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SEC charges FTX founder while Congress talks crypto rules

The SEC charged cryptocurrency firm FTX founder Sam Bankman-Fried with fraud Tuesday, shortly before a House committee met to discuss cryptocurrency industry regulation.

The arrest of FTX co-founder Sam Bankman-Fried on fraud charges is increasing debate among policymakers about whether to pass cryptocurrency legislation to protect investors and consumers.

FTX, a cryptocurrency exchange, filed Chapter 11 bankruptcy last month after it was discovered that Bankman-Fried secretly moved billions from FTX to his cryptocurrency trading platform Alameda Research. Alameda spent $5 billion of FTX customers' money on multiple businesses and investments between 2021 and 2022, according to testimony from FTX CEO John Ray during a U.S. House Committee on Financial Services hearing on Tuesday. Ray, who has a background in company restructuring, was appointed FTX CEO in November and is currently investigating FTX's collapse.

Not only did Bankman-Fried comingle assets between FTX and Alameda without customers' knowledge, he also granted himself multiple loans from Alameda exceeding $1 billion, Ray said. During the ongoing investigation, Ray said his team has identified several unethical business practices, including no security controls stopping senior management from accessing and redirecting customer assets as well as Alameda's ability to access funds "without any effective limits whatsoever."

"The FTX group's collapse appears to stem from the absolute concentration of control in the hands of a small group of grossly inexperienced, non-sophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company entrusted with other people's money or assets," Ray said.

The U.S. Securities and Exchange Commission on Tuesday charged Bankman-Fried with fraud, accusing him of building a "house of cards on a foundation of deception," said SEC Chairman Gary Gensler in a statement.

The FTX collapse "is a clarion call to crypto platforms that they need to come into compliance with our laws," Gensler said.

Even before the FTX collapse, policymakers in Congress began questioning whether legislation beyond existing SEC laws might be necessary to provide accountability and clearer direction to cryptocurrency firms.

FTX collapse puts spotlight on cryptocurrency legislation

Currently, the SEC maintains regulatory authority over digital assets considered a security -- that is, an asset that includes an investment contract. The SEC describes that as "the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others."

Other cryptocurrency regulatory bodies include the Commodity Futures Trading Commission (CFTC), and the U.S. Department of Treasury. Individual state laws also govern cryptocurrency firms.

But policymakers believe more regulation is needed. They cite the sheer growth of the industry along with the crash earlier this year of TerraUSD, which cost investors billions.

In August, U.S. Senators Debbie Stabenow, D-Mich., and John Boozman, R-Ark., introduced the Digital Commodities Consumer Protection Act of 2022 to give the CFTC more authority to regulate digital commodities, such as FTX.

During Tuesday's House committee hearing, chairwoman Sen. Maxine Waters, D-Calif., said the ongoing failures of cryptocurrency firms highlighted by TerraUSD and "most significantly" FTX and Alameda Research strengthens the need for Congress and regulators to prevent such failures. Waters said a committee working group is working on cryptocurrency legislation.

Committee ranking member Sen. Patrick McHenry, R-N.C., reiterated the committee's work toward a legislative outcome, questioning the ability of the SEC to stop bad actors like FTX in the future.

"I will work to provide clear rules of the road for the digital asset ecosystem here in the U.S.," McHenry said.

Enforcing existing crypto regulation

Gartner analyst Avivah Litan said there exists plenty of regulation governing cryptocurrency firms, but regulators need to do a better job enforcing the rules.

Between the SEC, CFTC, U.S. Dept. of Treasury and state laws, there is "already a lot of regulation," she said. If cryptocurrency firms are registered SEC brokers, for example, the companies must file financial statements and other documents that should reveal suspicious activities.

I will work to provide clear rules of the road for the digital asset ecosystem here in the U.S.
Sen. Patrick McHenry, R-N.C.

However, regulators lack the resources to properly assess a backlog of data to discover what Litan said should include "plenty of whistleblower complaints" and other information revealing suspicious activities. Regulators "can't keep up with this," she said. "They don't have the skills, they don't have the tools, they don't have the resources."

The FTX collapse was not due to a lack of existing regulation, said Forrester Research analyst Martha Bennett. Instead, it was due to a lack of vigilance and enforcement on behalf of regulators. Beyond specific cryptocurrency rules, Bennett said general rules exist for all businesses requiring appropriate record keeping and prohibiting fraudulent activity.

"There are many existing laws and rules that have been flouted by cryptocurrency firms for some time," she said.

Makenzie Holland is a news writer covering big tech and federal regulation. Prior to joining TechTarget, she was a general reporter for the Wilmington StarNews and a crime and education reporter at the Wabash Plain Dealer.

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