Is Gary Gensler to Blame for FTX Collapse? Congress Demands SEC Accountability in Crypto Meltdown

The crypto world is still reeling from the dramatic collapse of FTX, and fingers are pointing squarely at regulators – specifically, Securities and Exchange Commission (SEC) Chair Gary Gensler. But is Gensler truly responsible for the FTX fiasco? And more importantly, what does this mean for the future of crypto regulation in the US?

Why is Congressman Torres Calling for an Investigation into Gary Gensler and the SEC?

Congressman Ritchie Torres is not holding back. He’s directly accusing Gary Gensler of regulatory failure in the FTX meltdown. In a strongly worded letter to Gene Dodaro, head of the Government Accountability Office (GAO), Torres didn’t mince words:

“When it comes to FTX, Chair Gensler fundamentally failed as a regulator, and he has no one but himself to blame.”

Torres argues that the SEC can’t claim to be the top crypto regulator while simultaneously shirking responsibility when things go south, like they did spectacularly with the FTX exchange based in the Bahamas. He’s calling for a full GAO investigation into whether Gensler’s leadership and management at the SEC have actually weakened investor protection – the very thing the SEC is supposed to champion.

Here’s a breakdown of Torres’s key criticisms:

• Missed Red Flags at FTX: Torres believes the SEC could have – and should have – identified problems at FTX much earlier if they had dedicated sufficient resources and attention to the exchange. He suggests a lack of due diligence allowed FTX to grow unchecked, ultimately harming investors.
• HR Mismanagement: Beyond FTX, Torres is questioning Gensler’s overall management of the SEC, asking the GAO to investigate if HR issues within the agency are hindering its ability to protect investors effectively.
• Questionable Priorities: Torres points to the SEC’s action against Kim Kardashian for promoting a crypto scam as an example of misplaced priorities. He suggests the agency’s resources would have been better spent proactively scrutinizing firms like FTX rather than reacting to celebrity endorsements.

Is Regulation by Enforcement the Right Approach?

Gary Gensler has defended the SEC’s approach to crypto regulation, often described as “regulation by enforcement.” His stance is that existing securities laws already provide sufficient guidance for crypto companies to comply. Essentially, the SEC is waiting for companies to potentially step out of line and then using enforcement actions to clarify the rules of the game.

In a December 2022 interview with Yahoo Finance, Gensler stated that the “Runway is getting shorter” for crypto firms to achieve compliance before facing SEC action. He emphasized that the SEC already possesses the necessary authority to oversee the crypto space.

However, this approach has drawn significant criticism. Critics argue that “regulation by enforcement” lacks clarity and creates uncertainty for crypto businesses. They contend that companies are left guessing what the SEC considers compliant behavior until they are hit with an enforcement action.

Who Else is Criticizing Gensler’s Crypto Regulation?

Torres isn’t alone in his criticism. Democrat Congressman Tom Emmer has also voiced concerns about Gensler’s “indiscriminate and inconsistent” crypto regulation. Emmer highlighted that several crypto companies had complained directly to him, stating that the SEC’s extensive disclosure requests were stifling innovation within the industry.

Emmer pointed out that Gensler’s regulatory strategy failed to prevent the collapses of Terra/LUNA, Celsius, and FTX in 2022, raising serious questions about its effectiveness. Both Torres and Emmer, from opposite sides of the political spectrum, seem to agree on one thing: the current regulatory environment for crypto under Gensler is problematic.

What Legislative Changes are Being Proposed?

In response to the FTX debacle and broader concerns about crypto regulation, several legislative proposals are emerging:

• Proof of Reserves: Congressman Torres has proposed a bill mandating cryptocurrency exchanges to regularly disclose “proof of reserves.” This measure aims to increase transparency by requiring exchanges to demonstrate that they hold sufficient assets to cover their customer liabilities. This could help prevent situations like FTX, where customer funds were allegedly misused.
• Senator Warren’s Bill for Stricter Crypto Rules: Crypto-skeptic Senator Elizabeth Warren is drafting legislation to expand the SEC’s authority over the crypto industry. Her proposed bill, spurred by the FTX collapse, focuses on enhanced consumer protection. Key elements reportedly include:
  • Audited Financial Statements: Requiring crypto companies to provide regular audited financial statements to ensure greater financial transparency.
  • Minimum Capital Requirements: Establishing minimum capital levels that crypto firms must maintain to ensure they can meet customer withdrawal requests, enhancing stability and reducing the risk of insolvency.

Is Congress Divided on Crypto Regulation?

While there’s growing consensus on the need for clearer crypto regulation, Congress is far from united on the best path forward. Senator Sherrod Brown, Chair of the Senate Banking Committee, has cautioned against rushing into new legislation, fearing that the crypto industry could unduly influence the process. This reluctance, shared by Gensler and Brown, underscores the political challenges of navigating crypto regulation in a highly polarized Congress.

This legislative gridlock has real-world consequences. The uncertainty and perceived hostility from US regulators are pushing some crypto businesses to consider leaving the US market. Nexo, a crypto lender and exchange, announced its withdrawal from the US market in December 2022, citing a lack of regulatory clarity, despite engaging in talks with US regulators. This exodus could lead to more American investors being exposed to less regulated, offshore crypto entities – the opposite of investor protection.

Looking Ahead: What’s Next for Crypto Regulation?

The FTX collapse has acted as a catalyst, forcing a critical examination of crypto regulation in the US. The criticisms leveled against Gary Gensler and the SEC highlight a growing demand for a more proactive and clearer regulatory framework. While “regulation by enforcement” may have been the initial approach, the industry and lawmakers are increasingly calling for more explicit guidelines and a more collaborative approach between regulators and crypto innovators.

Here’s what we can expect to see in the near future:

• Increased Scrutiny of Crypto Exchanges: Expect heightened regulatory focus on crypto exchanges, particularly regarding their financial health, transparency, and handling of customer funds. Proof of reserves and similar measures are likely to gain traction.
• Legislative Push for Clarity: Despite political divisions, the pressure to pass some form of crypto legislation is mounting. While the exact form and scope remain to be seen, expect continued debate and efforts to create a more defined regulatory landscape.
• Global Regulatory Coordination: Crypto is a global phenomenon, and regulatory fragmentation is a challenge. Increased international cooperation among regulators will be crucial to prevent regulatory arbitrage and ensure consistent standards.

Conclusion: A Turning Point for Crypto Regulation?

The FTX saga and the subsequent scrutiny of Gary Gensler and the SEC may represent a turning point for crypto regulation. The calls for accountability and clearer rules signal a shift away from reactive enforcement towards a more proactive and comprehensive regulatory framework. Whether this leads to effective regulation that protects investors without stifling innovation remains to be seen. One thing is clear: the conversation around crypto regulation in the US is far from over, and the coming months and years will be critical in shaping the future of the industry.