In Digital Assets, FTX, House Financial Services Committee

On December 13, 2022, the U.S. House Committee on Financial Services (HFSC) held a Full Committee Hearing entitled, “Investigating the Collapse of FTX, Part I.”  The only witness to testify hearing was John J. Ray III, a bankruptcy expert who has since Nov. 12 served as Chief Executive Officer, FTX Group.

Former FTX CEO Sam Bankman-Fried, who goes by SBF, was expected to testify as part of a separate panel at the same hearing, but in a shocking turn of events, he was instead arrested on Monday night by authorities in the Bahamas, where he was residing, at the request of the U.S. government.

Here are eight significant takeaways from the hearing.

1.  Digital Asset Policymaking on the HFSC next year will be #Bipartisan. Really.

From the outset of Tuesday’s hearing, right through the Committee’s final gavel on Wednesday, Chair Waters and Ranking Member McHenry took pains to underscore the “bipartisan” nature of the hearing – with McHenry explaining that “we worked together to get this hearing on the books,” and calling it “the first bipartisan hearing this Committee in the last four years.”  This message was reiterated by McHenry and Waters repeatedly, on Tuesday, and again at a separate hearing on Wednesday.

We don’t think all of the recent back and forth is merely show.  We expect that House Republicans, led by McHenry, will seek to engage the Biden Administration in a sustained and generally constructive way, and that that his ultimate goal is a bipartisan bill that can pass the House with 300-350 votes.

There are many things outgoing Chairwoman Waters is sure to miss about the Democratic majority next year, but we think that having the final call on any bipartisan crypto deal is not likely to be one of them.  In fact, after spending the better part of two years jumping through hoops and using her considerable talent and influence to prevent any serious tangible legislative action on crypto, we expect Waters to embrace the opportunity to legislate and negotiate from the minority if given the opportunity.

2.  This was the hearing Rep. Brad Sherman (D-CA) has been girding for the past five years.

For well more than a year, U.S. Rep. Brad Sherman has served as the Chairman of the U.S. House Financial Services Subcommittee on Investor Protection and Capital Markets – a plumb perch through which to influence conduct of regulators, industry and all things market related – has been effectively barred from using his gavel as a platform to scrutinize (and criticize) the industry.  While it remains to be seen whether incoming HFSC Chair McHenry will greenlight subcommittee hearings on digital assets, Sherman is not waiting to find out to train his fire on the industry and its apologists in Congress.

According to Sherman, the use cases for crypto primarily involve “drug dealers, human traffickers, sanctions evaders who find [its lack of regulation] a good feature,” or “tax evasion.”  After reminding the HFSC that “for five years, I’ve been trying to ban American investments in crypto,” and that “I’m the only member of the House to get an ‘F’ from the only crypto promoting organization that rates members of Congress,” Sherman proceeded to use his time at the hearing to make a critical point: “My fear is that we will view SBF as just one big snake in a crypto Garden of Eden. The fact is, crypto is a garden of snakes. For my colleagues: Don’t trash Sam Bankman-Fried and then pass his bill.

Sherman also pointedly used the hearing to defend the SEC, and to call out specific members of the HFSC who have until very recently been among crypto’s biggest proponents and beneficiaries.

Now I’ve heard from some on the other side criticizing the SEC. In July, in this room, I criticized the head of the SEC head of enforcement of the SEC for not going after crypto exchanges. But the fact is that, without objection, I’d like to put on the record a letter signed by 19 Republican members designed to push back on the SEC, a brushback pitch if you’re familiar with baseball — — attacking the SEC for paying attention to and I quote, ‘the purported risks of digital assets.’ And I’d like to put into the record without objection comments from eight [HFSC] members designed to attack the SEC as being a Luddite and anti-innovation for their efforts.

3.  Get ready to hear a lot more about Ledger X.

Early in the hearing, Rep. Frank Lucas (R-OK) asked Ray whether it was correct that despite the FTX bankruptcy’s involving over 100 distinct corporate entities “some of the FTX entities were not included in bankruptcy, including Ledger X.”  Ray responded that: “Ledger X is a perfect example of the entities that were kept out of bankruptcy. It’s a regulated entity. It’s fully solvent that customer funds were segregated. We –we believe that there’s been no harm there whatsoever. There’s no reason to put it into bankruptcy. Ultimately, we will look to sell Ledger X, and put it in the hands of a good steward.”

Ledger X is significant because it is one of the handful of FTX owned or affiliated firms that was regulated by the CFTC in the months preceding the FTX meltdown and bankruptcy. At a Senate hearing last week, CFTC Chair Benham and a number of Senators from both parties suggested that there way a direct correlation between the way Ledger X was regulated and its ability to weather FTX’s collapse unscathed.

4.  John Ray thinks the FTX Bankruptcy is best visualized by thinking about 4 buckets.

“For structural purposes and just for ease of presentation, we tried to take the over 100 entities and we put those in for silos. To demystify that, it’s very simple. There was a U.S. silo, which was the FTX us exchange for U.S. investors. There was an international exchange called, again, for non-U.S. persons that invested in crypto. There was Alameda, which is purely a crypto hedge fund, which made other investments venture capital type investments. And there’s a fourth entity which was purely investments.”

5.  FTX is the Prince Andrew of Crypto Winter. It is even worse than it looks. Bernie Madoff had phony books, and Elizabeth Holmes had phony blood analyzers, but FTX didn’t even bother.

“The FTX group is unusual in the sense that I’ve done probably a dozen large-scale bankruptcies over my career, including Enron, of course. Every one of those entities had some financial problem or another. They have some characteristics that are in common. This one is unusual, and it’s unusual in the sense that literally, there’s no record keeping whatsoever in the absence of record keeping.”

  • John Ray responding to a request to “elaborate on the specific ways FTX is worse than” other corporate scandals.

“It’s an extensive list. It really crosses the entire spectrum of the company, from lack of lists of bank accounts, hundreds of bank accounts dispersed all over the world, lack of a just a complete list of employees and their functions by a group or name, extensive use of independent contractors as opposed to employees, lack of insurance that you’d normally would see in certain businesses, either inadequate insurance or complete gaps in insurance. For example, the Alameda silo had no insurance whatsoever. So, those are, I mean, the list goes on and on. We could spend all day on that.”

  • John Ray responding to a request for an “update on the extent of the poor controls” at FTX.

“Right. So, funds were taken from customers, funds were invested, trading losses incurred in Alameda, and then funds were deployed that will never be valued at the same dollar amount. There was over $5 billion of investments made. Certainly there’s some value there, and we will try to get that value and sell those assets. But oftentimes, even when he made those sorts of investments, whether it was directly or through others in management, sometimes he would do that really without any pro forma or any valuation. Not really quite sure how some of the purchase price numbers were derived. So, it gives you a sort of worry, obviously, that the purchases were overvalued. So, there’s a concern there as well.”

  • John Ray’s response to a request for “the big picture balance loss as a result of this bankruptcy?”

“So, this company, unfortunately, had a very, very challenging record here. For some transfers, there was no pathway for it. Our keys aren’t stored in a centralized location. We don’t know where all of our wallets are. Passwords were sometimes kept in just plain text format. So, this company was sort of uniquely positioned to fail. The lack of discipline on control of the wallets, their storage, the storage of passwords, allowing multiple users to set up accounts almost created an environment where there was not a complete inventory of wallets.”

  • John Ray’s response when asked how FTX bankruptcy differed from the “work you’ve done with other companies…by and large, money in banks or in other financial institutions.”

“You know, it’s virtually unlimited in terms of the lack of controls, no centralized records on banking, no daily reconciliations of crypto assets, silos where there’s no insurance, inadequate insurance, no independent board. No safeguards that limit, who controls an asset. So senior management literally could get access to any of the accounts in any of the silos. No separateness between customer money, and other customer money or other assets. It’s virtually unlimited in terms of the lack of controls. And that’s really the point of the unprecedent comment, I’ve just never seen anything like it in 40 years of doing restructuring work and in corporate legal work. It’s just a dearth of information.”

  • John Ray when asked to “elaborate on the internal failures and the inadequate policies that occurred and FTX leading to the collapse?”

6.   In face of criticism from the media about his close relationship with SBF, House Majority Whip Tom Emmer (R-MN) is trying to hang the FTX bankruptcy on SEC Chair Gary Gensler.

This was always going to be an awkward hearing for outgoing NRCC chair and incoming House Majority Whip, Rep. Tom Emmer (R-MN).  To the extent he seeks to address or refute this reporting, he seemed determined to do simply by blaming the problem on Gary Gensler and the Biden administration.

We know that Chair Gensler had more meetings with FTX than anyone else in the crypto industry. We understand that what was being negotiated was a framework for digital asset exchange registration and token registration with the SEC that would benefit both parties. It would expand the SEC’s jurisdiction in exchange for the SEC’s preferential treatment of FTX over other industry participants. We understand there was a lot of activity to move this idea forward.  Will you commit to sharing with this committee any internal documents you come across regarding communication between FTX and Mr. Gensler or others at the SEC?

7.  There were limited numbers of U.S. persons who placed investments on FTX’s international platform (, but but the number of customers is relatively small – “in the hundreds.”

According to John Ray: “A small number of U.S. customers that had engaged in [investing] on the platform, which was not available to U.S. users.  We don’t have [detailed] numbers on an investor basis. We have it on a customer basis. But you’re talking about less than a couple of hundred.”  Of course, the actual significance of being invested through FTX international arm or U.S. arm thus far appears to have mattered little and meant even less.  “There was a public distinction between the two. What we’re seeing now is that the crypto assets for both and for FTX U.S. were housed in the same database…in the same web format.”

8.  SEC Chair Gensler will be visiting the HFSC “early and often” in 2023. When he does, it will not be only the Republicans looking for opportunities to shank him.

“SEC Chairman Gensler has repeatedly claimed that most cryptocurrencies are covered by existing securities laws. Despite that the SEC has not proposed a single rule to create guardrails for digital assets. And it’s done a haphazard job of overseeing the space. There has always been a lack of certainty and clear rules of the road. And we’re seeing the impact of that front and center today. They failed to do their job and they failed to protect consumers in my opinion, I’ve been calling on with other members on financial regulators to step up and create clear guardrails for digital assets. Nearly a year ago, I addressed the Stable Coin Innovation Protection Act to create tough consumer protections and prevent destabilizing runs, like we saw with the so-called stablecoin Terra had failed earlier this year.”

The SEC has created a patchwork of ad hoc policies for crypto firms purely through spotty enforcement actions and random letters, haphazard enforcement that has missed the worst offenders. You can’t regulate through a random patchwork of letters. You have to write clear rules of the road, which is what I’ve been calling on for years now.”

Chairman Gensler has told our committee and stated publicly that he is the authority he needs to oversee this industry. Yet the SEC has unwritten rules and has failed to foresee and prevent disasters in the industry and protect consumers from Terra Luna and FTX. It’s time for the SEC to step up and do its job or another lead regulators should take the lead.” – Rep. Josh Gottheimer (D-NJ) – Dec. 2022.

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