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The FTX scandal looks like a new twist on an old problem

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Old story: FTX founder Sam Bankman-Fried, centre, is escorted from the Magistrate Court in Nassau, Bahamas on Wednesday after agreeing to be extradited to the US. (AP Photo/Rebecca Blackwell)

The swift collapse of the cryptocurrency exchange FTX and the arrest of its founder Sam Bankman-Fried could lead one to think that the complexities of crypto are at the root of the company's collapse. But a closer look reveals that FTX's implosion could allegedly be nothing more than simple fraud, the type that has flourished in unregulated markets and industries since the dawn of Anglo-American financial capitalism.

The collapse of the Charitable Corporation, a financial scandal that rocked 18th-century London, is an early example of the type of corporate mismanagement and embezzlement that still rears its head with surprising frequency and exemplifies a historical pattern where regulation and oversight are always far behind financial innovation.

Corporate power has also stayed concentrated in too few hands, something that the "boy genius" model of entrepreneurship only exacerbates in the present day. And lastly, the continual cosy relationship between politics and capital only serves to abet, rather than root out, fraud.

The Charitable Corporation was established in London in 1707 "for the relief of the industrious poor by assisting them with small sums at legal interest." This company was created to protect poor tradesmen from predatory pawnbrokers who charged 30 per cent interest. Lack of access to easy credit at reasonable rates hurt small tradesmen, which in turn hurt Britain, known as a "nation of shopkeepers“. As an alternative, the corporation provided loans at the average rate of 5 per cent in return for a pledge of property for security.

Amy Froide

The Charitable Corporation was something new, a Protestant example of the Catholic Monti di Pietà (a charitable fund established to combat usury, or high rates of interest).

In 18th-century Britain, however, the institution was created not as a non-profit, but as a business venture. The enterprise was funded by offering shares to public investors. Since the trading of public stocks and government securities had emerged as a new avenue for capital, the British were continually looking for new companies in which to invest.

There were two reasons the Charitable Corporation seems to have appealed to investors: The first was that an investor in it could turn a profit while also doing good, and the second was the attractive 10 per cent dividends the Charitable Corporation paid out.

But in 1725, a new board of directors diverted the Charitable Corporation from its original mission. These men made the corporation their own piggy bank, taking money from it to buy shares in and prop up their other companies. At the same time the company's employees began to engage in fraud: Safety checks ceased, books were kept irregularly and pledges went unrecorded. Investigators would find that £200,000 (about $53.4 million in today's money) went out on loan on fictitious pledges.

In the fall of 1731, rumours began to circulate about the Charitable Corporation, and one of its officers, John Thompson, hid the company's books and fled to continental Europe.

The General Court of shareholders (held quarterly in this period as opposed to today's annual corporate meetings) came to find money, pledges and accounts all missing. At this point, the shareholders appealed to Parliament for redress and intriguingly one-third of the petitioners were women. Although women were always a significant minority of public investors in early-18th-century Britain, they represented an impressive third of the investors in the Charitable Corporation, perhaps because it was thought of as a business doing social good.

The House of Commons quickly launched an investigation. While some lip service was paid to the poor tradesmen who may have also been defrauded, the major focus was on the company's shareholders.

Parliament's investigation of the Charitable Corporation scandal ended with criminal charges against some of its officers, the estates of all the managers being seized and two of its directors being expelled from the House of Commons.

The British government provided a partial bailout to the shareholders, with creditors and proprietors getting back only 40 per cent of what they lost. However, no rules or regulations were put in place to ensure such a fraud would not happen again. It was treated as an isolated incident.

The Charitable Corporation scandal of 1732 and the recent FTX collapse share several elements. The corporation was an 18th-century innovation. No one in Britain was providing low-interest loans to the working poor, and the British were the first to create a for-profit corporation to do so. In much the same way, FTX's Bankman-Fried enjoyed a reputation as a crypto entrepreneur and a leading spokesman for the new industry on the Hill.

Second, in both cases management was centralised into the hands of a few people with lax oversight. While the Charitable Corporation's charter called for a committee of 12 managers, in the 1720s a partnership of five took over and began to engage in a confederacy of fraud. The corporation did hold quarterly board meetings, but the shareholders never asked to see the books, or for regular audits or for any inspections of the warehouses that held the pledges.

FTX's management was even more centralised into the hands of one man, its founder. James Bromley, a restructuring attorney for FTX, notes it was "run effectively as a personal fiefdom of Sam Bankman-Fried“.

Central to the Charitable Corporation fraud was the siphoning of shareholder capital by the directors to speculate in other companies. According to prosecutors, something similar occurred at FTX, where Bankman-Fried allegedly took customer deposits in his exchange and funnelled them to shore up his separate company Alameda, which traded in cryptocurrencies.

In both cases, news of the alleged fraud comes as a complete surprise, with little advance warning. Trading on political and social connections may have delayed the alleged fraud's exposure.

The Charitable Corporation's directors included moneyed and elite men as well as powerful politicians. FTX's founder (despite all his tech-bro dishevelment) also enjoyed useful connections - including his Stanford Law professor parents and the celebrities who touted his company.

Bankman-Fried also hobnobbed with politicians on Capitol Hill, where he both testified before Congress and lobbied for the crypto industry. Bankman-Fried's chumminess with political leaders echoes how the Charitable Corporation put Members of Parliament in its directorship, who then helped the company gain a royal licence to enlarge its capital.

Finally, it is the philanthropic overtones of these companies that really tie together these scandals separated by three centuries.

The Charitable Corporation's name announced its purpose. Promoters noted the benefit it provided to the poor who suffered from lack of credit at reasonable rates. However, the “uncharitable“ gentlemen, as the press deemed the directors, ending up swindling rather than helping people.

FTX's founder Bankman-Fried also had charitable aspirations. He is a vocal proponent of effective altruism or EA, a philosophy indebted to 18th-century utilitarianism, that argues that making money is good because it can then be donated to the most effective causes.

Yet despite such talk and aspirations, in both cases, these operations were accused of having mismanagement and fraud at their core. In fact, fraud has been endemic to unregulated markets and industries since the first years of trading stocks in the coffee houses of late-17th-century London.

The public has allegedly been duped again, largely due to our captivation with novelty, our desire for quick money and Anglo-American capitalism's resistance to regulation of new and highly profitable companies and industries.

We treat fraud as an unfortunate (and always surprising) but perhaps acceptable by-product of our financial system. If most investors are doing well, some will be sacrificed. It has long been, and continues to be, the price for doing business.

Amy Froide is professor of history at University of Maryland, Baltimore County and is currently on fellowship leave at the Huntington Library

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Published December 23, 2022 at 7:55 am (Updated December 23, 2022 at 7:55 am)

The FTX scandal looks like a new twist on an old problem

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