The first hearing in the bankruptcy case of cryptocurrency exchange FTX was held on Tuesday, November 22. One of the lawyers representing the company, James Bromley, was forthright. “You’ve seen probably one of the sharpest and most difficult collapses in the history of corporate America,” he said in a Delaware courtroom. He described FTX as “the personal fiefdom” of his co-founder and former CEO, Sam Bankman-Fried, and claimed that a significant amount of FTX’s assets had been “stolen or missing.” The comments came five days after John J. Ray III, the new CEO of FTX, filed a document in Delaware federal bankruptcy court in which he echoed the same sentiment. “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of reliable financial information as occurred here,” Ray wrote in the filing. “From compromised systems integrity and faulty regulatory oversight overseas, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.” (“I wish I had been more careful,” Bankman-Fried wrote in a letter to former employees on the day of the hearing, apologizing for the collapse of FTX. “I am deeply sorry for my failure to oversee.” However, l ‘former CEO argued that, if he hadn’t caved in to pressure to file for bankruptcy, he could have saved the company.)

The valuation carries enormous weight coming from Ray, who, over his forty-plus-year career, has overseen some of the highest-profile corporate bankruptcies in recent history. He managed the liquidation of energy trading company Enron after its collapse in 2001 and oversaw the bankruptcies of Canadian telecommunications company Nortel and subprime mortgage company Residential Capital. His report is a stark indictment of FTX leaders, including Bankman-Fried, but it could also be interpreted as an indictment of safeguards that are supposed to keep markets safe for ordinary people. It will take months, even years, to fully understand what went wrong at FTX and its related companies and why. But two things could emerge from the FTX crisis, which could turn a tragic situation into a learning opportunity and could also make similar corporate meltdowns less likely to occur in the future. For one thing, investors may, in the future, be more wary of potential cryptocurrency investments, aggressive marketing, and the false promises that often accompany them. On the other hand, the regulation of digital resources could finally become clearer and more rigorous. “Any time you have a business fail, as the facts emerge, there are typically lessons learned that can inform other companies in that industry, as well as the general public, where the risks lie and how similar risks could be avoided in the future,” said Deborah Meshulam, a partner at DLA Piper and a former Securities and Exchange Commission official. “We’re in the very early days.”

The cryptocurrency industry and its US regulators have been in something of a cold war for several years. Dozens of new digital currencies and companies have been launched, and the agencies responsible for overseeing the markets have struggled to keep up. More than thirteen years after Bitcoin was first released, there is still no centralized regime to regulate the industry. “The state of regulation in the US is multifaceted,” Meshulam told me, sounding diplomatic. “You really have a number of different regulatory regimes that address different aspects of the digital asset business. And you have them at the federal and state level.

Digital assets consist primarily of coins, tokens and currencies, such as Bitcoin and Ether, which are created using cryptographic technology and whose transactions are recorded on a blockchain, a decentralized electronic ledger that is, in theory, transparent to all , a bit like a giant spreadsheet in the sky. Many cryptocurrencies are traded on specialized platforms, such as FTX. The best known of the regulatory agencies that oversee cryptocurrencies and other digital assets is the SEC, which has taken the position that most digital assets are offered as securities, making them subject to US securities laws and typically requiring that are registered with the SEC before being sold to the public. Rather than publishing a list of attributes that the SEC believes cause an asset to be classified as a security, however, the agency’s views have been communicated through a myriad of channels in ways that aren’t exactly accurate, at least according to some in the cryptocurrency industry. And, whenever something isn’t clearly defined, it creates space for different market players to argue that the regulations don’t apply to them.

One way the SEC communicates its interpretation of existing regulations to the public is by filing enforcement actions, usually by suing companies or individuals and accusing them of conducting an “unregistered securities offering” or committing fraud. The agency has filed a number of charges against cryptographic firms in recent years, including one against Kik Interactive, which the agency accused, in 2019, of violating securities laws when it issued unregistered tokens. (The agency won the case and Kik had to pay a five million dollar penalty). one hundred and seventy-one initial buyers worldwide, in an effort to raise funds. (In one settlement, the company agreed to return $1.2 billion to investors and pay an $18.5 million civil penalty.) A high-profile case involving similar allegations against Ripple Labs, which issued a token called XRP, is still unsolved. (“​​Like a hammer that wants everything to be a nail, the SEC keeps everything in the dark so it can argue that every cryptocurrency is a security,” Ripple general counsel Stu Alderoty wrote this summer.) If the SEC loses the Ripple case, it will be a major setback in its efforts to establish that most of the tokens are securities it should oversee.

The Commodity Futures Trading Commission, which regulates the derivatives markets, has also exercised some authority over digital assets that it classifies as “commodities” rather than securities. Within the cryptocurrency industry, the CFTC has, thus far, been seen as more lenient than the SEC, and many in the industry would prefer to see authority over the consolidated business under the CFTC. A bill seen as friendly enough for the cryptocurrency industry cryptocurrencies, called the Responsible Financial Innovation Act, presented to Congress last June, aims to clarify and streamline the division of responsibilities between the two agencies. Senator Cynthia Lummis, a Republican from Wyoming who co-sponsored the bill with Senator Kirsten Gillibrand, a Democrat from New York, recently tweeted that the FTX collapse would not have happened if their legislation had already been passed. .

According to the bankruptcy court filing, FTX was made up of four groups of assets: the unit containing FTX US, a US-registered exchange where US residents could trade digital assets and tokens; Alameda Research LLC, essentially a cryptocurrency-oriented hedge fund; a group of venture capital investment vehicles; and another group based on FTX.com, a cryptocurrency exchange located outside the United States. All were controlled by Bankman-Fried, with small minority stakes held by FTX co-founder Zixiao (Gary) Wang and former director of engineering, Nishad Singh.

As more details about Bankman-Fried’s empire and how it’s been run emerge, the argument for taking stronger regulatory and legislative action may garner more support. There were no appropriate “disbursement controls” on FTX’s expenses, Ray wrote in the court filing, noting that FTX employees “submitted payment requests via an online ‘chat’ platform in which a disparate group of supervisors approved disbursements by responding with custom emojis.” There was no centralized control of the company’s liquidity. FTX Group corporate funds were used to purchase real estate in the Bahamas, where the company was headquartered, for employees and consultants. Reuters reported that FTX, Bankman-Fried’s parents and company executives bought $121 million worth of real estate, mostly “luxury beach houses.” (FTX, Bankman-Fried and company executives did not respond to Reuters requests for comment. A spokesman for Bankman-Fried’s parents said they had sought to return the property to FTX prior to the bankruptcy proceedings. Separately, James Bromley, l FTX’s attorney said on Tuesday that the company spent $300 million in the Bahamas to buy vacation homes and properties for its senior staff.)

The FTX Group has not kept proper books and records, or security controls, with respect to its digital assets, according to Ray. Bankman-Fried used an auto-delete app to communicate with employees and encouraged them to do the same. Those handling the bankruptcy were unable to figure out even who worked at the firm, due to its “unclear records and lines of responsibility.” Ray also said that the company’s available financial statements — the company had been unable to find financial statements for two of its four business groups — shouldn’t be reliable; one of the accounting firms that worked on them is called Prager Metis, and its website describes it as “the first CPA firm to officially open its Metaverse headquarters in the Decentraland metaverse platform.” (In a statement to Bloomberg Tax, Prager Metis defended its financial statements, saying they were “justices.”) To add more dark comedy to the situation, Ray says at least $372 million in “unauthorized transfers” of digital assets FTX and another three hundred million dollars of unauthorized minting of an FTX-issued token called FTT occurred on the day of the bankruptcy filing, suggesting that other players in the cryptocurrency market were poised to take advantage of FTX’s mess. The company has hired forensic analysts, investigators and cybersecurity experts to try to identify those responsible for potential asset thefts, as well as resolve what could be “very substantial transfers” of FTX ownership in the days leading up to the bankruptcy. , FTX owes nearly $3.1 billion to its top fifty creditors, including c customers who have lost money they had in their accounts. But the real numbers could turn out to be even bigger. According to Ray, “debtors have located and insured only a fraction of FTX Group’s digital assets that they hope to recover.” ♦

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