these crypto companies”.

The CFTC oversaw a component of Bankman-Fried’s empire, LedgerX, a derivatives exchange registered with the agency for about four years before being acquired by FTX’s U.S. subsidiary in 2021.

Critics such as consumer group Better Markets have complained in recent days that the CFTC should have pursued red flags surrounding FTX.

But Behnam said the CFTC only has the ability to look at LedgerX — one of the FTX entities that is not bankrupt and continues to operate.

“Any rational person would infer that this regulation worked,” said Behnam, who has repeatedly called on Congress to give his agency more authority over exchanges that facilitate trading in Bitcoin and other crypto products.

Behnam threw his support behind a Senate bill it would give his agency the power to control digital assets, but the legislation now faces political headwinds as it also had the backing of FTX.

On Wednesday, Treasury Secretary Janet Yellen urged Congress to address crypto regulatory loopholes that were identified in an Oct. 3 Financial Stability Oversight Board report highlighting dangers that could develop. with the unregulated growth of the industry. The council is led by the Treasury and includes other top financial regulators, including the heads of the SEC and the CFTC.

In the meantime, with Congress likely to disagree for months over how to police the market, Yellen wants regulators to start expanding their authority.

“We have very strict investor and consumer protection laws for most of our financial products and markets that are designed to address these risks,” she said in a statement. “Where existing regulations apply, they must be rigorously enforced so that the same protections and principles apply to crypto assets and services.”

Zach Warmbrodt contributed reporting.