“Where were the lawyers and accountants?” That was the withering assessment of one U.S. judge after years of fraud and deception went undetected during the 1980s savings and loan crisis, despite a well-stocked entourage of audit, legal and compliance professionals who might have been expected to raise the alarm.
It’s a relevant question once more as watchdogs try to crack down on a largely offshore and patchily regulated cryptocurrency industry — worth $3 trillion at the peak — and as Binance and other platforms try to draw a line under the FTX scandal by appealing to the credibility of outside advisors. Wall Street’s top regulator is warning investors to be “wary” of how crypto firms promote the often narrow work done by accounting firms and is considering enforcement actions, according to The Wall Street Journal.
Auditors and attorneys are viewed as important “gatekeepers” by regulators with responsibilities to fight fraud and money laundering, yet it’s clear that they — like others — missed a bewildering number of red flags at bankrupt exchange FTX. Ex-billionaire founder Sam Bankman-Fried last year showed off his clean bill of health from auditors, tweeting that FTX and its U.S. arm had “passed U.S. GAAP audits,” even as he and his inner circle allegedly engaged in elaborate fraud and misuse of customer funds.
There’s no suggestion gatekeepers took part in wrongdoing. But no alarm bells went off despite FTX’s total lack of internal controls, its misleading communications about the insurance status of customer funds, a string of acquisitions reportedly “for regulatory purposes,” and a far-from-watertight separation between FTX US and the Bahamas-based firm where most of the alleged swindle took place.
FTX’s U.S. auditor, Top 100 Firm Armanino LLP, has told the Financial Times it stands by its work, saying the requirements of a private-firm audit don’t include reviewing internal controls. But there have been repeated warnings that crypto’s lack of oversight and limited accounting guidance bring risks of material misstatements, fraud and money laundering. Weeks before FTX’s collapse, Big Four firm EY parted ways with crypto mining firm Core Scientific over poor internal controls. It’s late in the day for accounting firms to only now be labeling crypto clients as “high-risk” or halting crypto work.
Legal advice may be more nuanced and less formalistic than accounting, but it’s notable that only when FTX was teetering on the brink did most of its legal and compliance team (apparently about 100 people) quit. FTX US’s general counsel, Ryne Miller, reportedly told staff via Slack: “I have very limited transparency and more is not possible without full cooperation from the founders.” If the apparent freezing-out of top lawyers was the norm at FTX, that in itself looks like a red flag. Bankman-Fried was certainly less shy about using Miller’s contacts with former regulators to schmooze with officials, according to the LA Times.
There’s an urgent need to ensure these patterns aren’t repeated as Binance and others try to fill the gap left by FTX while touting external seals of approval of their own opaque operations. When Top 100 Firm Mazars produced a “proof-of-reserves” report for Binance — little more than a few lines showing a snapshot of its Bitcoin assets — the exchange’s boss Changpeng Zhao held it up earlier this month as something much bigger: “Audited proof of reserves. Transparency.” Mazars has since suspended all crypto work.
Regulatory scrutiny will help, as will tougher standards. The SEC said this summer it would take “a hard look” at accountants and attorneys to ensure they were fulfilling 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 there was no magic bullet but cited crypto as one example where failure to comply with “well-known principles” of securities law had been costly.
Enforcement actions will also offer a deterrent effect. The SEC sanctioned individual auditors and attorneys last year in relation to fraud cases, which were not limited to publicly listed companies. The U.K. Solicitors Regulation Authority is also on a path to being able to issue “unlimited fines” for certain economic crimes. Lily Fang, dean of research at business school INSEAD, says past scandals like the Wirecard collapse in Germany show the need to prevent standards loosening during 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 speculative crypto euphoria and with bankruptcies still piling up, the old question of where the lawyers and accountants were will be asked again.