Episode 60 — The Foul Financials of Cryptocurrency (Feat. Francine McKenna) — Crypto Critics’ Corner

Crypto Critics' Corner

The Foul Financials of Cryptocurrency (Feat. Francine McKenna) Crypto Critics' Corner

Today Bennett and Cas are proud to have Francine McKenna, former auditor, current journalist, and soon to be professor at Wharton, to talk to us about all the problems with auditing, cryptocurrencies, and, let's face it, Tether's totally garbage attestations. Francine's newsletter: https://thedig.substack.com The Chickenshit Club by Jesse Eisinger: https://www.amazon.com/Chickenshit-Club-Department-Prosecute-Executives/dp/1501121375/ref=tmm_pap_swatch_0?_encoding=UTF8&qid=&sr= Dave Michaels' article on The Big Four: https://www.wsj.com/articles/big-four-accounting-firms-come-under-regulators-scrutiny-11647364574

Cas Piancey and Bennett Tomlin are joined by Francine McKenna, accountant by training, journalist by choice, and creator of The Dig, to discuss auditors, auditing, and crypto. 

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Auto-generated transcript:

Welcome back, everyone.

I am Cas Piancey, and I am here as usual with my partner in crime, Mr.


Tomlin, how are you today?

I'm doing well.

Cas, how are you?

I'm doing good.

We are joined by a guest that is once again, what an honor to have someone like this on.

We have Ms.

Francine McKenna, who is an accountant by training, currently a journalist.

She founded the Dig newsletter over at Substack https://thedig.substack.com/ .

We'll leave a link to that.

And she is a soon to be professor at Wharton in Philadelphia.

So first of all, Congratulations, Francine.

And second of all, thank you for joining us.

And can you give people kind of just a further description of your background and perhaps why we would be seeking you out to join us on the podcast?

Thank you.

I'm a cat that hopefully will have nine lives and maybe I'm on like six or seven right now.

So I started as an accountant, internal auditor.

That's my degree, my undergraduate degree, and worked at the first two big to failed Bank, Continental Illinois National Bank and Trust Company of the famous Penn Square scandal, which if you're under the age of probably 45, you probably will not know about that unless you learned about it in school.

But then I ended up working for KPMG as a consultant.

I went to work in Latin America.

I ran the Y2K project for JPMorgan in Latin America, which was tons and tons of fun.

It's really great when you have a really wealthy bank paying all of your expenses in three countries, came back, right, to hit the.com period in 2000 and develop the e-business strategy for KPMG Consulting, which morphed into Bearing Point, which is now bankrupt.

So I have a lot to say about the crypto wave, because it reminds me a lot of the e-business strategy, digital marketplace kind of wave that we went through 20 some years ago, did a lot of independent consulting, went back to Latin America, then ended up at PwC, auditing the firm itself.

So I'm kind of one of these rare people that can talk about the large accounting firms from the inside out, having been a managing director, a partner level person, because most of the time, if you work for one of the big four firms, if you leave, okay, if they let you go, if you voluntarily leave for some reason, you have golden handcuffs because you are either retired and you're getting paid by them or you somehow want to continue to do business with them in some way, shape or form.

You're in that ecosystem.

Me, I don't have anybody that I owe anything or that's paying me.

So I get to talk about them a lot.

And I started writing when I left PwC.

I started writing in 2006.

We were talking before we got on board here about how the early sort of social media era is also eerily similar to what we're experiencing in terms of the height in the crypto world and started writing my own blog, which then got me noticed on Twitter, which I have been on since 2008.

So every journalism thing, good journalism thing I've ever done has come from Twitter.

So Twitter is my tool and ended up with a full time journalism job at Market Watch and writing for Wall Street Journal.

And Barons, Too left there in the end of 2019 to go back independent, since I know how to do that.

And I've been writing the newsletter The Dig ever since.

But I love to teach and I teach at American University.

I teach in the MBA program there.

I've taught at Ohio State, at Baylor, et cetera, and just recently snagged a gig at Wharton.

So I'm going to be teaching financial accounting to the MBAs at Wharton starting in July, full time.

So kind of becoming one of those elder stateswoman academic types who maybe I get quoted more since I'm not a competitive journalist.

So how did you decide in that story to forgo the golden handcuffs and give up working with those firms to write instead?

Those things happen because you either get pushed out or you get so fed up that you have to leave.

And my leaving PwC was sort of a combination of the two things.

I was a director who was auditing the firm itself.

So I was looking around at how well PwC in 2005, 2006 was adapting to the new Sarbanes Oxley environment where the firms had now this independent regulator instead of regulating themselves.

And suffice to say that that does not make you very popular when you're highlighting what all these partners who've been there since they were interns in College, you come in from the outside.

And even though I had been managing director at another firm that didn't cut it, unless you grew up in the firm, you kind of don't get the same deference.

And so I was going around and telling them that they were partners, putting the firm at risk, and they didn't like hearing that and were pretty insulted.

And so we agreed to disagree that I was not going to become a partner at PwC and retire there.

And so after about two years, I left and thought, wow, I'm just so fed up with this whole auditing and accounting and consulting and that whole environment.

And I have this knowledge because I've worked outside the US.

I've worked for two different firms.

I've worked at a PNL level.

I can write about what really goes on.

It's nice to hear all that because as somebody who cares about fraud and looking into scams and all of this stuff, some of my heroes are people that most people are probably not familiar with them.

But it's like Cynthia Cooper, Sharon Watkins, the auditors at these firms who stuck their neck out to say, hey, I see a lot of problems going on and I think all of them seem to feel because I might be wrong about Sharon, but I know that Cynthia was an internal auditor for WorldCom and that Arthur Anderson was the primary auditor for WorldCom.

So can we talk about the issues of auditing back then, but maybe also the issues with auditing now because we're down to the big four.

I think it was in Enron's time.

It was the big eight, right?


When I got out of College, it was the big eight.

You still had Arthur Anderson and Ernst and Witty was not with I forgot what the other firm was.

That was young, I can't remember.

But anyway, and Price Waterhouse, there was also Cooper's and Library in.

And so you had sort of a lot more to choose from.

But let me go back to something you said because you talked about Cynthia Cooper and you talk about Sharon Watkins, you talk about sort of the Enron era whistleblowers.

Sharon Watkins never liked being called a whistleblower, although she sort of like accepted that sort of moniker now because it's what else?

And the reason is because she was actually inside Enron and she was a former Arthur Anderson partner who then worked at Enron, and she was more of a company Gal.

She really wanted to raise the issues, bring them up, talk to senior management.

She had the ear of Ken Ley and all those guys.

And she really thought that if she raised the issues, given her stature, her credibility, her tenure, her experience, that they would listen in a similar way as I thought when I was at PwC, you're like, I'm just trying to help.

I'm here to kind of keep you guys out of trouble.

And instead, Sharon was not appreciated.

And she reluctantly talked to the Feds reluctantly.

But she would say now she had no choice because her support, her efforts to kind of keep these guys out of trouble and get them back on the path were rejected.

And the thing is that if you are an accountant by training, if you choose that career and I count myself in that category, we have a certain sort of personality that attracts us to that career.


We're kind of more risk averse.

We're kind of more black and white in terms of what's right and what's wrong.

You're very detail oriented.

You're very policy and procedure oriented.

You're very documentation oriented.

So you want to follow the rules and you want to get other people to kind of understand the value of structure and rules and going with the program.

So there's that effort to try to do that.

And whistleblowers are not that common in terms of accountants and internal auditors or external auditors, because we're like Sharon Watkins, we think that the internal process can work.

We trust our colleagues.

We can't imagine that our colleagues would not be honorable or ethical or not feel the same way that we do.

And so you trust the process and you're really reluctant to sort of burn bridges, to kind of walk away to kind of say, call out others and divorce yourself from your organization or go out rogue and kind of be all alone.

And if you go to the very end of the beginning of the history of auditor, like the word auditor.


Like, Audrey, I think it's odd, er, whatever it is, but it's like the Latin for to listen.

The whole point is to listen to everything, not to necessarily insert yourself into it and prove some point or something.

It's like, no, the whole point is to listen realize what is objectively, the right path.

But clearly that's a minefield.


And if you remember the Time magazine, the Women of the Year, there were three women who were the whistleblowers in the Enron era.

And now I'm blanking on the third person.

I think it was FBI.


So you have women who were the whistleblowers in the Enron era.

What you have now at the largest global accounting firms is you have the men who are the inside traders.

There have been countless numbers.

I can count tons and tons because I've been tracking them since I started writing in 2006.

Senior level partners.

Leadership level partners, people who are practice leaders.

I mean, the Deloitte chief risk officer, okay.

Who were caught up in criminal insider trading scandals.

It's all guys.

So you have this sort of very different kind of attitude towards our profession that's developed now.

And instead you have this rampant proliferation of inside traders.

The recent scandal that we had of KPMG and the audit regulator, the PCOB, where KPMG had hired people from the regulator, and they were convicted.

So I can say that they encouraged them to steal regulatory data so that they could cheat on their inspections by the regulator.

It's all guys except for one woman.


It was all the leadership of the audit practice at KPMG, and it was all men who were the leaders of the auto practice at KPMG.

And you had one woman who was a PCOB Inspector who came over as the most junior member of the Scam team.

I'm not saying that ethics breaks down based on gender, but it seems like the history of the profession is that you had this effort for women to really make a Mark in the profession.

They were getting up to be like 50% of the profession, more than 50% of the accounting graduates.

I think you would see now that it's not only more than 50% women, but it's more than 50% diverse.

And yet the people that are doing the crimes, people that are involved in all these frauds, all these scandals, it's almost always men because they continue to be the ones at the top of the firms who are working with the most prominent clients.

They're the ones working with the GE's and the Teslas and all of the most notorious, the Under Armours and the Motels, it's all still men.

Are these types of insider trading scandals more of a recent phenomenon or something that's been pretty common throughout the modern history of auditing?

Well, I've been tracking it since I started writing in 2006.

They started coming right away.

And you had very senior level people who are getting caught.

You might remember probably the most notorious one was Scott London.

He was a partner for KPMG out on the West Coast, and he was trading on inside information about Herbalife and Skechers.

But he was a regional partner.

He was responsible for 500 people, 1000 people maybe on the West Coast, numerous all of the audits on the West Coast for KPMG, that was not that long ago.


That was less than ten years ago.

And you would think that these guys getting caught and going to jail, they usually go to prison for a year.

It's about a year, a year in a day, a year in a month or somewhere around that is kind of the Max.

But they do get prison terms.

And you would think that that would deter or dissuade others.

Instead, what I'm seeing, what I've been tracking, is that people are getting younger.

So now we have managers and senior managers who are in the M and A group or tax accounting, the tax M and A group.

We still have partners, still have people like a chief risk officer or vice chairman at Deloitte.

But you also have younger in fact, the most famous younger person was a young woman recently.

She was the girlfriend of the son of Congressman Collins, the guy who got convicted of insider trading.

And then President Trump pardoned him.

He didn't pardon his son.

He didn't pardon the other young woman and her mother and her father, who also got caught up in this because they were going to marry into Congressman Collins family.

But she got sort of caught up in something outside of anything having to do with her work at the firm.

But she was an accountant.

She was a CPA.

She was someone who had gone through all of the training that the firms put you through, all of the constant affirmation of your ethical and independence and all of the legal requirements of being in that profession.

And yet she couldn't figure out a way to stay out of this.

Considering how many of the issues we can point to with the accounting profession and with the people who are doing the accounting.

It brings up, I think, the age old question of who's going to audit the auditors.

And I just wonder if you think all these issues that seem to more or less just have continued but be consolidated over the past 2030 years, is there a way to stop it from being so common?

Is there a way to help fix auditing?

We have a bigger issue than the fact that the audit regulator that was put in place by the Sarbanesliac 20 years ago was completely discredited by the scandal that I just spoke of, by the fact that they had not only the one person who was still at the regulator who was handing off information, but two former people and a lot of other people who were sort of implicated during the trial who may or may not still be there.

It's a bigger problem because their regulator is sort of right now pretty impotent.


It's struggling through all kinds of things right now in terms of dealing with the China issue, dealing with crypto and auditing, all the new digital issues that we have.

It's struggling with sort of generally this politicization that's occurred during two different administrations.

But the bigger problem is that sophisticated investors don't give a rat's a** about audit.

And we saw that in Theranos I used Theranos, I talked to students about Theranos a lot.

And then we had another case recently, Aussie Media.

But Theranos is sort of the real case study of this.

You had in Toronto's affirm that was in place for whatever 15 years since Elizabeth Holmes dropped out of Stanford.

And we found out that they never had, except for now we know from the trial the first couple of years or whatever, they never had audited financial statements.

Investors invested.

Sophisticated investors.


Family offices of the Walton family, of the DeVos family, Rupert Murdock's family office, you name it.

You had all these former political cabinet member guys, military people, all kinds of people investing hundreds of millions, billions of dollars in Toronto's, and they never asked for audited financial statements.

And if anybody would have asked, which they did in the very first couple of years.


And they did have an audit from Ernst and Young, like for the first couple of three years.

And then nobody was asking, nobody was insisting on it.

It was an expense.

Elizabeth Holmes had a long view in terms of how long this was going to take to do what she thought she wanted to do.

And they basically blew it off.

Kpmg came in, thought they were going to do an audit.

There were disagreements about stock option expense.

Kpmg said, okay, fine, we won't do an audit.

We'll just be a consultant for the next ten years.

So you have investors, sophisticated investors, that are willing to put hundreds of millions, billions of dollars in these startups, and they do not need or think they need or value the audited financial statement information.

All they want is what is the height, what's the revenue growth?

When can I get out?

How can I get out?

And this is a good segue, right.

What you're talking about with Theranos, these investors.

And like you said, these were sophisticated investors were not asking for audited financials.

Now, this is so common in crypto, and we'll get to tether later.

We don't need to talk about tether right out the gate here.

I think there's a lot of questions about that, so we'll delve into that later.

But I do think it's interesting because I think it's not like it stopped with Theranos it's not like people were like, oh, wow, we really need to start asking about audited financial statements.

It's more like, who gives a s*** about audited financial statements?

It doesn't matter.

Why do you think that is?

What has happened?

What is that shift?

One is that we've seen over and over again corporate fraud didn't stop when the Sarbane Zoxliac was established.


So we've seen over and over again just the whole era of the Chinese reverse merger frauds.

You have corporate fraud occurring, and the auditors do not detect, prevent, or raise their hand when it's occurring.


They go into risk management mode, they go into minimize liability mode, they go into denial mode.

The classic response is, we were duped.

What other professional that gets paid big Bucks can get away with saying we were too stupid to catch it?

Okay, we were fooled.

It's not a good look.

And yet they keep getting paid billions and billions and so on the one hand, you have this like, well, okay, I have my own team.

I'm an investor.

I'm Mark Andreessen from Sixteenz or something.

I'm somebody like that.

I have my own team who can do due diligence.

I'm going to go look for what I need to look for, for how I invest.

The Toronto's trial is really interesting because you had over and over again investors who ended up suing and who ended up their claims were part of the criminal trial that she was found guilty of.

They said that basically they did their due diligence based on sort of feel and personality and the network and kind of the vibe of who else was investing.

Like, how do I feel when I talk to this person?

Other people that I know were investing.

So there was very little kind of hard kicking the tires on the financial information or asking, like, what's behind it.

So each investor makes the decisions on what's important to them based on their time frame, their risk profile, et cetera.

And then you have the other issue, which is these firms are, like, not acting in that capacity.


The firms, when they do audit, not only are they not catching stuff, but it's pretty clear from anybody on the inside that they're more interested in doing more work.

We used to say in the business at KPMG, getting a piece of the wallet, getting a bigger piece of the customer wallet.

So if you do the audit, you want to do tax.

If you do the audit and tax, you want to do consulting that's within the range so that nobody will complain about independence.

If the company doesn't complain about independence and the firm is willing to do it, who's going to raise their hand and complain about it?

Right everybody's getting what they want.

And so you have firms that are working with these companies not working on behalf of shareholders or investors who can't see inside.

And so investors look and say, you know what, what's the point?

If I don't have to pay for this, if this is not required, then why am I going to do it?

I'll get these guys to do good work to minimize taxes.

I'll get them to implement the financial system.

I'll get them to do the stuff that's absolutely required because they know how to do that kind of icky kind of boring stuff.

But they're not really at the table in terms of my decision about whether I'm going to invest or what round or what the terms of my deal are or when I'm going to get out.

They're not at the table in that in that sense.

I remember when we had Elizabeth Lapato on to talk about Theranos previously, she mentioned that, like, Betsy Devos'family office in specific, didn't want to do any due diligence because they were worried if they started requesting documents that Elizabeth Holmes and stuff might pull away and they might lose their opportunity to invest.

And so there was like this direct counter incentive to do any kind of diligence on it.

They talk about that a lot.

You hear that a lot.

In fact, when I reported on Theranos and was looking to see whether any of the investors had asked about it, I had one of the lawyers for one of the firms that ended up suing tell me, well, that's just not how it's done.

If you want to be in on these deals, you cause as least amount of trouble or pain as possible.

You don't want to be cut out.

In fact, that's the reason why Walgreens got screwed, because they were worried that CVS was going to get the deal instead.

And so Elizabeth Holmes used that kind of pressure, that kind of fear of missing out in order to discourage people from asking more questions.

And I don't have much sympathy.

So if we're in this world where sophisticated investors don't particularly want or care about audited financials, the major audit firms have regular like serious ethical breaches like insider trading, and the more ethically questionable task of upselling and cross selling different services.

Is the role of the modern auditor mostly just to provide a document the SEC requires for public companies, or is there still something more valuable in the role of an auditor right now?

Well, I would not have stuck with writing about these topics for the last 15 years since I left the firms if I didn't think that there was something important or good that could be done, if the job was done right, according to the ethics, according to the process, according to the procedures, there's an enormous amount of positive value that can be added.

The problem is that the extreme version to kind of throw up your hands.

What can we do version of what's next is the only thing that is keeping the firms in this business is the mandate is the legal mandate that to be listed to file with the SEC, you have to have a certified audit, and now it has to be a certified audit that is done by a firm that's registered with the PCOB, the regulator.

And so you have this mandate, and there's those that advocate for just forget the mandate.

Buyer beware.

Let's just throw it to the Wolf and let's have companies and their shareholders decide what they're willing to pay for.

And that to me is a very Terry and Leslie Fair kind of approach market.

It's a pure market approach.

And what I'm concerned about is that the retail investor, even the meme retail investor, even the GameStop retail investor, is not going to know what hit them.

They have no access.

They have no ability to get inside the companies.

They have no ability to understand what's going on.

I see it every day in terms of the very naive approach to the financial information, the kind of just seat of the pants approach to evaluating financial information that the companies have to put out, what would happen if the companies didn't have to put it out?

Or there was nobody even trying to make sure that it adds up.

And so I'm kind of against the eliminate the mandate.

I used to say that maybe more enforcement of making sure that the audit firms and the professionals act according to the requirements and the standards.

I thought that might work.

But frankly, I'm a little bit concerned that even the jail terms that are being handed out to some of the firms and the professionals, the fines that are being handed out, I don't know what it would take to deter people from acting badly.

I think it's going to require sort of an overhaul in the way we look at investor protection.

And it can't just be for retail investors.

It has to be for everybody, and it has to be something that is done whether sophisticated investors think they need it or not.

And I think that's the direction that the SEC is going, for example, with the private firm disclosure suggestions that they've been making.

What are the suggestions that they're making?

What are the private firm suggestions that they're making?

So the SEC has come out with sort of I don't know if it's a formal proposal.

I think it's more of a sort of floating some ideas about adding additional requirements for private firms to have to disclose more information about their investors and about financial information.

It's very preliminary at this point, but the idea is that private firms have become the place because less firms are going public, because supposedly it's too hard to go public or too expensive to go public or they don't want the audit requirements.

And then you end up with sort of this very leaky environment where retail and non accredited investors are getting involved in very sophisticated investments, in private placements, in ETFs and funds of funds where these funds are holding private company investments, and they don't really have good vetting.

We're not operating on the same principles.

Private firms, for example, Theranos was able to go all this time and raise money and not have to have an audit, and people could invest money.

Theoretically, it was only accredited investors, only large, wealthy investors who could afford to lose that money.

But I've heard rumors that there were retail investors that somehow got involved in a piece of various funds that invested in private company Dorano stock, and that goes on all the time.

You have private company stock that's put into hedge funds, and then those hedge funds sort of spin off into other products, and suddenly you have exposure to less sophisticated investors on things that are not regulated in the same way as public companies.

In a similar vein, about the SEC, I was rereading a piece you wrote for The Dig about a year ago about Gary Gonzler.

And one of the things that caught my attention in it was that you said the SEC has done a particularly poor job of catching accounting frauds.

Why do you think that is?

And then if you could also talk a little bit about the MFGlobal case you described in that newsletter, I think that would be helpful as well.

So we have to look at the incentives around enforcing or trying to staunch corporate fraud, saying that it exists, identifying the perpetrators if they're executives, and then having some kind of enforcement action, whether it's SEC or whether it rises to the level of a criminal action.

Okay, what are the incentives?

What's sort of going on around there?

Back in the day when I was raised as an accountant, when I went to accounting school, when they would use terms like revenue management or channel stuffing or a lot of these techniques that firms use to aggressively accelerate revenue recognition or fudge expenses, the kinds of things that the.com companies or the Enron era companies were caught out on, those things were called accounting fraud.

They were prosecuted as accounting fraud, meaning they were prosecuted with the understanding that people deliberately did those things in order to enrich themselves.

Usually they were enriching themselves because they were boosting the stock price or somehow otherwise reporting metrics that then enhance their compensation.

And you looked at the kinds of things that we're doing, and you said those things did not follow.

They did not comply with generally accepted accounting principles.

They violated generally accepted accounting principles, the standards that public companies have to follow when they're recording their accounting.

Why did they do that?

Well, in many cases, they did things like shifting revenues forward, the kinds of activities that were just recently recognized in the GE and in the Under Armor cases pull forwards and sometimes they were pushing expenses back.


So the kinds of things that in the GE and in the Under Armour case were called changing accounting estimates or aggressively manipulating models that are used to develop accounting estimates.

But in the GE, in the Under Armor case, those ended up getting prosecuted as disclosure fraud, not accounting fraud.

What happened?

Sarbanes Oxley happened in 2002, and when the Enron and the other Sarbanes Oxley era firms were put under for the kinds of things we're talking about accounting fraud, capitalizing expenses, okay.

Aggressively recognizing revenue, moving things around, window dressing, whether on the balance sheet or on the income statement, when they were put down and put out, when they went bankrupt, when their guys were prosecuted criminally, the Serbians Oxleyc was established, and there was this idea that we fixed it.

There will be no more accounting fraud.

Now, the auditors are going to look at this stuff really hard.

They're going to make sure controls are in place and there is no more accounting fraud.

And if stuff happens, it's going to be minor, it's going to be errors, it's going to be non deliberate misstatements.

And so in the last 1520 years since Sarbanes Oxley, the number of what we call restatements for material errors and misstatements, where somebody really screwed up on the accounting and violated gap and has to restate prior periods.

Okay, those have been completely tanking.

Like you went from 80% of the restatements being the kind that required correcting prior periods, announcing it to the market, taking that hit.

Sometimes the auditor is getting fired, etc.

Or two, oh, these are errors.

These are misstatements.

But one, they're not deliberate, they are not material, and therefore, we can just kind of correct them going forward.

So this is the situation of Big R versus Little R restatement that you might hear about a little bit.

And it's really all about characterizing the things that they were doing during the.com era and the Enron era as mistakes and errors that are not material and the kinds of things that companies do.

And as long as they disclose them to investors, it's okay.

So you might need revenue managing.

You might be channel stuffing, you might be accelerating or decelerating your expense recognition.

But as long as you tell investors that that's how you're managing your PNL, it's okay.

And so when you saw the big enforcement actions of GE, Under Armor and a few more in the last few years, more and more, the SEC is prosecuting those as disclosure fraud.

The executives are not getting tagged.

There are no criminal prosecutions.

And yet the language of what they're doing is exactly the same.

And that's what I've documented.

And that's what I'm saying is the problem, because there's been sort of this gradual slide down the Hill that says we are not going to call people out anymore.

We are not going to admit that people are cheating.

We are not going to take compensation away from executives.

We're not going to ruin people's lives.

And the primary reason, I believe, is goes back to a really great book.

I would recommend everybody read by Jesse Eisenberg, who now writes for ProPublica and Deal book called The Chicken Chick Club.

And it's about prosecutors identifying too closely with the people that they prosecute.

And that is the problem at the SEC.

That is the problem at the DOJ.

This is so fascinating for me to hear because I remember when MicroStrategy was in the midst of buying all this Bitcoin, and I decided to write an article about MicroStrategy's previous history and about Michael Taylor and the executives getting into all this trouble with MicroStrategy during the.com bubble.

But what was really interesting to me about that and for the life of me, I can't recall who their auditor was.

So forgive me, but what I do recall is that MicroStrategy and the executives had to pay whatever money.

But the hit that really got taken on that enforcement action was the auditor had to pay like, I don't know if it was like five or ten times as much in penalties and fines over what MicroStrategy did.

The enforcement action was towards the auditors for the mistakes that were happening at MicroStrategy, even though it was so similar to what you're talking about, where it was executives essentially lying to auditors.

But the auditors were blamed.

The auditors were said they were told, like, hey, your job is to get to the bottom of this, and you didn't do a good job of that.

Whereas it sounds like what you're saying now is when the auditor says, I don't know, the executives didn't tell me the truth.

I guess now they'll just walk away without getting a fine.

Well, two things even more important in that MicroStrategy case, from way back with Michael Sailor.

Michael Sailor did have to pay a fine, but the SEC did not bar him from becoming a public company CEO or board member in the future.

That is critical when the SEC does not bar a CEO or CFO from holding that role in the future at a public company, or when the SEC finds or sanctions a professional at a public accounting firm, but only makes it a two or three year sanction and then lets them go back to work as a public accounting professional when they do that.

And the violation was Egregious, where really you have someone who a reasonable person would say they're going to do it again, the fine and the sanction is not deterring future behavior.

And in the case of Michael Sailor, it definitely did not.

And so you have a situation where Michael Sailor and I think I tweeted this when his MicroStrategy right now about crypto first was getting really popular and people were talking about it, I said this guy was given another life.

And the reason is because he had a really good lawyer and his really good lawyer was a former SEC enforcement attorney.

Almost anybody who goes up against the SEC gets a lawyer who is a former SEC enforcement attorney.

I mean, it's almost like you'd be an idiot if you didn't, right?

Because one, they're all out there, right?

When they leave the SEC, that's what they go do.

They don't go work in plaintiffs firms.

They may now go work in crypto firms.

There's a really good Wall Street Journal article that just came out from Dave Michaels about how they're going to work in crypto firms now.

But the thing is that they almost always go to work for white collar firms, probably the one they worked at before they went to the SEC.

And they defend the people that are facing charges by the SEC, why they know their way around.

They know how to talk to their buddies who are still there.

They know how to push the buttons.

It was a really good I also wrote the new SEC enforcement director, Gerber Gruel, who sort of has a different background because he was a US attorney in New Jersey.

He was the attorney general of New Jersey.

And he has kind of a different sort of he's not a securities law guy.

He's a criminal law guy.

And he spoke in December and said basically he was talking about the auditors, how the auditors and all the fines and all the sanctions and everything don't seem to be deterring.

We're having all these cases.

And he keeps looking at them and saying, where were the auditors?

Where were the gatekeepers?

I was sitting in my dining room here listening to that speech in December, and I was just delirious.

I wanted to pop champagne because I was like, you get it.

You really get it.

But one thing that he said is that he said they sit there and when they come in to talk about the issues and the charges or the potential allegations, and they bring their lawyer and the lawyer says, well, this is not a big deal, because the last time this happened, you only gave the guy a $25,000 fine and a slap on the wrist.

So it looks to be about that size this time.

And basically what he was saying is that this kind of leniency, this kind of inaction is a self fulfilling prophecy because the lawyers use it against the SEC, and everybody kind of plays the same game in terms of don't make my guy an example.

Then you hear the other stories, which is the people that are not connected, the people that don't have Xsdc attorneys, the people that are like nobody, those guys get made examples of.

And I've written about a few of those.

So you have the opposite complaint that the SEC goes way too hard on people that are nobody, that nobody sent.

But if you come from if you are sent by somebody who somebody sent from the SEC, you have an exclusive, then you've got this kind of already sort of self fulfilling prophecy that they're not going to do anything worse than what they've ever done before.

And they didn't do anything worse before because they didn't do anything worse before.

I know it's depressing.


It really is like what you're talking about, where the inaction begets in action.

And like the leniency begets, greater leniency just continually weakens, like the political will that would be necessary to do, like, larger reforms and larger restructuring, because people look at, say, the SEC and say, why would we give them money to restructure this?

Why would we try to rebuild this one?

For the last 20 years, they've done so little, they've been so ineffective.

And so it's just a really destructive pattern.

Well, and the SEC is a political organization, and I say that because that's just how it works, although you have this layer, maybe 70% of the professionals, which are career professionals.

I mean, the SEC even has a Union.


You have a very significant core group of people who are really great professionals, competent, want to do a good job.

But you hear over and over and over again that they're stymied by the people who go through the revolving door at the top, and we see the revolving door revolving even faster.

I mean, just in the 20 years that I've been writing, the people that are in high level positions are younger and younger, and that means that they have more career after the SEC that they have to worry about.

And so it's very much become a stepping stone, resume thing for the people that are politically appointed.

And so you have this lack of sort of long term or even medium term thinking.

It's a very short termism in terms of how will this affect me outside?

And there's been academic research written about this from the lawyer perspective, not a lot from the accounting professional perspective, because the SEC is run by lawyers.

And so the lawyers always talk about the lawyers.

But there's the same kind of thing going on, because there's an enormous amount of the core, both political and core professionals at the SEC who are revolving in and out from the accounting firms.

This is going to be a little bit of a change of pace.

I think that cryptocurrency has benefited from lack of serious enforcement.

And when I say serious enforcement, Bennett and I have referenced this in previous episodes, like we are talking about EOS getting I don't know how much it was $4 billion and then getting a $20 million fine or $30 million fine or something.


The incentive is not there for them to abide by the rules.

And so this brings us to one of our favorite topics, which is Tether, and how Tether has long promised an audit that has never been seen.

But I think what a lot of people don't understand, and I think even Bennett and I, as much as we've covered this space and like to think we know it in full, is the difference between an Attas station, an audit, what those differences entail, like why those are important differences.

And also if what Tether is currently doing qualifies as an Attas station and what you think, like what you would like to see from Tether as a former auditor.

Okay, so this is an interesting topic because we've had to answer more questions about these differences in this language.

Now that we've got the Trump issue, where Trump's accounting firm resigned and basically disowned ten years worth of his financial statements.

And people asked the question, what was that?

Because initially people were calling in an audit, but Trump's financial statements, he never had an audit.

He hasn't had an audit since he had his casino way back in the early 2000s.

The Trump financial statements were what's called compilations, which is basically an audit firm just puts the information together based on information that the company provides.

And that's essentially what's happening with the Tether reports that the auditor.

Now it's some bizarre hybrid in the Bahamas or Bermuda or something like that.

Now, whatever.

Or you could talk about Circle, USDC, where you have Graham Thornton at Circle for USDC, same thing.

So let's talk about the language.

Assurance product is used kind of as sort of a euphemism.

It's sort of a branding kind of a word.

A lot of the firms will say that everything that they do that's audit, like is an assurance product, meaning they provide some kind of assurance based on agreeing to do certain things and doing those things according to certain standards and then preparing a report.

In some cases, you provide an opinion.

In other cases, you're just doing something like what Mizar's was doing for Trump.

You're just putting the financial statements together according to the accounting standards, according to the standards of how that kind of work is done.

But Mazars never provided any kind of opinion on the veracity or the completeness or anything else related to those financial statements.

In fact, they disowned the quality of those financial statements because they said in some cases the numbers weren't even according to generally accepted accounting standards.

In the case of Tether or Circle, what the audit firm is doing.

And I say audit firm, because these firms are really doing more than audit, as we talked about.

They do audits, they do tax, they do consulting.

They do due diligence.

They do all kinds of things.

The firms are saying, okay, Tether, okay, Circle, you managers give us information about your balances in the bank that are backing up the stablecoin balance.

You say you have 100 billion in stablecoin market valuation.

We want to see bank statements and other financial statements from brokerages, etc, etc, etc.

That you have 100 billion equivalent market value of other assets that are backing.

If you're going to say that you're doing it, one to one.

And so that's all they're doing, basically, is they're collecting statements from the banks and from the brokerage firms and from the investment firms.

If it's commercial paper or however, the company has that information and they're tallying it up at a certain point, and they're saying it matches the number that Tether or Circle is saying that they have in terms of market valuation for that stable coin at that particular point in time.

So what's the fundamental problem?

The fundamental problem is that that process takes time, even though they're not really doing much, they're not doing any kind of review of that that information or validation of that information.

They're basically taking the company's word for it, just as Mazar's is doing with Trump.

They're not vetting that information at all, other than theoretically saying, oh, is this a fake bank statement?

But if there was a fake bank statement or something like that, like the wire card case where the auditors were getting fake bank statements, I doubt that they would probably notice that because they're not doing any additional procedures to kind of make sure they're not even probably calling those banks.

They're taking the information for management, then they're taking that information at a certain point in time.

So I think if it's December 31 or it's January 31 or it's February 28 or whatever it is, Circle or Tether says, okay, we're going to give you a number as of December 31.

We're going to give you a number as of January 31, and then we're going to give you all the information to check that number or match that number up to all of our financial statements for the backing assets.

And that takes a little while.

And generally these reports are coming out about a month and a half after the as update we saw in the Tether enforcement action by the New York AG.

We saw in that case that basically they said Tether was fudging.

They were moving stuff around between accounts.

It's kind of like you go and you want to rent an apartment and the apartment guys says we need to check your bank, that you've got enough money in the bank, and we need to call your employer and make sure that you really are employed and you line it all up to get somebody to say that at that particular point in time, and then the next day you quit your job and then you take all the money out of the bank.

That's what Tether did.


And that is the problem with producing a report that's as of a date, but not producing that report until a month or a month and a half afterward, it's worthless.

And as you said, tell me if I'm getting this wrong, but if I'm getting this right, they are getting bank statements or whatever, commercial paper statements from Tether, and they're just trusting them as being totally correct and not right.

So they call that an attestation, because what that is, is that something where they're actually agreeing to do things according to certain standards, professional standards, and they're going to assemble that information and they're going to sign their firm's name to it, but they're not doing any kind of significant audit procedures.

And you see those disclaimers in the actual report as opposed to a true complete financial audit.

So when you're doing a financial audit so, for example, Coinbase has Deloitte doing its full financial audit.

When you're doing the full financial audit, then you're actually looking at everything, the balance sheet, the income statement, the cash flow statement you're going through, and you're testing those balances.

You're vetting, you're calling the banks and you're getting confirmations on those balances, et cetera.

But again, you're still doing an audit as of a particular date.

So that too is sort of lack, sort of go forward value.

You're basically just getting insurance that as of December 31, for example, the auditor has gone through all of these additional procedures, but they actually do collect evidence and they make calls and they review and they recalculate and they test and they talk to people and they go out and they check the systems and make sure the systems are robust.

They have controls in these cases, whether it's a compilation of financial statements for Trump or whether it's just putting together and matching up, whether or not the financial statements and the other bank statements and brokerage statements from all of the backing investments equal the amount that Tether or Circle says that they have a stablecoin valuation at that point, all they're doing is just basically doing a matching.

You get a spreadsheet and you put one number on the left and you add up all the numbers on the right, and you say as of that point, and it's taking them a month and a half to do that, and then they're signing their name.

And so for me, it doesn't really do any good.

And then you have all the additional issues of the quality of those assets.

And what is the requirement?

Is there any requirement for Tether for Circle to really break down or disclose?

Where is that commercial paper coming from?

What is the rating?

What's the quality of that commercial paper?

Are those cash equivalents?

Meaning that they are less than 90 days maturity.

Can they get cash tomorrow for those investments, or is there some valuation risk in terms of if you cash it out, you're going to lose money on that?

So what is the true cash equivalent value of the investments that are backing that?

I read something from this one guy, a research person from Yale, that talked about sort of the circular nature of sort of the Tether backing stuff.

When they talk about Treasury securities and you talk about stablecoin as a substitute for Treasury securities or the fickleness of the Fed, et cetera.

But yet the Treasury securities short term Treasury securities are what is backing.

It's just sort of a circular motion machine, no pun intended.

So related to this search, and stablecoin executives have claimed at times that it is literally impossible for them to get an audit, and an Attestation is the absolute highest level of assurance they can provide.

Do you think that's plausible?

I think that is I mean, that's really the problem, and they know it because it's a moving target.

And the other thing is that there's really no requirement right now that they disclose all the details.

There's no what's the breakdown of these assets that back?

What is the requirement for segregating these assets?

I mean, I see, like in Coinbase and in Circle, they give a lot of discussion to the segregation of certain assets.

But then you have all kinds of other products that they're offering in terms of lending against assets that are being deposited.

And it's very confusing.

And then you have self custody by these firms.

So you have the stable Coin that they're counting in these balance.

It's just very, very confusing.

And so it's true.

It's too dynamic to get a traditional audit.

In a sense that what are the auditors going to look at?

They're looking at a virtual blockchain entry, and it's constantly moving, and there's anonymity associated with the sources and uses and the flows.

And then you've got this now products that are layering, as they say, in the traditional financial world, you have rehypathication, which means that you're lending out things that are supposedly backing other things.

And you have sort of this extended chain that is just moving too fast for anybody to put their finger on.

And in the banking world, they've developed systems to try to narrow that down.

And you've have established rules, and you have requirements in terms of how much capital that banks and other investment firms and brokerages have to hold.

And right now, we're operating in an unregulated environment because all of these firms are just operating voluntarily.

They're trying to sort of bridge without going all the way because they don't want to go all the way.

They want to be unregulated, but they need to go sort of one third halfway in order to appear to be providing some level of security.

It sounds like the challenge for an auditor would be that these stablecoin companies are engaging in activities that appear very similar to activities we generally regulate, except these entities that are engaging them are not regulated under those rules.

And so when the auditor looks at it, they can't audit it like a bank because it's not a bank, and they can't audit it like a money market fund because it's not a money market fund.

And so that's the problem as of right now.

And they can't audit it as a broker dealer who has to have customer segregated amount.

I've written a lot about this in terms of Coinbase and the other exchanges that are operating as sort of unregulated broker dealers because they're facilitating trades in the various crypto.

And again, they're sort of going part of the way to give the appearance of operating in the same environment.

But if you look at their financials, they very clearly say, we don't promise you we're doing any of this stuff, and we don't have to do any of this stuff because we're not regulated as a bank.

We're not regulated as a broker dealer.

We're not regulated as an investment adviser.

We're not regulated as the only thing that you really have is you have the money license.

So basically they're kind of glorified money transmitter.

Money transmitter license.


And when Rohan Gray was on here a couple of months back, we talked about how the US money transmitter regime is very patchwork state by state.

And so it is a challenging framework in which to enact regulations.

Well, it's also, as you said, state by state.

So right now you have, as always, New York taking the lead, but yet New York takes the lead and does things like with Tether, and they just operate around that.

The only thing I want to end with was to make sure that you are able to perhaps I think your voice is very valuable, and this space has needed someone to talk about this stuff in an informed way for a long time.

I think a lot of people in cryptocurrency just don't give a d*** about audited financial statements.

And on a final question for me, why is it important?

Why should they care?

And how do you hope to see this kind of progress in the cryptocurrency world?

So the cryptocurrency crypto digital assets world has sort of progressed over time.

I started reporting on it in the ICO environment, and we saw sort of that blow up because the people that were trying to sell tokens were trying to operate on the edges they were trying to be in, but not in all the way they were just putting dipping a toe in maybe filing with the SEC to do a private placement, but then not really considering what they were doing security.

So they were just kind of waiting around.

And as you said before, the SEC picked off a few in order to discourage that activity.

And all that's left are the ones who want to keep fighting with the SEC, like Ripple and XRP.

So then you move on and you say, okay, now there's been a development of Bitcoin and E kind of become predominant in terms of they're the ones that are outside of the securities regime.

And then you have everybody else sort of on the edges, and then you have the development of Stablecoin, which has created all kinds of questions and concerns.

And then you go down the road and you say, all right, now we've got NFCs, which is presenting the same exact problems for any kind of corporate entity or any kind of retail investor that wants to get involved.

And the fundamental problem is that people that are promoting cryptocurrencies digital assets and all of the products that have developed along the way related to them are essentially anti regulation libertarian.

Leslee, leave me alone.

I want to operate outside of the government's scrutiny.


I get it.

However, you can't have one toe in and one toe out.

And the SEC and the DOJ and many of the regulators all over the world have allowed these things to get really big because they're afraid.

They're either afraid of cutting off an opportunity for them to go work as chief legal officer, like many of the excess you see people have done, or they're afraid because they don't feel like they're up on it because they're just getting too long in the tooth and they don't want to learn what's going on and see what's good and what's bad, or they are intimidated by the people who end up becoming really zealous about this stuff.

But either way, they've just been afraid.

And they let this stuff get big.

And that's what happened with the ICOs.

They let people file the format's.

They let them apply for the private placements.

They let them raise money, and then, Bam, they picked off a few here and there after they had raised millions of dollars, in some cases billions of dollars.

To me, that's like, dumb.

Why don't you just make a rule, make a position, and then cut it off at the pass?

But they won't do that.

And so they let this stuff grow and grow and grow.

And then it's like, too hard.

It's really, really hard.

It's a big giant elephant in the room and nobody wants to tangle with it.

They're concerned about systemic risks.

They're concerned about making the wrong decision.

They're concerned about the power of people that are bought off by lobbyists and campaign contributions.

And so it's a problem because we have people that we put in a position to be looking out for investors who are not acting quickly enough.

They're not acting decisively enough.

When I was down in Latin America working for JPMorgan to try to fend off the Y twok bug, okay, we didn't know what the h*** is going to happen.

We didn't know if something was going to really happen, and all of the electricity grids were going to go down in Argentina and Brazil and Mexico.

But certain people had to stand up and be leaders.

Certain people had to wrangle everybody else and say, all right, here's what we're going to do.

And I'm going to take responsibility for the consequences of my decision.

And so many are unwilling to take a leadership role and take the consequences of their decision.

They want to pit a pitter around.

And so we end up with these things getting bigger and bigger and bigger, and it's too late.

And if I would have done that, I know people don't believe there really was a y two K bug, but there was we fixed a lot of really ugly code at JPMorgan that would have completely crashed the systems if it had not been fixed before the Millennium passed.

But I can say JPMorgan is still thriving in Latin America and I hope that the financial system is still thriving for as long as I'm still kicking but it's going to take some people standing up and getting some kojones and taking responsibility for their decisions and the consequences of their decisions in order to protect the rest of us.

And they do know better.

They know better.

They just have to stop being so self serving.

Well, that was fantastic.

Thank you for joining us, Francine.

It was educational and enlightening, often in depressing ways, but I appreciate it nonetheless.

We keep working, though.

We keep trying exactly and Congratulations on your upcoming professorship and hopefully we can talk again soon.

I really enjoyed this.

Thank you.

You did it.

You made it through our longest episode ever.

One of the most educational episodes ever with Francine McKenna but also you're feeling grateful, you're feeling happy?


Excited virtuous.

So you're going to leave a rating and review and they're going to be good and then everybody wins.

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