Beware of crypto-billionaires who brag about audits

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“Where were the lawyers and accountants?” That was the withering assessment of a US judge after years of fraud and deception went undetected during the 1980s savings and loan crisis, despite a well-stocked entourage of audit, legal and compliance experts who could be expected to raise the alarm.

It’s a relevant question once again as watchdogs try to crack down on the largely offshore and partially regulated cryptocurrency industry — worth $3 trillion at its peak — and as Binance and other platforms try to draw a line under the FTX scandal by appealing to credibility. external consultants. Wall Street’s top regulator is warning investors to be “cautious” about the way crypto companies promote the often limited work done by accounting firms and is considering enforcement, according to the WSJ.

Auditors and lawyers are seen as important “gatekeepers” by regulators with anti-fraud and anti-money laundering responsibilities, but it is clear that they – and others – missed a bewildering number of red flags at the bankrupt FTX exchange. Former billionaire founder Sam Bankman-Fried last year showed his good will from auditors, tweeting that FTX and its US subsidiary had “passed a US GAAP audit”, even though he and his inner circle were allegedly involved in an elaborate fraud and misappropriation of customer funds.

There are no suggestions that the goalkeepers were involved in the crime. But no alarm bells went off despite FTX’s complete lack of internal controls, its miscommunications about the insurance status of client funds, a series of acquisitions purportedly “for regulatory purposes” and the far from watertight separation between FTX’s US and Bahamas. the company based where most of the alleged fraud took place.

FTX’s U.S. auditor Armanino LLP told the Financial Times it stood by its work, saying audit requirements for private companies did not include a review of internal controls. But there have been repeated warnings that lack of oversight over cryptography and limited accounting leadership bring risks of material misstatement, fraud and money laundering. A few weeks before the FTX collapse, EY parted ways with crypto mining firm Core Scientific over poor internal controls. It is late that accounting firms are only now labeling crypto clients as “high risk” or stopping crypto clients.

Legal advice may be more nuanced and less formalistic than accounting, but it’s notable that most of the legal and compliance team (reportedly around 100 people) quit just when FTX was on the brink. FTX US general counsel Ryne Miller reportedly told staff via Slack, “I have very limited transparency and it’s no longer possible without the full cooperation of the founders.” If the apparent freezing of top lawyers was the norm on FTX, that in itself seems like a red flag. Bankman-Fried was certainly less shy about using Miller’s contacts with former regulators to ban officials, according to the LA Times.

There is an urgent need to ensure that these patterns are not repeated as Binance and others attempt to fill the void left by FTX while touting external stamps of approval on their own opaque operations. When accounting firm Mazars produced a “proof of reserves” report for Binance — little more than a few lines showing a snapshot of its bitcoin holdings — exchange chief Changpeng Zhao earlier this month held it up as something much bigger: “Revised proof of reserves. Transparency. ” Mazars has since suspended all work on the cryptocurrency.

Regulatory oversight will help, as will stricter standards. The SEC said this summer that it would “closely scrutinize” accountants and lawyers to make sure they are meeting their responsibilities. Former SEC Commissioner Allison Herren Lee suggested earlier this year that minimum standards of professional conduct for lawyers should be developed and enforced, including the obligation to report red flags. She acknowledged that there is no magic bullet, but cited crypto as one example where failure to follow “well-known principles” of securities law has cost dearly.

Enforcement measures will also have a deterrent effect. Last year, the SEC sanctioned individual auditors and attorneys in connection with fraud cases, which were not limited to publicly listed companies. The UK Solicitors Regulator Authority is also on track to be able to issue “unlimited fines” for certain economic crimes. Lily Fang, dean of research at INSEAD business school, says past scandals such as the collapse of Wirecard show the need to prevent standards from loosening in times of market optimism.

For now, the focus is rightly on Bankman-Fried and his inner circle – with two of his former associates pleading guilty to fraud charges. But as the dust settles on years of speculative crypto euphoria and the bankruptcies that continue to pile up, the old question of where the lawyers and accountants were will be asked again.

More from Bloomberg Opinion:

• Musk drags Twitter down a dangerous rabbit hole: Parmy Olson

• Starving for yield? Check out money market funds: Alexis Leondis

• FTX Crypto Victim Card can be hard to play: Lionel Laurent

This column does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. He was previously a reporter for Reuters and Forbes.

More stories like this are available at bloomberg.com/opinion

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