Sam Bankman-Fried of FTX is only one part of a system of broken regulatory actors, so his arrest isn't even close to sufficient for full accountability. The financial industry needs major overhauls. But how? From where, and whom?
On December 12, Sam Bankman-Fried was arrested at his apartment complex in the Albany resort in the Bahamas, after US prosecutors sent formal notice to local officials that they had filed criminal charges against him. The founder of the cryptocurrency exchange FTX, which Bankman-Fried announced was filing for bankruptcy on November 11, had been scheduled to testify on December 13 about what had caused the overnight implosion of one of the most prominent businesses in the cryptocurrency industry. The indictment was unsealed today, and contains eight charges against one person, including wire fraud and conspiracy to commit wire fraud (against both customers and lenders), securities fraud and conspiracy to commit securities fraud conspiracy, and money laundering.
The crux of the case for US prosecutors involves the relationship between two of Bankman-Fried’s major holdings, FTX and Alameda Research: the former a crypto exchange and hedge fund, and the latter a crypto trading firm. In November, journalist research into FTX’s finances, while the company was courting Binance (another crypto exchange) for support in a downturn, revealed that more than half of its clients’ funds had been siphoned to Alameda, where the money was propping up high-risk ventures.
These transfers, which had apparently been underway since the inception of FTX, were in express contravention not only of FTX’s terms of service, but also of deeper principles of financing that ostensibly place hard limits on what an entity operating like a bank is permitted to do with its holdings: namely, not gamble on high-risk ventures, and not fail to disclose when such exchanges are taking place. FTX had also sold itself to consumers on the promise of an “risk engine” that would automatically sell off a customer assets to protect their collateral. This promise was broken when Alameda could bypass such failsafes, essentially dipping into FTX funds as a line of credit with an unlimited negative balance.
Another key principle broken by these markets, which will inform prosecutor action, has to do with the naming of financial products. If the mere act of moving something from one place to another has no impact on its value, and if the movement itself doesn’t create value, it’s not a site of possible market speculation. But the moment that moving something into or out of a given product can change its value, we’re dealing with a security, like stocks, bonds, and mutual funds. One of FTX’s programs gave depositors the ability to earn interest on their crypto assets—but without calling it a security, and certainly without getting it properly registered with the US Securities and Exchange Commission (SEC).
But the SEC’s claims run even deeper, and more personally, against Bankman-Fried, whom they accuse of having borrowed over $1.3 billion from Alameda: money used for personal investments, real estate, and political donations (which we now know were distributed to both Republicans and Democrats). FTX co-founders Nishad Singh and Gary Wang are also accused of having borrowed, respectively, $554 million and $224.7 million.
Today the House Financial Services Committee is hearing testimony from current FTX CEO John J. Ray III, as it continues to investigate the collapse of a company that lost tens of billions in market value practically overnight. Bankman-Fried is also expected to face extradition to the US soon.
These are tangible movements toward accountability, but they do not fully address the systemic and institutional failings that created this situation in the first place.
On March 16, SEC Chair Gary Gensler received a letter signed by eight members of Congress and headed by Tom Emmer (current House Majority Whip). The letter questioned the SEC’s “authority to secure the information and transparency” of cryptocurrency and blockchain firms, and suggested that the SEC’s regulatory investigation into crypto industry was in violation of federal law. (The “Blockchain Eight” were invoking the Paperwork Reduction Act of 1980, meant to reduce the burden of everyday government paperwork, but not to impede criminal investigations.)
One of the companies the SEC was then investigating (in part, for the above concern about the existence of an unregistered security) was FTX. Five of the signatories of the letter pushing back on this investigation received direct campaign financing from FTX, while the National Republican Congressional Committee (for which Tom Emmer had been chair) received a total of $2.75 million from funds traceable to FTX’s SuperPAC and co-CEO Ryan Salame. This was money put into play in the latest US election.
After openly promoting his March pushback, Emmer has now called for Gensler to testify before Congress, and is renegotiating public interpretation of the original letter to which he was head signatory, which essentially put congressional pressure on the SEC to back off its initial investigation.
Another complex government entanglement is still being hashed out by the Commodity Futures Trading Commission (CFTC), which in early December pushed for Congress to establish a more robust regulatory framework for cryptocurrency and other such digital assets. But The Washington Post put the hypocrisy most succinctly when it published a related article under the headline “Lawmakers who benefited from FTX cash probe its collapse”. Granted, sometimes the fox is the best choice to point out weaknesses in the henhouse, but the corruption here runs deep.
The CFTC is run out of the Senate Agriculture Committee; a group of mostly rural-state representatives, and an unusual place to house a regulatory body for highly nuanced digital financial products. However, it is also an illustrative example of how much economics has changed since certain rules and jurisdictions were built into the US government, and how much work remains to be done for Congress to stay up to speed with market action.
According to CFTC Chair Rostin Behnam, Bankman-Fried met with top officials more than 10 times in 14 months, to try to pass an amendment to his license for LedgerX LLC that would remove the need for intermediary involvement when settling crypto derivative products.
Meanwhile, Bankman-Fried strongly supported a measure the CFTC was drafting, the Digital Commodities Consumer Protection Act of 2022 (also known as the Stabenow-Boozman Bill, based on the bipartisan senators involved in its construction). While regulation is indeed sorely needed, critics in August immediately noted many major issues with this particular legislation. For instance, the bill would change jurisdictional authority, and potentially redirect primary authority from the existing regulatory body, the SEC, to the CFTC (and with it the Senate Committee on Agriculture, Nutrition, and Forestry). The CFTC would then have exclusive jurisdiction and broad authority to regulate a number of crypto markets.
Better Markets, a financial reform group, recently highlighted how this bill will also more broadly impact financial definitions, by “expand[ing] the definition of commodity [and] restrict[ing] the historic definition of securities, [which] will result in endless litigation because the longstanding legal test for securities will have to be changed”. In short, issues like the FTX deposit program that the SEC was investigating (which acted like a security, but wasn’t registered as such) might have been swept away under this new framing.
This bill has now been compromised by the collapse of FTX, and by its association with Bankman-Fried as a strong proponent of its current language.
The question is: What will take its place?
“Ponzinomics” refers not just to a specific fraudulent scheme, but rather, a whole economic dynamic that supports individual grifts. Whenever any financial system is overly centralized and under-regulated, circumstances are ripe for further FTXs and Bankman-Frieds. As Edward Chancellor recently wrote for Reuters, history is filled with financial swindles, but there’s very little innovation in their core methodologies. Like many grand schemers come before, Bankman-Fried garnered major investors (Sequoia Capital, the Ontario Teachers’ Penson Plan, Singapore’s soverign fund Temasek, and hedge fund manager Paul Tudor Jones) and then “flog[ged] worthless assets to the public” until his luck ran out.
There’s plenty of blame to go around, though. As Jon Stewart noted in a recent interview with David Dayen (executive editor of The American Prospect, which covered government complicity in FTX), journalists also played a reprehensible role in creating this crisis. Finance publications in particular contrived a hagiography of genius around Bankman-Fried as the “next Warren Buffett”, instead of doing more to highlight the red flags that abounded.
So, yes, one person accused of defrauding thousands of people of billions of dollars has been arrested. And yes, congressional investigations into the collapse of FTX are underway.
But if we truly want to build a better marketplace, we have a lot to do to update our regulatory frameworks to keep up with today’s digital realities, reduce the role of electoral bribery in government oversight, and provide fellow citizens with the economic literacy to recognize a grift in process, before it attains the level (and damage) that this one did.