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What Washington’s Response to Enron Might Portend for FTX and Crypto

Enron’s collapse 20 years ago spurred Congress to enact the Sarbanes-Oxley Act. Will FTX’s downfall do the same for crypto?

Last year was the 20th anniversary of the Enron accounting scandal. As readers may recall, Enron leaders used well-respected auditors to hide billions of dollars in debt from deals and projects that had failed. After the shady accounting practices were revealed in October 2021, Enron declared bankruptcy and took its audit firm, Arthur Anderson, down with it.

On the occasion of the anniversary, a Bloomberg headline from late 2021 warned, “Twenty years after Enron, investors are still vulnerable to fraud.”

How prescient that headline turned out to be.

The collapse of FTX Group — the Bahamas-based company founded in 2019 and run by Sam Bankman-Fried — was the world’s third-largest cryptocurrency exchange by volume. Its collapse has been compared to the demise of Enron and has understandably created a buzz on Capitol Hill and within the financial regulatory agencies.

The question is: Will this new scandal lead to the type of legislation or regulations the Enron debacle did?

“A bigger mess than Enron”

In an interesting twist, the same man who was asked to take over Enron in the wake of its scandal and bankruptcy has been tapped to do the same for FTX.

John Ray III was appointed FTX’s CEO on November 11. He thinks the fraud perpetrated by FTX presents “a bigger mess than Enron.”

According to the company’s bankruptcy filing, FTX leaders used corporate funds to purchase homes and other personal items for employees and advisors. Former U.S. Treasury Secretary Larry Summers has pointed out the same happened at Enron. As the New York Post reported, Summers “cited ‘stadium namings very early in a company’s history’ as well as a ‘vast explosion of wealth that nobody quite understands where it comes from’” as potential warning signs for regulators and financial law enforcement that something was amiss at Enron, just as it was at the crypto giant.

According to David L. Morris from Coindesk, there are other similarities, including the fact that internal “assets flowed between entities that were nominally or even legally separate, but that in fact served the same masters.” Morris said, “This enabled egregious financial self-dealing in the form of balance sheets pumped up by fictional valuations, a very fragile form of bootstrap leverage that unwound rapidly as soon as the falsely-inflated assets began to waver.”

Ray is tasked with untangling this mess.

Specifically, he will see FTX through bankruptcy and try to recover some of the company’s $8 billion shortfall. So far, however, his team has found only a “fraction” of the digital assets FTX had on its books. Ray concluded, “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”

Members of Congress could not agree more.

Washington’s reaction to the FTX collapse

Like the Enron scandal, FTX’s collapse has attracted significant attention from policymakers from both sides of the aisle.

Sens. Elizabeth Warren (D-Mass.) and Sheldon Whitehouse (D-R.I.) sent a letter to the Department of Justice (DOJ) calling for a criminal investigation of what they called the “fraudulent tactics” by Bankman-Fried.

The incoming chair of the House Financial Services Committee, Rep. Patrick McHenry (R-NC), a Republican who has been supportive of a stablecoin regulatory regime but who had thus far resisted the creation of a strong regulatory regime for digital assets, said, “The recent events show the necessity of congressional action. It’s imperative that Congress establish a framework that ensures Americans have adequate protections [in the digital assets ecosystem] while also allowing innovation to thrive here in the U.S.”

It may be the one area in which the incoming GOP Chairman of the House Financial Services Committee and President Biden’s Chairman of the Securities and Exchange Commission (SEC), Gary Gensler, agree. Gensler said, “It’s a Wild West with a lack of disclosure, a lot of leverage and a lot of interconnectedness; it’s like Jenga blocks all built up, and, as each block gets pulled out, it topples a bit.”

The strong, bipartisan reaction is materially more aligned — and more aggressive — than the manner in which both parties have contemplated government’s role in the digital asset space to date. And with some in Washington, including the chair and ranking members of the Senate Agriculture Committee, backing legislation that would give the Commodity Futures Trading Commission (CFTC), not the SEC, the authority to oversee digital assets, it’s notable that Biden-appointed, Senate-confirmed chair of the CFTC had a close relationship with both FTX and Bankman-Fried.

This fact will significantly undercut the argument in Congress that the CFTC should be in the driver’s seat with regard crypto oversight.

Congress is likely to hold hearings on the FTX collapse in the coming weeks and months, and the odds of a significant, bipartisan digital asset regulatory framework being enacted into law next year have increased exponentially.

So what exactly happens next?

In addition to buying the naming rights for sports arenas, former FTX CEO Sam Bankman-Fried tried to be a big player in politics. He was an outspoken crypto advocate before Congress and regulators and spent millions of dollars backing Democratic candidates in the lead-up to the midterm elections last month.

Those investments are meaningless now.

As AXIOS reminded readers shortly after FTX’s collapse, the Enron bankruptcy led to the passage of the Sarbanes-Oxley Act in 2002, a law that tightened accounting rules for public companies and made it harder for companies to go public in the first place. AXIOS said those rules pushed “companies to seek more capital from the private markets (like FTX did).”

The Enron scandal also rallied U.S. voters sentiment in favor of more regulation, AXIOS noted.

Even before news broke of FTX’s collapse, Americans wanted more regulation. As Coindesk reported, “A national poll conducted by the Crypto Council for Innovation in October revealed that 52 percent of the 1,200 voters surveyed want the industry to be more regulated, while a mere 7 percent said they think the industry should be less regulated. The remaining 41 percent of respondents were evenly split between thinking the industry was sufficiently regulated already, or not having an opinion.”

A Grayscale poll also conducted last month found nearly 80 percent of respondents believe the U.S. government should provide clearer crypto regulations.

As a reminder, the Biden administration already has released a plan to give the American people what they want: more regulation. On September 16, the White House released what it called the “first-ever comprehensive framework for responsible development of digital assets.” It called for:

  • Creating a federal framework to regulate nonbank payment providers.

  • The Treasury Department to work with other agencies to identify, track, and analyze emerging strategic risks that relate to digital asset markets and to collaborate on identifying such risks with U.S. allies, including the Organization for Economic Co-operation and Development (OECD) and the Financial Stability Board (FSB).

  • Aggressive SEC and CFTC investigations and enforcement actions against unlawful practices in the digital assets space.

  • The Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC) to redouble their efforts to monitor consumer complaints and to enforce against unfair, deceptive, or abusive practices.

  • Regulatory agencies to issue guidance and rules to address current and emergent risks in the digital asset ecosystem and to share data on consumer complaints regarding digital assets.

  • Regulatory and law enforcement agencies to collaborate to address acute digital assets risks facing consumers, investors, and businesses.

That list is long and, despite the fact that Republicans are expected to focus heavily on oversight of financial regulatory agencies like the SEC and CFPB once they take control of House committees in January, in the wake of FTX, it is an agenda that could find significant support on Capitol Hill since the American people are so aligned on the question of cyrpto regulation.

Even strong crypto supporters on Capitol Hill, like Sen. Cynthia Lummis (R-Wyo.), want action.

As Coin Telegraph reported, Sen. Lummis has described the collapse of FTX as a “wake-up call” for Congress. She also has argued a bill she introduced this year would have prevented the FTX collapse since regulators would be able to see if an exchange fell below the threshold “Immediately.” “Those are things that had they been in place for FTX, would have set off alarm bells, that would have created regulatory enforcement actions and reviews by federal regulatory agencies,” Sen. Lummis explained.

How quickly — and how broadly — will Congress act?

Only time will tell, but there is little doubt that, 20 years from now, we’ll look back on the FTX collapse as the instigator of significantly more regulatory scrutiny on the digital assets sector.

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