Beware Crypto Billionaires Boasting of Audits


Commentary

“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 savings and loan crisis of the 1980s, despite a well-stocked entourage of audit, legal and compliance with those who were expected to raise the alarm.

It’s a relevant question once again, as watchdogs try to crack down on a largely offshore and loosely regulated cryptocurrency industry worth up to $3 trillion, and Binance and other platforms try to end the FTX scandal by appealing to credibility. of external advisers. Wall Street’s top regulator is warning investors to be “cautious” with how crypto firms promote the often limited work done by accounting firms and is considering enforcement actions, according to the WSJ.

Auditors and lawyers are viewed as important “gatekeepers” by regulators with responsibilities to combat fraud and money laundering, but it is clear that they, like others, missed a bewildering number of red flags in the house of change in bankruptcy FTX. Former billionaire founder Sam Bankman-Fried last year showed that the auditors had no health problems, tweeting that FTX and its US arm had client funds.

There is no suggestion that the guardians participated in the evil deeds. But no red flags were raised despite FTX’s complete lack of internal controls, its misleading communications about the insurance status of client funds, a spate of acquisitions allegedly “for regulatory purposes,” and a far-fetched separation. watertight between FTX USA and the Bahamas. -company based in which most of the alleged scam took place.

FTX US auditor Armanino LLP told the Financial Times that it stands by its work, saying that the requirements of an audit of a private company do not include a review of internal controls. But there have been repeated warnings that the lack of oversight of cryptocurrencies and limited accounting guidance carry risks of significant misstatement, fraud and money laundering. Weeks before the FTX collapse, EY parted ways with cryptocurrency mining firm Core Scientific due to poor internal controls. It is late in the day for accounting firms to only now label crypto clients as “high risk” or halt crypto work.

Legal advice can be more nuanced and less formalistic than accounting, but it is notable that only when FTX was on the brink did most of its legal and compliance team (apparently about 100 people) quit. FTX US General Counsel Ryne Miller reportedly told staff via Slack: “I have very limited transparency and it’s not possible to do more without the full cooperation of the founders.” If the apparent freeze on top lawyers was the norm at FTX, that in itself sounds like a red flag. Bankman-Fried was certainly less shy about using Miller’s contacts with former regulators to chat with officials, according to the LA Times.

There is an urgent need to ensure these patterns are not repeated, as Binance and others attempt to fill the void left by FTX while touting external seals of approval on their own opaque trades. When accounting firm Mazars produced a “proof of reserves” report for Binance — little more than a few lines showing a snapshot of its Bitcoin assets — exchange head Changpeng Zhao presented it earlier this month as something much bigger: “Audited Proof of Reserves Transparency.” Since then, Mazars has suspended all crypto work.

Regulatory scrutiny will help, as will tougher standards. The SEC said this summer that it would take “a close look” at accountants and lawyers to make sure they were living up to their responsibilities. Former SEC Commissioner Allison Herren Lee suggested earlier this year that minimum standards of professional conduct for lawyers should be designed and enforced, including the obligation to report red flags. She acknowledged that there was no magic bullet, but cited cryptocurrency as an example where failure to comply with the “well-known principles” of securities law had been costly.

Coercive actions will also have a deterrent effect. The SEC sanctioned individual auditors and lawyers last year in connection with fraud cases, which were not limited to publicly traded companies. The UK Solicitors Regulatory Authority is also on track to be able to issue “unlimited fines” for certain financial offences. Lily Fang, Dean of Research at INSEAD business school, says past scandals like the Wirecard collapse show the need to prevent standards from being relaxed 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 crypto speculative euphoria and with bankruptcies still piling up, the age-old question of where the lawyers and accountants were will be asked again.

More from Bloomberg’s opinion:

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

• Hungry for performance? Take a look at 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 columnist for Bloomberg Opinion covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.

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