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HFSC FTX Hearing

House Committee on Financial Services

Investigating the Collapse of FTX, Part I

Tuesday, December 13, 2022

Topline

  • A bipartisan group of Members said the SEC failed to protect consumers ahead of FTX’s collapse.
  • Republicans and Democrats agreed on the need to regulate the crypto industry.
  • FTX Group CEO Ray said Sam Bankman-Fried committed embezzlement and that FTX had no internal controls, no governance structure, no transparency, centralized control, and comingled assets.

Witnesses

Opening Statements

Chairwoman Maxine Waters (D-Calif.)

In her opening statement, Waters said that she was hopeful the arrest of Sam Bankman-Fried (SBF) means he will be held accountable. She also noted that the timing of his arrest denies the public the opportunity to get answers, since he was scheduled to testify today. Waters said that FTX displayed a total disregard for standard business practices, governance, risk management, and criminal conduct and highlighted that she has been troubled to hear about SBF and employees “stealing from the cookie jar” to fund their lavish lifestyle. She explained that the Committee will look into FTX’s deep ties with Alameda, which gambled away customer’s assets. She closed by applauding the Securities and Exchange Commission (SEC) for authorizing charges against SBF.

Ranking Member Patrick McHenry (R-N.C.)

McHenry expressed his gratitude for yesterday’s arrest, noting that he still looks forward to “getting SBF’s lies here on the record under oath.” He highlighted the need to: (1) examine the actions of various employees at FTX who may have contributed to the collapse; (2) provide answers for customers stuck in limbo; and (3) work to ensure that this never happens again. McHenry said that it is important to separate the bad actions of an individual and the good created by innovation and reasserted his confidence in the promise of digital assets and blockchain. He closed by noting that SEC Chair Gary Gensler’s regulation by enforcement is not going to stop bad actors and argued that Gensler has failed to provide clarity of securities laws on trading platforms.

Testimony

John J. Ray III, Chief Executive Officer, FTX Group

In his testimony, Ray said his first act as CEO was to initiate the Chapter 11 filings and that he has implemented a five-part plan with the overarching objective of maximizing value for FTX customers and creditors to mitigate harm. He explained that the recent collapse stemmed from control being concentrated in the hands of a small group of “grossly inexperienced, unsophisticated individuals.” Ray listed some of the unacceptable practices, including: (1) no security controls preventing redirection of assets; (2) no security controls or encryption of customers’ keys; (3) the ability of Alameda to borrow funds held by FTX with no limits; (4) comingling of assets; and (5) lack of documentation for investments made with assets. He further explained that the scope of his investigation is enormous and includes detail tracing and noted that every week, they are gaining a better understanding of what occurred. Ray concluded by listing what the company knows currently. Specifically, he said that customer assets were comingled with assets in the Alameda platform, Alameda used client funds to engage in margin trading, FTX spent $5 billion on businesses and investments in 2021-22, loans and other payments were made to insiders, and Alameda’s business model required funds to be deployed to unsafe third-party exchanges.

Question & Answer

Historical Comparisons to Enron and Madoff

Reps. Ann Wagner (R-Mo.) and Roger Williams (R-Texas) asked Ray to elaborate on how FTX is worse than Enron. Ray said what makes it unusual is that there was no record keeping and employees would send invoices or expenses on Slack. He also said they used QuickBooks for accounting and that there was no independent board. Ray also said the crimes at Enron were sophisticated, whereas the FTX event is simply embezzlement. Rep. Ed Perlmutter (D-Colo.) noted that distributions from the Madoff event are still being made and that bankruptcy was filed in 2008.

Bahamian Authorities and Arrest

Rep. Madeleine Dean (D-Pa.) asked how SBF and others in his circle were able to go in and mint tokens to transfer them to the Bahamian authorities. Ray said it is because of how centralized control was, so they knew what the keys were and where the wallets were.

Rep. Alexandria Ocasio Cortez (D-N.Y.) noted Bahamian provisional liquidators came to the U.S. bankruptcy court and sought an entry to recognize the Bahamian liquidation as the main foreign proceeding. She asked Ray how this may benefit SBF. Ray said it seems there has been an effort by the Bahamians to get control of the liquidation.

Rep. William Timmons (R-S.C.) said that as a former prosecutor, congressional testimony from SBF under oath would have been very helpful. He said he looks forward to figuring out why the Department of Justice issued a provisional arrest warrant to prevent SBF from testifying.

Rep. Bryan Steil (R-Wis.) asked if the movement of assets after the bankruptcy was due to a hack or at the direction of Bahamian authorities. Ray said it was both and that Bahamian authorities were aided by former FTX employees taking the funds. Ray said the Bahamian authorities have been uncooperative when asked for clarity and that he believe it violates the stay of bankruptcy. Steil asked Ray if he thought SBF was trying to undermine the bankruptcy, and Ray said it appears so and that the pushback from the Bahamian authorities is extraordinary to him.

The Collapse and Alameda’s Role

Waters asked if there was independent governance of Alameda. Ray said the operations were not segregated and they were effectively one company. She also asked if FTX had sufficient risk management and controls. Ray said there were virtually no internal controls and no separateness.

Wagner asked if it was true $10B was transferred to Alameda. Ray said he did not have an exact number but that it was definitely several billion.

McHenry asked Ray to describe the business structure. Ray said there was the U.S. silo (FTX US), international exchange (FTX.com), Alameda (margin trading), and an investments silo. He said Alameda was effectively a customer of FTX.

Rep. Blaine Luetkemeyer (R-Mo.) asked if Alameda is chartered in the U.S. and if FTX needed Alameda because it could not get a bank account. Ray said Alameda is not a bank and that funds were just transferred with no limits.

Rep. Sean Casten (D-Ill.) asked about the comingling and open margin positions Ray observed. Ray said comingling was taking place and that FTX had open margin positions at times in Alameda.

Rep. Gregory Meeks (D-N.Y.) asked how much the lack of an independent board contributed to the collapse. Ray said it was a critical aspect of the failure.

Rep. Tom Emmer (R-Minn.) asked if a board oversaw the entirety of FTX and if there was a legal and compliance department at FTX. Ray said there was no board and that there were individuals with legal and compliance titles, but there was no experience behind it.

Rep. Richie Torres (D-N.Y.) asked if there was an issue with FTX counting their own tokens as assets, and Ray said that was an issue and that he suspects customers did not know that was the case.

Investigation and Recovery of Assets

Rep. Andy Barr (R-Ky.) asked Ray to explain the governance structure. Ray said there was virtually no governance. He said he has installed a CIO, CFO, and independent board. Barr also wanted to know if the not-for-profit entities, like FTX Foundation, were properly established or if the funds received were improper. Ray said they were owned by SBF, and the funding was comingled.

Luetkemeyer also asked if the deal with Farmington Bank has been investigated. Ray said he is looking into that.

Reps. Alma Adams (D-N.C.), Ayanna Pressley (D-Mass.), Joyce Beatty (D-Ohio), and Sylvia Garcia (D-Texas) asked about how many users lost money, if users will get all their money back, and when users can expect their money back. Ray said he does not have an exact number of how many individuals because multiple accounts could be owned by the same person. He also had no timeline for recovery.

Rep. French Hill (R-Ark.) asked Ray if the auditing firms FTX used will be participating in the investigation. Ray said he is getting what he needs from them but then investigating the matter with his own team.

Rep. Warren Davidson (R-Ohio) asked about liquidity, and Ray said at one-point there was a certain amount of liquidity. He went on to say the run was the problem, underscored by comingling.

Rep. Steven Lynch (D-Mass.) asked if anything suggests FTX tried to comply with U.S. securities law. Ray said everything has been provided to regulators and that he only knows the outcome, not intent.

Rep. Jake Auchincloss (D-Mass.) asked Ray to disclose any evidence of collusion between SBF and authorities to the Committee. Ray agreed to.

Impact and Need for Regulation

Rep. Nydia Velazquez (D-N.Y.) asked what Congress should keep in mind throughout this. Ray did not want to speak to detailed regulation, but he said the most important things needed are records, controls, and segregation of assets.

Rep. Tedd Budd (R-N.C.) asked if the outcome would have been different if FTX.com were domiciled in the U.S. Ray said he thinks it would not have been different.

Rep. Josh Gottheimer (D-N.J.) voiced his displeasure with the SEC Chair Gensler’s regulation by enforcement and failure to create guardrails. He and Rep. Lucas (R-Okla.) asked what made LedgerX different, and Ray said it is because LedgerX has segregated accounts and is regulated.

Reps. John Rose (R-Tenn.) and Juan Vargas (D-Calif.) agreed that Gensler failed to protect consumers and said the SEC has to step up.

Rep. Chuy Garcia (D-Ill.) said this is not about one guy but an entire industry that thinks it is above the law.

Rep. Pete Sessions (R-Texas) asked if the SEC came to visit FTX at any point to question anything. Ray said he did not know since he just began on November 11. Sessions also asked if FTX properly filled out IRS forms and if the Committee could receive that information. Ray said they hired Ernst & Young to look into that and that he is happy to get the Committee what they need.

Rep. Al Green (D-Tex.) said a message needs to be sent to others who take advantage of people.

Innovation

Rep. Jim Himes (D-Conn.) said that whether the Committee likes it or not, crypto is here, and they need to learn it. Emmer said the blockchain will expose what SBF did due to its open and permissionless nature. Finally, Hill said he did not want FTX’s collapse to distract everyone from reasonable regulation.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.