Misappropriating the FTX Scandal

That announcement from the SEC was released at 2:10 am Eastern Standard Time on the morning on December 13, 2022. Why would bureaucrats send out a press release—concerning what was, after all, an accusation of mere civil-law violations—at two o’clock in the morning, an hour when only the unfortunate night-desk editors would be awake to receive it? Perhaps because the SEC (and its publicity-hungry head, Gary Gensler) had been told that the U.S. Attorney for the Southern District of New York, often called the sheriff of Wall Street, was going to livestream his much more attention-getting criminal-law charges against Samuel Bankman-Fried later that day, at two o’clock in the afternoon on December 13.[ii]

In short, just one month after FTX declared bankruptcy, the competition was on among regulators and bureaucrats to appropriate for the advantage of their personal fiefdoms whatever hay could be made from the company’s collapse and its customers’ ruination. Of course, that is just what the Public Choice theory of James Buchanan would have predicted about bureaucratic behavior: Whether it is pay, people, power, or publicity—they grab as much as they can. The irony is that the basic accusation being lodged against Samuel Bankman-Fried by the SEC and the Manhattan U.S. Attorney was exactly: misappropriating assets for personal advantage.

Why Market Advocates Should Care

If no more were at stake than a turf war between law-enforcement agencies, if this were just a battle to claim credit for punishing Bankman-Fried and his confederates, the whole affair might not matter very much to pro-capitalist on-lookers. But judging from history, very much more is going to be at stake.

Anti-capitalist politicians and bureaucrats absolutely love business bankruptcies. Bankruptcies allow them to say to voters: “Forget the theoretical case against capitalism. You can see for yourselves the consequences of private enterprise. You can see that government must do something to protect you from this deeply flawed system.”

In 1932, the collapse of Samuel Insull’s Midwest utility empire first became fodder for FDR’s presidential campaign, and then (after FDR’s election) became a political justification for the creation of the SEC. It did not matter in the slightest that, as Insull’s most meticulous biographer concluded, “Nobody got the story straight.”[iii]

In 2002, the failure of Enron provided the main political justification for the Sarbanes-Oxley Act, signed into law in July 2002, just eight months after Enron entered Chapter 11. The American Enterprise Institute blurbed its 2006 book on the subject as follows: “The Sarbanes-Oxley Act of 2002 (SOX) is a colossal failure, poorly conceived and hastily enacted during a regulatory panic.” A 90-page Yale Law Review article published in 2005 provided a definitive account of the Act’s creation by grandstanding politicians, and it called the result “quack corporate governance.”

In 2022, the FTX debacle is already being touted as possibly the largest business scandal in U.S. history. So that is Why market advocates must prepare to understand its collapse: to prevent this “crisis” from becoming yet one more excuse for “leviathan.”[vi]

But How should market advocates understand FTX’s failure? The short answer is: We don’t know yet. The facts are still coming in. And in the immortal words of Sherlock Holmes, “It is a capital mistake to theorize before one has data. Insensibly, one begins to twist facts to suit theories instead of theories to suit facts.”

All that market advocates can do at this time is to draw on past experience and set forth the various frameworks within which pro-capitalists might interpret this particular business failure. Then, as facts become available, they can be fitted to one or more of the potential interpretations.

Four Templates

Market advocates have four basic options when trying to understand why a significant business failure has taken place. The first two involve illegality: (1) Criminal Fraud, and (2) Culpable Negligence. The second two involve mental error: (3) Mistaken Business Judgment, and (4) Flawed Corporate Culture.

The first two present no challenge to capitalism. Fraud and Negligence are banned by the laws that govern even the freest markets. Businessmen are jailed if they practice fraud and sued if they are negligent. David Henderson has made a hobby of watching anti-business films, where people heroically fought against certain business behavior, and pointing out that the heinous business behavior being damned in these films was always behavior that was expressly forbidden and punished in a free-market society.

Mistaken business judgment, the third possible explanation for catastrophic corporate failures, involves no violation of capitalist rules. So it is, in that sense, more difficult for pro-capitalists to explain to a public seeking political vengeance. The failure of IBM executives to foresee the decline of mainframes economically devastated my home locale of Dutchess County for an entire generation. What can one say? Like everybody else in this world, businessmen make mistakes, whether it is IBM, AT&T, US Steel, or GM. So, don’t put all your eggs in one basket, either as an individual or as a community.

Progressives naturally promise that interventionism, if overseen by bureaucrats, will make fewer mistakes than free markets, but that has been decisively proven false, in practice and in theory. The extended order of the market keeps the inevitable mistakes of business fewer and smaller, discovers them earlier, and eliminates them faster. It also rebuilds prosperity more quickly. Creative destruction is creative as well as destructive. Responding to business errors with regulations or protectionism or subsidies will only slow down the beginnings of new growth.

Contra-Capitalism. Then there is the fourth interpretative option, again one not involving legal misdeeds: This interpretation says: The company failed because its corporate culture was contra-capitalist, that is, opposed in spirit and morality to bourgeois capitalism, the outlook that created the wealth of the West.

The term “contra-capitalism” was coined by business historian Robert Bradley Jr. in his tetralogy on the rise and fall of Enron, where he worked for nearly twenty years. While at Enron, but more especially while writing its history amid the wreckage of the company, Bradley noticed a syndrome of destructive corporate behavior that did not fit neatly into any of the other three destructive patterns. On the one hand, the behavior was not illegal. It was not negligence or fraud. Certainly it would not be considered such under the laws of laissez-faire capitalism, whatever today’s laws may say. But on the other hand, the destructive behavior in question was not simply a matter of some “best laid plans” that did not quite work out. It was not simply Mistaken Business Judgment.

What Bradley noticed was a syndrome of management actions and employee behavior at Enron that seemed to run—consistently and persistently—contrary to the broad contours of the “best practices” developed by bourgeois-capitalist morality during the two-and-a-half centuries of that system’s existence (1700-1950). The Enron people involved were no longer even trying to live up to the traditional bourgeois-capitalist model of behavior. They were practicing business flatly contrary to that model.

The broad contours of bourgeois-capitalist behavior that Bradley had in mind included: a reliance on free markets, frank and honest communications with counterparties, and a determination to confront reality when evaluating risks. Because behavior at Enron again and again ran contrary to those capitalist traditions, Bradley termed the pattern of behavior he was observing: Contra-Capitalism. And contra-capitalism thus becomes the fourth interpretative possibility for FTX.

Where does this leave us? In my next post, we’ll examine the evidence so far.

Roger Donway is a research assistant at the Institute for Energy Research and freelance editor and writer.

[i] Securities and Exchange Commission, “SEC Charges Samuel Bankman-Fried with Defrauding Investors in Crypto Asset Trading Platform FTX,” press release no. 2022-219, December 13, 2022. Indictment available at: Securities and Exchange Commission v. Samuel Bankman Fried, U.S. District Court, Southern District of New York, Civil Action No. 22-cv-10501, filed December 13, 2022.

[ii] The speculation about the SEC’s motives is from Jeff John Roberts, “Gary Gensler’s PR Stunts Can’t Hide How He Botched Crypto Regulation,” Fortune Crypto, December 14, 2022. The livestream announcement from U.S. Attorney Damian Williams of the Southern District of New York is available from YouTube here. The criminal indictment is United States of America v. Samuel Bankman-Fried, a/k/a “SBF,” U.S. District Court, Southern District of New York, 22 Crim 673, unsealed December 13, 2022.

[iii] Forrest McDonald, Insull: The Rise and Fall of a Billionaire Utility Tycoon, (Chicago, IL: University of Chicago Press, 1962; repr. Washington, DC: Beard Books, 2004), p. 339.

[vi] The way that U.S. Progressives have used emergencies to increase statism received its most memorable formulation in Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (New York: Oxford University Press, 1987). A parallel study of the same process in the field of energy (Energy Crisis and Leviathan) is forthcoming from business historian Robert Bradley Jr., chronicler of Enron’s rise and fall.