FTX’s Venture Capital Backers Face ‘Serious Questions,’ CFTC Official Says | Hacker News Reader

FTX’s Venture Capital Backers Face ‘Serious Questions,’ CFTC Official Says

bloomberg.com

96 pointsmirthlessend74 comments

If the CFTC does this, I hope they limit it to investments / valuations of $1B or more, as seed-stage companies shouldn't have to pay for an audit, etc.

This is what happened with Sarbanes Oxley where they overregulated the IPO process and caused the companies to stay private (and uninspected) for longer as well as removing the post-IPO growth upside from retail investors [1].

This is not to mention the recent SPAC craze being a way to get around this as well, which ended up with the median SPAC losing 70% of its value, while the S&P lost roughly 1/4 of that over the same period. [2]

There's a sweet spot for this kind of regulation, and overly "get tough" never works more than sensible restrictions where the risk is highest.

[1] https://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Cri...

[2] https://www.fa-mag.com/news/spac-euphoria-turns-into-painful...

SOX is, IMHO, one of the most reasonable regulations people came up with in the last decades. There seems to be quite some push back against some of the SOX rules, especially when it comes to internal controls, and especially coming from the start-up community.

I think that it's mostly reasonable too, but there's a balance in regulation pushing the bad behavior to less regulated places and stifling what you're trying to encourage.

One example of this in the Bay Area was the Ghost Ship Fire [1] where they were forced to live off the grid because of over regulation, and then dying in a fire that some of that regulation was trying to prevent.

It's a classic problem. Laws have enforcement costs and knock-on effects.

https://en.wikipedia.org/wiki/Ghost_Ship_warehouse_fire

I agree we need to think hard about tradeoffs of regulation and adjust when the pendulum swings too far in one direction. But I think you can come up with a better example of downsides of overregulation than the Ghost Ship Fire.

To say that people were "forced" to live there due to overregulation is quite a stretch I think. I've known a few creative people in the bay area who lived in similar situations and they all were making an active choice to live in communal housing illegally converted from industrial use. They found it creatively energizing.

Yea, a lot of my friends live in the same housing and for the same reasons, but I find many of them move out once they make enough money for typical housing.

A better Bay Area example if housing regulations stopping all growth and leading to all sorts of problems, but that's well covered.

It's really weird the way people argue how disastrous regulations are when their are clear examples of them being fine.

- California bans non-competes and it is essentially the fastest growing economy in the western world. But if you read WSJ banning non-competes is a disaster.

- SOX is supposedly a disaster, but when SPACSs bypass that process they are almost universally terrible. Also, the stock market and the VC business have both done great under SOX.

I think we don't realize how good the existing US regulatory framework is. If we try to improve it we should have a strong status quo bias.

> - California bans non-competes and it is essentially the fastest growing economy in the western world.

Source? From cursory Googling, it doesn't even seem to crack the top 10 US states, let alone Western world economies...

https://www.usnews.com/news/best-states/rankings/economy/gro...

Maybe not in percent but in added billions $ of gdp or gdp per capita. A large shell getting larger instead of a tiny one doubling.

Just a shot in the dark though.

On your own link it's 6th in terms of GDP growth. The other 2 are growth of young population and net migration where California is much more behind.

Your link doesn't exactly mean what you think --- they're giving a combination of economic growth and population growth. When looking at just the GDP growth, your link suggests that they are the 6th fastest growing US state economy. As a sibling commentator noted, this is growth is on top already being the largest state economy. (Texas had the 2nd largest GDP percentage increase from 2020 to 2021. Texas grew 2% faster than California, for an economy only 2/3 the size. Raw data [which the usnews article cited] here https://www.bea.gov/itable/regional-gdp-and-personal-income )

Not too long ago there was news that CA is about to pass Germany to become the 4th largest economy in the world. (CA press release here: https://www.gov.ca.gov/2022/10/24/icymi-california-poised-to... original article by Bloomberg)

You make a really good point, I should have cited a source. Let's compare California with the top state on that list.

https://www.statista.com/statistics/187834/gdp-of-the-us-fed...

https://www.statista.com/statistics/187861/gdp-of-the-us-fed...

What's kind of a joke about that is that between 2020-2021 California added an Idaho.

Also, to undermine my point, Texas seems to have grown at almost exactly the same rate (80% increase in 20 years): https://www.statista.com/statistics/188132/gdp-of-the-us-fed...

Compare this to an excellent first world economy, Germany. I think all Europe and Japan is worse. South Korea is probably much better.

https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?end=2021...

So I think you could say California only grew at the pace of the fastest states in the US in the last twenty years (all with non-competes, which was my point) but the overall amount of growth was by far the most. The point is having no non-competes didn't seem to destroy it.

And here's the propaganda version -- I think being skeptical of this stuff is a good idea. https://www.gov.ca.gov/2022/10/24/icymi-california-poised-to...

I was being too flip and you were right to point this out.

lol what just happened here?

Parent: This specific regulation causes unwarranted problems.

You: Wrong, because there exist regulations that are good and wrongfully impugned. <top reply>

Me: ???

Anecdotally, companies in bad shape use SOX as an excuse for a lot of their bad behavior.

I worked at an ad tech which decided engineers should not have access to revenue data. Nor should they have access to click data or other relevant data on how customers were doing.

Needless to say, if you are a transactional business who makes money when people perform an action - this is critical information to know. The company eventually lost focused and failed to IPO.

While all of this was done in the name of SOX. I don’t believe SOX required any of it.

> SOX is, IMHO, one of the most reasonable regulations people came up with in the last decades.

SOX is a reasonable regulation, but there should have been a useful lower limit below which it doesn't apply.

When I was treasurer of a non-profit, I made us carry SOX insurance (along with some other insurances which were by far our biggest annual expenditures). All this was silly given that we had about $2K of dues every year and less than $10K in savings. Consequently, we couldn't possibly have paid for the legal fees required if we got called on SOX compliance.

A limit somewhere around $1M in revenue/assets would probably be useful for SOX compliance dropout.

I don't think they have a case if they are arguing they didn't audit. VCs don't audit all the time. You will note they said "conflict of interest."

A conflict of interest would be if they invested $x and then got early access to y tokens. The announcement of their investment suddenly makes y tokens more valuable. You could even imagine the tokens could be sold for more than the investment. In that case, what incentive does the VC have to audit? Also, that should be illegal if it isn't.

Don't worry about the cost of audits. I do think if you took tokens from a VC investment and sold them you may have done something illegal.

> as seed-stage companies shouldn't have to pay for an audit

According to the new CEO, FTX had no board and lacked basic due diligence.

That doesn't seem too onerous for seed-stage companies once they have taken external funding to have in place.

Most seed funds (sub-$2M checks) have to make a large number of investments (like 15 per partner every 2-3 years) to make the fund economics work. Sitting on as many boards would be impossible / ineffective.

The situation is different when you hit SeriesA, where partners generally do up to 3x investments per year. This results in a more manageable board load.

Here in India, Sequoia has backed multiple startups that had glaring lapses in corporate governance (Zilingo and most recently, GoMechanic)

This is another symptom of zero interest rate policies. It encourages bad behavior up and down the pecking order.

There are already strong calls to reduce interest rates. Imo, most people crying out for lower interest rates are likely swimming naked and just want the tide to come back in.

This seems like misdirected blame: maybe low interest rates incentivize this behavior, but surely we expect VC firms to be capable of operating within host legal frameworks, right?

I think it’s maybe more judicious to look at the culture these VC firms have fostered instead: one where law and civic interest are secondary at best responsibilities. Racing to an obscene valuation that gets saddled on public investors is the #1 priority.

Yeah it’s strange these firms, staffed with expensively educated professionals from top institutions, with decades of industry experience, somehow lose all autonomy if interest rates get too low for too long.

It seems like every egregious mistake firms make somehow gets traced back to interest rates. A very convenient way to absolve people of responsibility.

>it’s strange

I don't understand what's strange about it. Short term thinking spreads even among people who know better because of competition. If you're not taking the risks other people are, then how do you do business?

A fairly well known quote from a bank CEO is "As long as the music is playing, you’ve got to get up and dance".

The corollary, from that perspective, seems to be that government regulation is required to save industry because individuals can't prevent a crisis.

Tiger Global thrashed every other VC because they did no due diligence, so everyone else stopped doing it. Competition frequently leads to market failures

You are partially right, of course the individuals bear responsibility. But you also have to acknowledge that at a macro level every economic crises since 1999 has been caused by central banks blowing bubbles. Including the recent VC bubble.

In general, I’m skeptical of any sort of “look what you made me do” reasoning. Central banks can incentivize more or less risky market behavior, but they don’t strip investors’ autonomy. It takes a conscious effort to dump your money into patently fraudulent ventures.

>In general, I’m skeptical of any sort of “look what you made me do” reasoning

Sure, I would be too. But you're not conversing with the people who did it, are you?

Not sure what you mean; the GP’s comment is an example of this reasoning format.

A VC firm charging 20% carry has a massive incentive not to put their civic interests before profit.

Plus, if they don't chase returns, their competitors will, then they'll struggle to raise subsequent funds.

Market forces + low interest rates are a recipe for recklessness.

A lot of human activity is mimetic--from learning slang/jargon, accents, all the way to hiring and laying off people. If one top tier VC invests in a company X, other top tiers pile on X, thereby increasing the valuation multiples.

Parent is comment is referring to poor corporate governance, not necessarily illegal.

VC firms are not really capable of anything purposeful: they're here to find a discount, which helps the company return a premium: they're a symbiotic parasite and whatever the culture they foster, when discount is hard to find or when premium look gigantic, well they jump on anything forgetting that finding a discount in a difficult period or a gigantic premium is a red flag.

But do you expect parasites to start thinking ? They cant.

Sequoia put in their own website that the FTX CEO was playing a video game while pitching hundreds of millions of investment. The same firm would kick me out of the door if I went without a tie to interview for a secretary job.

Difference is that I dont promise a huge premium at a huge discount. And it's a red flag for any sentient when someone is distracted in a high stake conversation, but not to the Sequoia parasite only eating premiums.

It doesn’t absolve VCs of their fiduciary responsibilities, but it does explain their callousness. If both founders and their backers know that money is practically free, governance lapses can always be papered over by raising another round.

And since interest rates are negligible, there’s too much money chasing too few deals. Any VC that stops to do active due diligence is too late to close the deal.

> Imo, most people crying out for lower interest rates are likely swimming naked and just want the tide to come back in.

Is it possible that zero interest rates are bad and excessively high rates are bad at the same time?

The long term inflation goal in the US, I believe, is 2%. And long term interest rates here that are determined by the market are higher, but not as high as policymakers have set short term rates to.

Would it not make sense to set rates somewhere in that window (roughly 2-4%) and stop messing with them? For other countries, scale rates accordingly.

Metaphorically, I feel like the US federal reserve was driving a car with the gas pedal to the floor and it didn't respond for a while, so they kept going until they suddenly found themselves going 100 mph, and now they are determined to keep on the brakes as hard as they can until they are 100% motionless. This is not a good way to drive in traffic, even if you do survive it.

There is an alleged tendency of almost everybody to justify their job by looking busy even if what they are doing is worse than doing nothing. And that's what I think of when I think of central banks in my adult lifetime. Along with being a passenger in a car where the driver is on and off the gas and brakes constantly to the point of nausea.

Inverted yield curves worry people even if they can't agree on how linked they are to recessions. So...why not just not invert them? I believe that markets have to be regulated, but they also should be listened to.

High interest rates are product of high inflation. That's why 2% inflation target means 2 percent interest rate target. Nominal interest rate = inflation rate + real interest rate.

Are you agreeing with something I wrote, or disagreeing, or what?

I wonder if HN has banned using ChatGPT to comment or is considering it.

> Would it not make sense to set rates somewhere in that window (roughly 2-4%) and stop messing with them? For other countries, scale rates accordingly.

That alone wouldn't work because inflation is affected by factors beyond interest rates, but this is basically a part of Modern Monetary Theory: set short-term interest rates at a fixed price, then use other levers to push inflation back to target.

IMO, a more compelling alternative to the current system is Nominal GDP Targeting.[1][2]

[1]: https://www.mercatus.org/research/research-papers/case-nomin...

[2]: https://www.mercatus.org/research/working-papers/nominal-gdp...

There's a lot of finger pointing here. Luckily there's a lot of blame to go around. Let's start with the two obvious questions:

1. How did VCs give billions in funding to someone without insisting on an adult in the room? I mean having a respected CFO to report on the company's finances. Additionally, there should be regular board meetings and an audit committee who reviews such documents; and

2. Why was the SEC so toothless here? For anything connected to the US financial system or operating within US jurisdiction, the SEC should, at the very minimum, be ensuring compliance with custodial assets.

For 1, I think the obvious answer was that the Fed, thanks to ZIRP, created an environment where investors were clamoring for investment opportunities. This gave high-growth companes, like FTX was on paper, a lot of leverage with the terms of investment.

> like FTX was on paper

FTX was high-growth in practice too. FTX was a phenomenal business. It wasn’t like most crypto projects that are scams; their business and profits were genuinely massive.

What they did was take consumer funds and loan them out without real collateral. That’s bad and dumb and illegal, but doesn’t change the fact that the growth and economics of FTX were real.

Crypto exchanges, like other platforms, grow because there is capital that wants to trade there. This means that they have the same bootstrapping problem as a competitor to Uber or Facebook.

FTX's solution to that problem was Alameda Research, which traded huge volumes on their exchange. That, in turn, made the exchange look big enough to be a serious player, which drove customers and more growth.

The "phenomenal" part of FTX's business was the fraud.

Ahhhh yes, The this was a great business if only they hadn't thrown all the money out the window argument. If a business is throwing money out the window then it doesn't matter how good the rest of the business is. The company is a bad business.

FTX was high growth but apparently 0 profit which does not make a business good. Claims that, if only they hadn't been crooks and/or incompetent, this would have been great doesn't change the fact that they were, in fact, either highly incompetent or crooks.

Yea this is almost certainly the correct answer. I think any founders that raised a round in the last 2 years can easily understand how this happened.

Especially to Sequoia, which felt like they were behind in crypto investments (while a16z was getting into all the "big winners"). Lots of pressure to deploy capital, and like the other commentor pointed out, there was a massive a amount of real revenue being made by FTX.

That likely also contributed to the lack of scrutiny. Who in their right mind would commit such massive and blatant fraud, when if they simply didn't touch client funds in any weird/illegal way, they would still be an insanely rich billionaire!

> Especially to Sequoia, which felt like they were behind in crypto investments (while a16z was getting into all the "big winners").

Sequoia had other peers that resisted this temptation, though, so the "blame ZIRP" argument isn't sufficient.

VCs have a fiduciary responsibility to their investors (technically, Limited Partners or LPs). Those investors could have a valid cause of action that the VCs were reckless and negligent in how they handled the FTX investment with no oversight.

isn’t it enough that the VCs lost money and credibility

do we need the heavy arm of the law in everything?

> How did VCs give billions in funding to someone without insisting on an adult in the room?

Don't know how the whole VC thing works but I suspect that the people who took the decision weren't risking their own money, and they probably won't face many consequences.

For 2, it’s (still) not clear who the chief regulator for crypto should be. The SEC has tried at times to assert authority there with pushback all around.

The current legislative push is to make the CFTC the regulator. The CFTC both by mission and culture is more hands off. It’s also much smaller in size than the SEC so focuses on cases where the law is more obviously being broken (eg boiler rooms selling leveraged gold contracts as physical gold to senior homes).

Crypto is a cutting edge area where the laws and regulators have not kept up and where until recently most of the participants liked it that way.

Re: #2, as Matt Levine likes to say, everything is securities fraud. All the stuff that FTX did before was probably illegal, but it was in a grey area without a particular regulator. Once it became clear that FTX falsely claimed to investors that it had effective risk controls, didn't misuse/steal customer funds, and wasn't operating a giant Ponzi scheme, it moved squarely into the SEC's remit.

> 2. Why was the SEC so toothless here?

The head of the SEC, Gary Gensler, 's former boss happens to be the father of the CEO of Alameda-the-scam.

SBF and Caroline Ellison: these fraudsters were very well-connected.

As a sidenote early on in the scandal a US senator wrote that there were suspicion that SBF was working hand in hand with corrupted officials to engage in regulatory capture of the cryptocurrencies exchange market.

And when did the shit hit the fan for SBF? Once he got very cocky and tweeted how he was going again to DC and how CZ (from Binance) was not allowed to go there.

These were SBF's famous last words. CZ answered that SBF wasn't a team player. Then the leak on Coindesk happened and all the articles exposing the SBF/FTX/Alameda scam came out.

Ain't it "strange" that it all unfolded after a tweet were SBF was boasting about how he was going to DC while CZ wasn't welcome there?

A paper billionaire fucked with a cash billionaire and found out what happens when you try to do that.

> the SEC should, at the very minimum, be ensuring compliance with custodial assets.

FTX claimed that none of the things they had custody of were securities. Most crypto claims the same. Why would the SEC be able regulate them? Their case for not being securities seems reasonable.

Regulators (specifically Gary Gansler at SEC) job is to protect consumers generally, pointing at VCs just shows that they are not doing their job.

FTX is an offshore company, but Genesis, Blockfi, FTX US, Gemini, Coinbase are not, and regulators let them offer unregistered securities for a long time.

FTX stole investors' funds. That's a far greater concern than unregistered securities.

The former usually follows the latter

Lucky for those investors the FTC’s investigation shows the funds/VCs handling their investments were negligent and breached their fiduciary duty by not conducting any due diligence. Time for those investors to sue the VCs/funds.

Looking forward to the depositions.

Yea, this is more of a story of SBF and other crypto elites making a lot of donations to wealthy politicians, media companies, etc. who were hesitant to investigate them.

Bloomberg apparently was presented evidence of the FTX fraud many months before its downfall which it didn't cover because it was bad for business. [1]

This was also what happened in the Madoff case where outside investigators discovered the fraud and sent their pile of evidence to the Feds, who sat on it for years as the fraud expanded. [2]

I bet we'll eventually see messages from SBF & Co. talking about Madoff specifically as a model for the scheme.

[1] https://www.youtube.com/watch?v=qXzvVRw_Qgw

[2] https://en.wikipedia.org/wiki/Harry_Markopolos#Madoff_invest...

It is hard to believe the claim in the video that ‘5 crypto ladies’ at Bloomberg passed on this enormous story absent evidence from the speaker.

Regarding Madoff, there were indeed investigations after some of the complaints. Notably, these situations differ in that Madoff was a respected figure within the regulatory apparatus (but it’s hard to imagine that SBF holds sway over the editorial process at Bloomberg). It is true that the investigations into Madoff were ineffectual, at least according to reports I have seen

Yea, that's why I linked to the video (re: source is a single witness), but also SBF was definitely a powerful guy almost to the degree Madoff was, and we already see publications like the NY Times covering for SBF [1], so I don't see that as a big jump.

I have a personal journalist friend whose editors didn't let them cover Theranos before the WSJ broke the news for similar reasons, so it's not out of the question.

Not to mention the regulatory apparatus and Congressional inaction. [2]

[1] https://www.youtube.com/watch?v=UqDJ6Ph8r9o

[2] https://fortune.com/2022/11/10/ftx-crypto-collapse-binance-c...

> FTX is an offshore company,

FTX.US is not

OP listed FTX US in the category of “in the US”.

I agree Gansler are not doing their job. In this case, I think the CFTC (who seem to do more and make fewer speeches than Gansler) are doing good work though: Investors helped SBF commit his fraud, they funded it, they advertised it and they endorsed it. They SHOULD face some repercussions. The level of negligence they showed is frankly breath-taking.

I love how SBF is continuing the grift. He is on Twitter posting spreadsheets claiming that FTX is still solvent even today.

*FTX US

FTX's current CEO, in charge of the bankruptcy, explained why SBF was, once more, full of it. The accounting by which FTX.us would be solvent relies on the $250m that LedgerX owns (FTX.us bought LedgerX). The problem is that... These $250m came from Alameda and is money stolen from customers and investors as part of the multiple frauds SBF committed.

They’re all the same

I have zero faith that Binance or Tether are solvent either.

Barry Silbert was going around claiming that Genesis is fine and they have all the money. And yet…

They’re now trying to pump the market to lure in money on the sidelines so they can get some exit liquidity.

This industry attracts crooks of the highest order.

I don't see any immediate evidence there were conflicts of interest here (happy to be proven wrong). I do see an astounding lack of any of the actual work an investment manager should be doing. Such a huge degree of laziness that I think it should be criminal. People at these firms didn't just squander their client's cash (this wasn't money lost because not ever bet is a winner, it was basically given away). They actively assisted one of the worlds largest frauds. Arthur Anderson were basically destroyed because they enabled Enron. And Enron was a much subtler, more complex fraud. There are serious questions to be answered here IMHO.

This action will have a useful side effect. The CFTC has been seen by the crypto community as a toothless tiger. Legislation was proposed (by FTX!) to get the SEC out of crypto enforcement and turn it over to the CFTC. With the CFTC looking at funding sources of scams, that now looks far less attractive.

Non-paywall link: https://archive.ph/7yuc1

This feels like a stretch by the CFTC.

The investors’ LPs should have a bone to pick with what happened to their money, but there’s a good reason why you have to be a qualified investor to become an LP. But the funds themselves aren’t CFTC regulated anyway.

The real issue is the utter fraudulence of the whole crypto”currency”* sector, but the CFTC doesn’t have authority over that (not clear anyone does, unfortunately) and that’s not the subject of action here.

* I refuse to overload the abbreviation “crypto” when it has a perfectly useful definition already.

Kevin O’Leary invested and was paid as a promoter. He has made more than he lost. What is to say that the funds aren’t in on the con?

What if LPs were agents of pension funds, endowments, etc? Such LPs have no skin in the game.

They are still considered sophisticated investors. Or perhaps I didn't understand your comment.

Reply on news.ycombinator.com