Beware of cryptocurrency billionaires who brag about audits

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“Where were the lawyers and accountants?” That was the withering assessment by a US judge after years of fraud and deception that went unnoticed during the savings and loan crisis of the 1980s, despite a well-stocked entourage of audit, legal and compliance professionals they could have launched 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 $3 trillion at its peak — and as Binance and other platforms try to draw a line under the FTX scandal by appealing to the credibility of external consultants. According to the WSJ, the top Wall Street regulator warns investors to be “wary” of how cryptocurrency firms promote the often narrow-minded work done by accounting firms and is considering enforcement actions.

Auditors and lawyers are seen as important “gatekeepers” by regulators with responsibilities for fighting fraud and money laundering, but it is clear that they, like others, have missed a bewildering number of red flags to bankruptcy. ‘FTX exchange. Former billionaire founder Sam Bankman-Fried showed his good health to auditors last year, tweeting that FTX and its US arm had “passed US GAAP audits,” even though he and his inner circle were allegedly involved in elaborate fraud and misuse of client funds.

There is no suggestion that the Guardians took part in any wrongdoing. But no alarm bells have been raised despite FTX’s complete lack of internal controls, its misleading disclosures about the insurance status of client funds, a series of reportedly “for regulatory purposes” acquisitions, and a far from leak between FTX US and the Bahamas where most of the alleged scam occurred.

FTX’s US auditor Armanino LLP told the Financial Times that he supported their work, saying the requirements of a private company audit did not include reviewing internal controls. But there have been repeated warnings that cryptocurrency’s lack of oversight and limited accounting guidance pose risks of clerical errors, fraud and money laundering. Weeks before FTX collapsed, EY spun off from cryptocurrency mining firm Core Scientific due to poor internal controls. It is late for accounting firms only now to label crypto clients as “high risk” or stop crypto work.

Legal advice may be more nuanced and less formalistic than accounting, but it should be noted that it was only when FTX was on the brink that most of its legal and compliance team (apparently around 100 people) resigned. 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 founders’ full cooperation.” If apparent freezing of top lawyers were the norm at FTX, that in itself seems like a red flag. Bankman-Fried was certainly less shy about using Miller’s connections with former regulators to chat with officials, according to the LA Times.

There is an urgent need to ensure these schemes do not repeat themselves as Binance and others seek to fill the void left by FTX as they promote external seals of approval of their own opaque operations. 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: “Verified proof of reservations. Transparency.” Mazars has since suspended all work on cryptocurrencies.

Regulatory scrutiny will help, as will stricter standards. The SEC said it will take “a careful look” at accountants and lawyers this summer to make sure they are meeting 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 requiring them to report red flags. She acknowledged that there was no magic bullet, but cited cryptocurrencies as an example where failure to comply with the “well-known principles” of securities law had been costly.

Enforcement actions will also offer a deterrent effect. The SEC fined individual auditors and attorneys last year in connection with fraud cases, which weren’t limited to publicly traded companies. The UK’s Solicitors Regulation Authority is also on track to be able to issue “unlimited fines” for certain economic offences. Lily Fang, dean of research at the INSEAD business school, says past scandals like the collapse of Wirecard show the need to prevent standards from easing during times of market optimism.

For now, the focus is rightfully 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 cryptocurrency speculative euphoria and bankruptcies continue to pile up, the 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 yield? Check out Money Market Funds: Alexis Leondis

• FTX’s crypto victim card can be tough 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 Bloomberg Opinion columnist covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.

More stories like this can be found at bloomberg.com/opinion

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