Hal Scott and John Gulliver ask a very good question in an op-ed in the Wall Street Journal. Why didn’t the Securities and Exchange Commission stop crypto exchange FTX?
In 2008, after Bernie Madoff’s Ponzi scheme was revealed, SEC Chairman Christopher Cox promptly initiated an internal investigation into the commission’s failures to uncover the fraud. Gary Gensler, the current chairman, has so far failed to do the same. Madoff’s evasion of applicable SEC regulations was a surprise. FTX’s state of nonregulation was the reddest of flags. Madoff was largely cheating rich sophisticated investors. FTX’s retail investors were left helpless.
Congress should begin by asking a very basic question: Why wasn’t FTX subject to any SEC regulation and enforcement? Mr. Gensler has said the laws governing the securities industry provide the SEC with the legal authority to regulate crypto exchanges and to bring enforcement actions against them for fraud. The SEC’s view, as reflected in its recent civil actions against FTX executives, is that FTX was trading securities, specifically tokens, or crypto issued by the company itself.
If the SEC has the authority to regulate crypto exchanges, it should have done so long before now. The SEC could have simply prohibited U.S. customer assets from being held by unregulated crypto exchanges. Instead, as we have written in these pages, the SEC’s only action made the problem worse by blocking banks and brokers from taking custody of crypto assets.
and here’s what looks to me like a smoking gun:
Congress also needs to investigate the missed opportunities to catch the alleged fraud. Mr. Gensler and his staff met with Mr. Bankman-Fried and FTX executives repeatedly in the months preceding FTX’s failure. Those meetings were reportedly focused on providing FTX with a regulatory license as a securities exchange, apparently without probing their operations at the same time.
In early 2022, the SEC also sent FTX inquiries related to its handling of customer assets—the heart of the alleged fraud—but these inquiries clearly didn’t lead to an enforcement action. What was FTX’s response to these inquiries? Did the SEC follow up? Congress needs to investigate all SEC meetings and communications with Mr. Bankman-Fried and his staff.
Their call for an investigation should be music to the incoming Congress’s ears since they’re already showing signs of being Investigations R Us. IMO there are more fundamental questions. What is the purpose of the SEC? What is it actually doing? Do we need a federal agency to accomplish what they’re actually doing?
In the past I have posted numerous times on how the SEC is chronically unable to satisfy its notional responsibilities which are to protect investors for a simple reason: regulatory capture. I have also proposed strategies for addressing that although I have no illusion that any of them will ever be adopted. The SEC is too cushy a gig in its present form.
They already have the authority and the mandate. What they lack are will and direction.
Unmentioned; SBF was one of the President’s top donors and apparently a top donor to Congress in 2020 and 2022.
I omitted that intentionally, allowing the interested reader to fill in the blanks. I don’t think the reasons are limited to that, that it’s the most important, or even that it would be possible to determine that. Treating every major company you’re supposed to be regulating as a prospective employer is enough.
I just realized that “even that it would be possible to determine that” is a bit cryptic. Government agencies don’t need to be directed specifically to use kid gloves in regulating certain companies or individuals. Regulators, recognizing the implications, may just silently decide to leave hands off. The regulators are political actors, too. That way leaves no paper trail.
The FTX co-chair was quietly donating to the GOP. If you look at financial institution political donations they often contribute to both teams, maybe giving more in any given year to the team they think most likely to win. And as we know, or should, donations are important but being able to offer jobs to friends and family is even more important.
In the case of crypto it was actually unclear, from my readings, exactly what regulations applied. Notice that Cowen and other crypto advocates are still advocating that we not add regulations to crypto even after this event. The SEC may say they have the authority but I dont think that is so clear.
I do think regulatory capture of some sort is probably at fault. If you you have finance guys working at the SEC they all want to believe that the successful rich guys, including Madoff and Bankman, are all just smarter and work harder. They all get the benefit of the doubt. The SEC rarely find fraud first, but then they are like police. They catch and prosecute after. Most companies that consider fraud wont commit fraud if they know the SEC could come in and investigate.
Steve
Yup.
If you are as familiar with the SEC as I, the questions answer themselves. The SEC is all but worthless.
I’ll bet most regulatory agencies are just as poor at fulfilling their supposed mandates. The FAA may be an exception, one of the best, at least wrt safety.