01/12/2022 Alexander

Analyzing the FTX scandal from a compliance perspective

FTX: A Case Study of a Major Failure in Corporate Controls and Compliance

FTX, a digital currency exchange, is known for its low trading fees and aggressive market strategies. In 2021, while many crypto firms went bankrupt, FTX managed to thrive. However, the leak of Alameda Research’s balance sheet revealed that FTX was vulnerable due to its connection to Alameda Research, which had its own tokens called FTT. This led to a crash in the price of FTTs and FTX took a hit as funds moved from FTX to Alameda. FTX’s CEO called it an “unprecedented” failure in management and financial opacity.

To address this major failure in compliance by FTX and other imperative issues such as anti-money laundering, KYC (Know Your Customers), sanctions, market abuse, manipulation, and fraud, Gatenox CEO Pawel Kuskowski invited top practitioners of corporate compliance, Carol Van Cleef and Art Middlemiss, to talk about it in Crypto Compliance Podcast.

FTX vs compliance

Carol Van Cleef, an attorney and consultant embedded in the crypto industry since 2012, and Art Middlemiss, a lawyer in New York, handle fraud issues as a prosecutor and address crucial issues such as money laundering, sanctions, and anti-corruption practices. When asked about the setup of FTX in the Bahamas from a regulatory perspective, Art mentioned that anyone who invests their money somewhere would expect their money to be safe in that regime. The probable reason why FTX was set up in the Bahamas and not in the US was that it had a better regulatory regime. However, what happened with FTX has been a “horrible public relations disaster” for the Bahamas in terms of the reception of their regulatory environment. Carol adds that the people of the Bahamas have worked very hard to put up a regime that protects the regulatory background that provides a backbone to the crypto system.

In contrast, the US exchanges are generally safe, regulated, and have worked with the government to meet compliance requirements, e.g., Gemini. Carol states that the Bahamian entity did not back their transaction one for one, whereas the US entity did, so funds held in the US entity were safe. US Money Transmitter licenses meant that there was not a chance to be the same kind of run on the bank that was seen in respect of the parent company, FTX.

Crypto has been celebrated for its transparency, and there is a great likelihood of finding information using a blockchain analytics tool that can show what could have been done to prevent the fire that has been sparked.

In the crypto space, companies are expected to segregate client money to fund any other activities of the company. However, nothing similar exists in the crypto space. Although the concept of segregating client money existed, it was not implemented or enforced in the Bahamian regime. Thus, customers in the US have some level of comfort because they can at least expect their money to be in safe hands.

Crypto has been celebrated for its transparency, and there is a great likelihood of finding information using a blockchain analytics tool that can show what could have been done to prevent the fire that has been sparked. Although the harm has been done, this information can be used as a prevention tool in the future to stop the same from happening again and conduct surveillance. As Art states, when people are entrusting their funds to a platform, they need to know the platform’s practices and have some degree of transparency about what is happening to their money.

In conclusion, the FTX case study serves as a reminder of the importance of corporate controls and compliance

Art also says that when people are entrusting their money to an entity, people should ask “What do I know about that entity?” and “Is my money safe there?” but unfortunately they don’t ask this everyday. The hallmark of fraud is that if something looks to be too good to be true, most of the time, it is.

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Carol Van Cleef is an internationally recognized authority and pioneer in legal issues involving cryptocurrencies and blockchain technology. With a focus on regulatory, compliance, and enforcement matters, Carol has built a global reputation as a leading attorney, counselor and problem solver working with fintech companies, blockchain developers, virtual currency exchanges and wallets, payment processors, prepaid access programs, and other business ventures.

As a certified anti-money laundering (AML) specialist, Carol created a series of AML compliance training programs in partnership with the Conference of State Bank Supervisors and attended by state regulators, executives from domestic and foreign banks, securities firms, money services businesses, and other entities.

Arthur D. Middlemiss practices in the areas of financial crimes compliance. He focuses on providing strategic counsel to foreign and domestic entities seeking to mitigate regulatory, criminal and reputational risk in the areas of anti-money laundering (AML) and anti-bribery and corruption (ABC). Arthur  has represented individuals and corporations in criminal investigations, investigated alleged violations of the Foreign Corrupt Practices Act, and advised financial and other companies with respect to best practices in the fields of AML and ABC compliance.