The oversight gaps that allowed for the disastrous bankruptcy of FTX, which until a few weeks ago was one of the world’s most respected cryptocurrencies before being debunked as a house of cards, underscores the profound risks of trading on unregulated digital currency exchanges . It has prompted policy makers in Congress and federal agencies to consider new laws and more aggressive sanctions to avert a future meltdown. Cryptocurrencies have flourished in a regulatory gray area, where even assets resembling 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 facing intense scrutiny as to why they haven’t done more to protect consumers.
“Part of what we’re seeing is a sign that the financial regulatory system is unable to evolve as quickly as it should to address emerging threats,” said Kate Judge, a professor at Columbia Law School.
FTX’s bankruptcy filing includes hair-raising allegations from top executives — including Bankman-Fried, a former political mega-donor — treating FTX and its 130 affiliates like a slush fund. Behind its elegant veneer, FTX was actually a loosely organized network of investment firms, cryptocurrency firms, and holding companies with no centralized accounting system, little personnel oversight, and few internal controls to keep Bankman-Fried and other employees from diving in the company.
“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,” wrote new FTX CEO John Ray III, who previously led the restructuring of Enron , in a bankruptcy filing Thursday. “This situation is unprecedented.”
Because the Bahamas-based parent company of FTX never registered with the SEC or the Commodity Futures Trading Commission — and spent tens of millions of dollars on a Washington influence campaign to dismiss any arguments that it needed to — FTX’s internal operations have never been scrutinized like Wall Street banks or traditional exchanges.
The SEC and CFTC have the power to initiate investigations into companies that are not registered with them, but there must be an indication of potential fraud or manipulation affecting the securities and derivatives markets 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 activity or the use of clients’ money for illegal reasons.”
It’s one reason SEC Chairman Gary Gensler has asked cryptocurrency exchanges to register with his agency, according to sources familiar with the commission’s thinking. Registered exchanges must disburse their books on demand.
Gensler, who led the CFTC during the Obama administration, has argued for two years that securities laws cover most crypto assets.
But the SEC’s efforts to probe unregistered digital currency activity often encounter fierce resistance, including costly legal battles from the industry and broadsides from pro-crypto lawmakers to Congress.
In March, Gensler even spoke to Bankman-Fried, fellow FTX executives and IEX trader about IEX’s plans to enter the cryptocurrency market, according to people familiar with the meeting. FTX’s US affiliate later announced an investment in IEX.
Before executives could elaborate on their presentation, Gensler interrupted and spent the rest of the meeting talking about how cryptocurrency exchanges should meet stock exchange standards, the people said, asking not to be named as they discussed private conversations.
“I don’t think – within our framework – that there was an opportunity for the SEC to intervene in this case,” Rep. Stephen Lynch (D-Mass.), who chairs the Financial Technology Task Force of the House Financial Services Committee, said in an interview.
Chairman of the Senate Banks Sherrod Brown (D-Ohio) said the SEC chief “believes he has the authority to do a lot of things, but Gensler’s problem is that he inherited an agency that essentially opened the door for these crypto companies.”
The CFTC oversaw a component of Bankman-Fried’s empire, LedgerX, a derivatives exchange that had been registered with the agency for about four years before being acquired by FTX’s US affiliate in 2021.
Critics like consumer group Better Markets have complained in recent days that the CFTC should have pursued the red flags surrounding FTX.
But Behnam said the CFTC only has the ability to look into LedgerX, one of the FTX entities that is not bankrupt and continues to operate.
“Any rational person would take from what the 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 cryptocurrencies.
Behnam has left his support behind a Senate bill this would allow his agency to police digital assets, but the legislation is now facing political headwinds because it also had the backing of FTX.
Treasury Secretary Janet Yellen on Wednesday urged Congress to address cryptocurrency regulatory gaps identified in an Oct. 3 Financial Stability Oversight Council report that highlights dangers that could unfold as the industry grows unregulated. The board is led by the Treasury and includes other top financial regulators, including heads of the SEC and CFTC.
Meanwhile, with Congress likely to disagree for months on how to police the market, Yellen wants regulators to start beefing up their authority.
“We have very strong investor and consumer protection laws for most of our financial products and markets that are designed to address these risks,” he said in a statement. “Where existing regulations apply, they must be strictly enforced so that the same protections and principles apply to cryptographic assets and services.”
Zach Warmbrodt contributed to the report.