These are the broad details of fraud in what was one of the world’s biggest crypto exchanges that has deepened the chill for bitcoin and rival currencies, already in the grip of a global liquidity squeeze. FTX filing for bankruptcy protection has unnerved cryptocurrency investors, and lawmakers the world over are becoming increasingly vocal about regulating them. In the US, the Department of Justice, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have begun investigations into FTX.
The Ray of Sunshine
Bankruptcy specialist John Ray, whose dogged efforts at failed energy company Enron secured its creditors a better deal, is now heading FTX as its CEO. He said in a court filing the lapses in corporate governance at FTX were graver than anything he had encountered during his career, including his stint at Enron.
Spectacular fraud throws up opportunities to test regulatory strength, particularly in a borderless virtual economy. India has been calling for concerted global regulation of cryptocurrencies. But what about its evolving oversight of corporate and market participants?
- The first count is about the gullibility of venture capitalists. The Securities and Exchange Board of India (Sebi) is seeking greater transparency in startup valuation by requiring private equity and venture capital funds to furnish information about valuers and practices. The effort is aimed at lowering investor risks through enhanced disclosure by close-ended alternative investment funds (AIFs). This swivels oversight from systemic risk to business risk.
- The second point of inspection is about what is being traded. The Reserve Bank of India (RBI) has been steadfast in its view that cryptocurrencies are worthless unless backed by underlying assets. If left unregulated, they pose risks to financial systems, quite apart from what individual traders face due to extreme volatility in crypto trading. The central bank’s opposition to private cryptocurrencies has not been diluted by the Supreme Court overturning its ban on trade.
RBI is piloting its own fiat digital currency for wholesale and retail transactions on a government commitment that accompanies deterrent taxation on crypto speculation. Fiat coins with the rupee as underlying are expected to lower costs involved in settling physical trades. The structure for the wholesale segment, based on accounts, will eventually mesh with the token-based system for retail transactions that replicates the bearer treatment of currency notes.
On financial intermediaries trading with client money, Sebi has tightened rules and has penalised exchanges for lack of oversight into commingled funds following the Karvy Stock Broking scam. Karvy was found to have transferred securities of clients into a demat account that were pledged to raise money from banks and non-banking financial companies (NBFCs). As the rules stand now, all securities are held by the clients at depositories and unused funds are sent back into customer accounts periodically. This places Indian regulation ahead of several jurisdictions where brokers have free access to client securities and funds.
In the Line of Sight
Sebi is also seeking more disclosure on related-party transactions by listed companies that enlarge the scope of transactions material for shareholder scrutiny as well as the definition of related parties. Industry argues that such enlargement adds to their compliance burden. Companies are seeking two concessions:
- Doing away with shareholder approval for related-party transactions in the ordinary course of business.
- A proportionate definition of material transactions.
Next, the role of auditors. A committee to review the quality of audits in the country has recommended the powers of the National Financial Reporting Authority (NFRA) be enlarged to act against auditors and company managements. These include seeking information from, and acting against, promoters, directors and executives in the course of investigation into the conduct of auditors.
The committee has also set out a bunch of new conditions for auditors, like reviewing the list of proscribed non-audit work in large companies, looking into the books of subsidiaries, standardising the manner of audit qualifications, joint audits for certain categories of companies and providing a statutory backing for forensic audits.
- Finally, corporate governance. Oversight in corporate boardrooms by independent directors is work in progress. Independent directors can now be appointed or dismissed by a special resolution of shareholders requiring a 75% vote in favour. This is designed to weaken the influence on independent directors of promoters and managements.
The nomination and remuneration committee, tasked with choosing the candidates for appointment as independent directors, has to explain the reasons for their choice. The committee itself must be made up of a two-thirds majority of independent directors. The audit committee must be similarly composed and the independent directors on this committee are empowered to clear related-party transactions. Improvements in oversight provide a degree of comfort that India does not lag too much in institutional capacity.