The FTX Trial Is An Opportunity For Better Regulation Going Forward

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Even though the FTX trial has just gotten underway, the Department of Justice has already sent a strong message to the global crypto market; lack of crypto-specific standards and laws for every situation is not an excuse. Specifically, the DOJ rebutted an argument put forward by Samuel Bankman-Fried’s legal team. In this argument the position was taken that because 1) FTX was not regulated in the United States, and 2) that all applicable rules were followed concerning FTX U.S., no charges leveled against FTX should be included in this trial.

Unsurprisingly the DOJ took exception to this argument, and stated that even though legislation might be needed to prove a mandatory legal obligation does not effect the reality that customers and invested committed money to FTX, and Bankman-Fried personally. Since there are rules already in place for all organizations connected to how customer funds are treated, and that Bankman-Fried has been charged with 1) stealing customer assets, 2) misappropriating customer funds, and 3) commingling customer funds, the argument presented by the legal team are irrelevant.

So what does all of that legalese mean for the crypto market, including both investors and developers?

Crypto Is Financial And Technological

Proponents of cryptoassets, blockchain, and any number of the emerging technology trends tend to argue that these products and solutions are technology solutions first and foremost. This is all well and good, but if there are customer funds involved this immediately changes the conversation and applicable rules. Fiduciary duty, anti-money laundering rules, and regulations related to who exactly can access what products and services are well established aspects of running a financial services organization. As tempting as it might be for innovators – across industry lines – to think of innovation as entirely new ways of conducting business, existing rules do apply.

Blockchain and cryptoassets might represent new ways of storing, transferring, and accessing data between network members and counterparties, but if an organization is conducting financial transactions there are a bevy of rules that apply, regardless of how these transactions and conducted. The allegations concerning FTX include misusing customer funds, failing to establish an effective internal control environment, and breaching the fiduciary duty and responsibilities trusted to them by customers and investors. A key lesson that should be taken away, both now and going forward, is that the moment financial transactions are launched compliance needs to be a priority.

Reporting And Auditing Need To Catch Up

One of the major issues that accompanied the fallout from FTX is that almost immediately following the spectacular collapse questions were asked about what exactly the external auditors engaged with FTX had done? John J. Ray III is on record stating that in his career he had never seen such a comprehensive failure of internal controls; this from the same individual who was tasked with unwinding Enron during its bankruptcy process. More pointedly, if FTX had audit engagements, how were all of the alleged failures, accounting errors, and misappropriations able to occur? The firms involved in the audits of FTX have both been involved in legal matters, with one currently being sued by the SEC, and the other firm exiting the digital asset auditing business altogether.

The following question needs to be asked; why were accounting standard setters so slow to get started on developing and producing crypto-specific accounting and auditing standards? The U.S. tax and legal systems have proven able to do so, albeit with results that seem to be anti-crypto in nature, but the accounting regulatory apparatus has just started, with the first accounting codification set to pass at the end of 2023. Accounting standard setters and rule-makers seem to have realized crypto accounting and auditing are material items; this realization should not fade with time.

The U.S. Needs To Lead On Policy

With the antagonistic stance taken by the SEC against most iterations of crypto and blockchain firms in the U.S. , a tax code that seems unwilling to acknowledge the unique nature of cryptoassets, and an accounting framework that is just starting to do so, the U.S. lags behind other jurisdictions in terms of crypto regulatory frameworks. The FTX trial, with all of the allegations and sensational stories that will almost surely come out of the trial as it unfolds, with certainly cause numerous headlines. There will be a temptation to focus on these headlines and dwell on the negative externalities that have resulted from the FTX collapse.

Instead, the focus both during and after the FTX trial should be on the opportunity that this case provides U.S. policymakers and regulators. Determining what exactly happened at FTX, how it happened, and how it remained undetected until it caused billions in market damage should be taken as the opportunity to create more robust, transparent, and objective rules. Every market sector needs clear and consistent rules, applied on an objective basis to survive and thrive; crypto is no exception to this rule.

Bankman-Fried may be in the headlines now, but the legacy of FTX should be that it spurred on better, and world-beating marketplace rules for the U.S. and the firms operating therein.

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I am a professor at the City University of New York – Lehman College. I serve on the Advisory Board of the Wall Street Blockchain Alliance, where I chair the Accounting Work Group. I am also the chairperson of the NJCPA’s Emerging Technologies Interest Group (#NJCPATech). I sit on the Advisory Board of Gilded, a TechStars ’19 company and AICPA-CPA.com startup accelerator participant. I was a Visiting Research Fellow at the American Institute for Economic Research during 2019.

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