Is the SEC run by an inept bunch of clowns?
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If you think the SEC is going to protect you as an investor you're either incredibly naive or...drum roll...incredibly naive.
A Question for Congress: Why Didn’t the SEC Stop FTX?
Securities regulators seem to be more interested in protecting their turf than protecting investors.
By Hal Scott and John Gulliver, SEC
Jan. 18, 2023 1:26 pm ET
The Securities and Exchange Commission brought an enforcement action last week against the cryptocurrency brokerages Genesis Global Capital and Gemini Trust. As with the failure of crypto exchange FTX, the SEC is late to the game—likely too late for the 340,000 U.S. customers affected by Genesis’ decision to halt all withdrawals.
Genesis’ financial problems stem from large holdings with FTX, and it is unlikely to be the last crypto firm caught in FTX’s wake. Who is to blame and what can be done to protect U.S. retail investors in crypto?
Rep. Patrick McHenry, the new chairman of the House Financial Services Committee, can answer that question by investigating the SEC’s failure to prevent the FTX disaster. The harm to U.S. investors from the alleged theft of FTX customer assets by Sam Bankman-Fried is likely to be enormous. FTX’s global operations held more than $8 billion in customer assets, and there were 2.7 million U.S. customers of FTX’s U.S. operations alone. FTX customers have had their assets frozen in bankruptcy and now face large losses. They deserve to know why the SEC failed to be the “cop on the beat.”
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.
Similarly, the SEC has asked crypto exchanges to register with regulators, but it has provided no guidance making it possible to do so. Once the SEC does provide that guidance, it should require crypto exchanges to register or shut them down. Instead, the SEC has taken enforcement actions against alleged unregistered public offerings of crypto tokens for lack of disclosure, while largely ignoring the risky activities of crypto exchanges with millions of retail customers. Worse, as reflected in this month’s regulatory agenda, the SEC still has no plan to regulate crypto exchanges. Congress needs to investigate the SEC’s regulatory failings.
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.
Mr. Gensler has lobbied against bipartisan legislation that would have provided the Commodity Futures Trading Commission with additional regulatory authority over crypto markets. This could have protected retail investors, but the SEC and CFTC are rival regulators with a long history of competition. Congress should investigate the extent of Mr. Gensler’s lobbying and whether this turf war was a higher priority than protecting investors.
Congress also should examine whether a lack of SEC staff resources contributed to the SEC’s failure to stop the FTX scam or to regulate crypto markets generally. The SEC has embarked on an unprecedented rule-making agenda to remake U.S. capital markets. Overworked staff have departed, and resources are being diverted away from their core functions. Did this contribute to the lack of action against FTX?
Although the focus of Congress’s investigation should be the SEC, lawmakers should also look to whether banking regulators and the CFTC, through action or inaction, may also have contributed to the failure to stop FTX’s alleged scam.
It is time for the House Financial Services Committee to exercise its oversight authority and hold the SEC accountable for its failures. The U.S. customers of FTX deserve nothing less.
Mr. Scott is an emeritus professor at Harvard Law School and director of the Committee on Capital Markets Regulation. Mr. Gulliver is the committee’s research director.