Could the government have stopped the massive crypto scams?

Prosecutors accused Sam Bankman-Fried of allegedly diverting billions of dollars of client funds placed on his crypto trading platform, FTX. Bankman-Fried, the alleged mastermind of this massive fraud, was arrested in the Bahamas.

The Securities and Exchange Commission (SEC), the federal agency charged with protecting investors, also charged him with violating securities laws. The agency alleges that Bankman-Fried lied to those who sent billions of dollars to FTX, telling them their assets were safe, when in fact he was engaged in a massive embezzlement scheme.

Bankman-Fried allegedly secretly sent his clients’ money to a hedge fund he controlled and used it for all kinds of hidden investments, lavish purchases and large political donations.

The SEC’s action seeks to protect him from any further violations of federal securities laws and to secure the return of his ill-gotten gains. But unfortunately, it seems that the government is failing to put an end to this huge scam. If the history of such botched deals is any guide, FTX’s investors and client traders will find their money wasted and get almost none of it back.

Among the most prominent crypto-assets are digital currencies that represent an alternative to traditional government-backed money. Using elaborate protocols and blockchain technology as ledgers, they function as mediums of exchange and storehouses of wealth.

The SEC opined a few years ago that, solely in this way, they are not securities because their customers are buying goods that they can use or consume. But these would be securities under the well-established investment contract theory, where their buyers expect a gain such as an increase in the value of that digital asset from the managerial efforts of others.

In these cases, all the reasons for securities laws to protect investors would be activated. The sale and trading of digital assets would thus directly fall within that regulatory framework. The SEC certainly knew that cryptocurrencies and their trading platforms, including FTX, could be under their purview.

Should these federal officials have more closely monitored operations like FTX and taken legal action to stop those who violated the registration and anti-fraud provisions of the laws they are charged with enforcing?

When I worked at the SEC as a young attorney, I saw that the wealthy Wall Street community was largely exhausted and had to monitor and be able to prosecute only 2 percent of securities law violations at most. Despite this, the agency has generally received high marks for its effectiveness since its creation in the New Deal legislation. Also, to its credit, the SEC is making admirable efforts to get those who would give their savings to companies like FTX to first investigate their representations promising them a sure profit.

Still, the agency has occasionally stumbled badly, most infamously in the Bernie Madoff scandal in which the SEC failed to catch a decades-long Ponzi scheme that bilked investors out of tens of billions of dollars. It seems we have yet another unfortunate example of a government late in the day and lacking a dollar in investor protection.

Lawsuits by private attorneys may be able to find compensation for investors by going after well-resourced participants in this fraud, like FTX’s celebrity promoters. And actions by the Justice Department and the SEC against Bankman-Fried could have a deterrent effect on future fraudsters.

However, I fear that the FTX debacle will join the ranks of other major frauds such as Madoff, Enron and WorldCom, where investors lost their savings to unscrupulous fraudsters.

Daniel J. Morrissey is a professor and former dean of the Gonzaga University School of Law.

Leave a Comment

Your email address will not be published. Required fields are marked *