More than 20 years since the Enron scandal erupted, the name has become synonymous with fraud and corruption. The legacy of those events in 2001 can still be felt across corporate America. Today, the lessons of Enron continue to shape the business landscape through regulatory and procedural safeguards that were set up to prevent such catastrophic failings from ever happening again.
But has the digital asset industry somehow wriggled its way through cracks in America’s post-Enron fraud protection framework? Its detractors certainly think so. And now, the New York Attorney General’s lawsuit against Digital Currency Group (DCG) and its affiliates could initiate a similar reckoning for the US crypto sector.
On Thursday, October 19, New York Attorney General Letitia James filed a sweeping lawsuit against three crypto firms accused of defrauding investors of over a billion dollars.
James’ complaint can be roughly condensed into 3 basic charges levied against the crypto exchange Gemini, the now-bankrupt crypto lender Genesis, and its parent company DCG.
Firstly, Gemini is accused of lying to investors about the Gemini Earn risks – a program in which users could generate a return on their crypto, which was lent out by Genesis. According to the complaint, while Gemini painted the scheme as a low-risk investment opportunity, in reality, the bulk of Genesis’ income was drawn from risky, unsecured debt.
The second major theme of the complaint relates to Genesis’ auditing protocols. Specifically, it charges the company with failing to adequately audit Three Arrows Capital (3AC) and then lying to Gemini by claiming that it regularly reviewed its borrowers’ financial statements.
Finally, senior executives at Genesis and its parent company DCG are accused of conspiring to hide losses incurred after 3AC and another smaller counterparty defaulted on loans amounting to $1.1B.
Both DCG and its founder Barry Silbert have pushed back against the New York Attorney General’s claims, stating that they intend to fight the case in court.
There are multiple lines of comparison connecting the Enron scandal to the Gemini-Genesis-DCG fraud saga. Both cases involve off-balance-sheet vehicles, complex debt structures and C-level executives desperately scrambling to cover up huge holes in their companies’ finances.
In the years leading up to Enron’s collapse, the group used a series of increasingly complex accounting tricks to make it appear as if it had more assets and fewer liabilities than it did.
Likewise, a central component of the charges against DCG and Genesis is the existence of a promissory note between the two companies, which would see the former pay the latter $1.1B in a decade. According to the charges against it, Genesis then concealed the existence of the promissory note on its balance sheet, effectively hiding the true extent of its losses.
Perhaps one of the most important lessons of the Enron crisis is that manipulative accounting practices don’t just happen by themselves. Although it can often be difficult to pin the blame on individuals, it requires willful and potentially criminal misdirection on the part of senior decision-makers to pull the wool over investors’ eyes.
When the business imploded and brought Enron’s founder, Kenneth Lay, and CEO, Jeffrey Skilling, to trial, the charges against them totaled 48 counts of fraud.
Today, former Genesis CEO Soichiro Moro and DCG founder Barry Silbert face a similar litany of charges relating to their “campaign of misstatements, omissions, and concealment.”
In the wake of the Enron scandal, in 2002, Congress passed the Sarbanes–Oxley Act, which created new financial record-keeping and reporting obligations for corporations.
Two decades later, 2022 will undoubtedly stand out as an inflection point at which multiple bankruptcies and corporate scandals galvanized efforts to regulate the sector.
In the past year, both the House and Senate have made several attempts to pass new crypto regulations. Whether sponsored by Republicans, Democrats, or bipartisan collaboration, contemporary efforts to regulate the crypto sector invariably point to significant consumer losses incurred by failures at Gemini, BlockFi, FTX, and others.
While lawmakers remain divided on the best course of action, there is a growing consensus that something must be done to protect American investors.
Looking ahead, the purported fraud carried out by DCG and its associates offers a strong case in favor of crypto’s equivalent to the Sarbanes–Oxley Act.