Investors in Madoff Securities and FTX were both warned, but by different sets of people.

If it turns out to be true that without customer knowledge FTX took billions of dollars of customer account money to invest in a risky company owned by FTX’s CEO, this will truly compare to the Madoff scheme for audacious fraud (though smaller in dollar size).

The major difference is that with Madoff, whistleblowers were trying to alert regulators that his stated returns didn’t make sense, not to mention his use of a tiny accounting firm and having no independent custodian for his funds.

Regulators on Madoff just missed it.

With FTX, regulators were the ones shrieking that this was a dangerous proposition, but many people didn’t listen.

In September, the UK’s financial market regulator warned consumers that FTX was operating without their approval, and that investors “may not be able to get their money back if things go wrong.” This followed previous warnings about other crypto platforms.

Before that, in March of this year, three European Union regulators for securities, banking, and insurance issued a joint statement warning consumers that they faced the very real possibility of losing all their invested money if they buy these assets. Consumers in crypto had no recourse to compensation under existing EU Financial Services law, the statement said.

The same month, Securities and Exchange Commission Chairman Gary Gensler, in a tussle with the U.S. commodities regulator and members of Congress over who gets to regulate crypto, stated: “If the platform goes down, guess what? You just have a counter-party relationship with the platform … Get in line at bankruptcy court.”[1]

Our modest contribution to pointing out the early days of Crypto regulation came in April, with When Too Few Regulatory Problems Add to Risk.


Who Gets Most of Our Sympathy?

Being in the due diligence business, I can be surly when people worth millions of dollars decide to forego a few thousand in due diligence and then complain they made an investment that was riskier than they thought it was. Many of the Madoff victims fell into this category.

The same goes with the richest people investing with FTX, as well as the insiders who willingly took FTX play money (FTT) instead of dollars, and then banked it all at FTX instead of in a “wallet” separated from the company.

I have a lot more sympathy for the small investor our investment laws are meant to protect – the “unaccredited” investor not worth that much money who perhaps can’t afford expensive due diligence and who depends on the government to watch over those taking in investments to make sure the money is properly segregated and invested appropriately based on the stated risk profile.

In this case, though, even the government was pretty clear that this was the Wild West: Crypto was a law unto itself and you risked fighting to get your money back in bankruptcy court.

Nobody can say they were not warned.

[1] A former Harvard Law School Professor co-wrote in yesterday’s Wall Street Journal that Gensler’s agency may be partly responsible for some of the FTX customer losses, because in March it discouraged banks and brokerages from keeping crypto assets in their custodial businesses without adding them to the bank’s balance sheets. That is not the requirement when keeping stocks and bonds in custody.