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Blogs from January, 2023


CFTC Commissioner on the Crisis of Trust Post FTX

R Tamara de Silva

There have been many post-mortems of FTX post its bankruptcy filing on November 11, 2022 and many more to come. Last Wednesday, addressing the Wharton School of Business, U.S. Commodity Futures Trading Commission (CFTC), Commissioner, Christy Goldsmith Romero, added hers.

FTX’s Lawyers and Law Firms

Similar to my prior observations on the topic, Commissioner Romero singled out the law firms and lawyers of FTX International and its affiliated entities for their roles in the fall of FTX. Without naming names, Ms. Romero points out that lawyers in the futures industry and the securities world writ large, have responsibility to act as gatekeepers, who also always protect customers and the integrity of the financial markets. She is not wrong.

It will take gatekeepers speaking truth to power, or choosing to leave firms that do not take their responsibilities to customers seriously—something that as a former Inspector General, I know takes a lot of courage. But it is necessary if the industry (and their gatekeepers) wish to restore any semblance of trust. Most importantly, it is necessary to protect customers and promote market integrity.

Commissioner Romero’s speech, page 11

It is undeniable that the auditors and law firms of FTX International and Alameda failed the customers of FTX. 

As we have seen in many instances on Wall Street, greed creates conflicts of interest. We have seen this before with the largest credit ratings agencies before the Credit Crisis. It is ever present when a client is worth so much to a partner or firm in terms of billing income, that it may become more difficult to tell the client what it may not want to hear.

But this ability is nowhere more important than in the field of securities law-in regulation and compliance work. And also in establishing entities, related to other entities that even in the absence of a regulatory regime, lawyers and law firms must be willing to look at the total picture of the clients’ activities and educate their client on basic requirements of securities and futures law. In the case of FTX, this advice would have called for advisement and questions regarding the segregation and safeguarding of customer funds.

FTX spent tens of millions of dollars on law firms and counsel. It hired former partners from the largest, most respected law firms in the world as general counsel. It sought out the top white shoe firms from New York and Washington and yet somehow- is it possible that no one looked at the whole picture and advised their well paying client accordingly? That tens of millions of dollars of legal advice later, FTX was established without basic safeguards in place towards customer funds, or any checks and balances whatsoever on corporate governance.

Venture Capital and Private Equity Firms

FTX achieved a valuation of $32 billion from four financing rounds in which some of the most sophisticated parties on Wall Street including Sequoia Capital, Paradigm, Softbank, Paul Tudor Jones, et. Al. presumably did some due diligence.

Commissioner Romero questions the extent of the due diligence that was conducted. Admittedly, crypto is in its infancy and crypto exchanges are either unregulated or lack meaningful regulation other than their regulation on a state by state basis as money service businesses (MBS)-which I have written about here.

Unlike traditional centralized exchanges in the futures and securities world, there are no established rules or checks and balances on the segregation of customer funds. There is also significant opacity in terms of the liabilities of these exchanges, and the ability to conduct proof of reserves among centralized crypto-exchanges. All of the foregoing taken together ought to have indicated the need for more due diligence not less.

It is not as if there would not have been significant red flags relative to any other due diligence conducted by these same entities on any other investment…right? Perhaps this is why we study history, because it does repeat itself.

The full text of the speech, addresses other topics also, is available here.

R Tamara de Silva

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