Financial, Political Fallout May be Just Beginning After FTX Collapse

(KNSI) — The financial and even political fallout after the scandal and collapse at cryptocurrency exchange FTX may be just beginning.

FTX was illegally commingling client accounts with company money to provide collateral for bets made by sister company Alameda Research. Those investments have either gone bad or are illiquid and can’t be closed out in time to provide cash so FTX can honor the number of customers asking for their money back.

Ledge Wealth Management Financial Advisor Marshall Grams says that could result in major headaches for investors. He explains crypto should be seen as an asset, not money, and to diversify accordingly.

“Really ask yourself, ‘Is the amount that you have invested or on these exchanges a material amount that would affect your life negatively if it went to zero? If you could never get it?'”

Grams says recent events will affect confidence in cryptocurrencies among the average person, but it is too early to know what the repercussions of that will be for the future.

The episode harkens back to more than $74 billion Enron or $430 million Tyco International scandals. It also has similarities with the 2008 financial crisis. Then, Wall Street firms like Lehman Brothers were too exposed to subprime mortgage-backed securities. Grams explains how that relates to crypto today.

“What some people have done when their exchange, their custodian of funds comes up in the news [is] sell or transfer and ask questions later.”

He says there are exchanges that are publically traded companies with audited financial statements. If you are worried about their health, you can make your own personal decision about them through documents available online.

The Associated Press is reporting that John Ray III, who oversaw the Enron bankruptcy, is also involved in trying to wind down FTX. He says FTX sister company Alameda Research does not appear to have any audited financial statements.

“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,” Ray said. “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.”

Lawyer and St. Cloud State University Professor Kathleen Uradnik says the amount of fraud creates an interesting political situation. FTX now has over one-million creditors lined up to try and recover some of what is owed to them.

Former FTX CEO Sam Bankman-Fried and other company employees were prolific contributors to various political and charitable causes. Bankman-Fried gave nearly $40 million in donations to politicians and third-party political action committees during the midterm election cycle. Over 90% went to the Democratic Party, according to watchdog Open Secrets.

Uradnik says the process of a bankruptcy trustee going after inappropriately transferred funds is called a clawback. In this instance, it will also apply to employees who used client money to buy homes and other lavish expenses, similar to Minnesota’s Feeding Our Future scandal.

Uradnik says, “I am not aware of any statute that specifically protects campaign contributions from a clawback.” She does mention a potential exemption for religious and charitable donations, which stems from a 1998 law.

“The law basically states that a percentage of such donations is protected from a clawback — if they were standard donations — that is, if the donations were typical for the bankrupt person to engage in. So, let’s say an individual gives $20 per week to his church, week in and week out. These transactions are presumed protected up to a cap of 15% of the bankrupt person’s annual income under this law.”

Uradnik says if she were personally the bankruptcy trustee, she would attempt to claw back those donations, but it will be interesting to see if the courts agree.

Federal Elections Commission documents show one politician who benefited from Bankman-Fried’s contributions is U.S. Senator Tina Smith. He gave the Minnesota lawmaker $2,900 in March. Representative Angie Craig got a similar donation in July. When asked what Smith felt the donation was for, given the fact that she is not up for reelection until 2026, no response was given. Senator Smith did, however, issue the following statement.

“I have long expressed concerns about crypto and the financial risks it presents to retail investors-which is only underscored by these recent events. I believe we need to think carefully about how crypto is regulated and how we can best protect consumers and the economy. It’s critical for us to fully understand what happened so that I can take appropriate next steps.”

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