MONTGOMERY, Ala. — The dozy capital of a state where roughly a fifth of the population lacks internet access seems like an unlikely hub for crypto regulation. And Joe Borg is an unlikely captain of that effort.
While federal regulators took no action, Borg and his counterparts in Texas, New Jersey, Kentucky and Vermont targeted the operations of two key crypto players at the heart of this summer’s crypto meltdown, Celsius and Voyager, filing cease-and-desist orders against them months before the self-styled crypto banks declared bankruptcy.
The state financial watchdogs also were way ahead of the feds in the summer of 2021 when they issued a cease-and-desist order against BlockFi, another rapidly growing crypto bank, leading to a $100 million, first-of-its-kind settlement for securities law violations. The Securities and Exchange Commission, the federal agency most often thought of as the crypto watchdog, joined talks between the two sides only as they neared a deal, state regulators say.
Now, Borg and his fellow state regulators are working to help hundreds of thousands of Celsius and Voyager customers recoup billions of dollars’ worth of assets from frozen accounts. Again, federal regulators are either largely silent or late to the action. The Federal Reserve and the Federal Deposit Insurance Corp. only wrote Voyager demanding that it drop “false and misleading” marketing claims three weeks after it had declared bankruptcy.
“I didn’t anticipate we would end up in the driver’s seat,” said Borg’s counterpart in Texas, Joe Rotunda, the enforcement director at the Texas State Securities Board, who estimates roughly 100,000 Texans invested in Celsius and Voyager. “There’s a lot of money on the table, these are very complex cases, and it would be the job of the national regulator. I don’t know why the SEC isn’t out there in these areas right now.”
SEC chair Gary Gensler rejects the notion that his agency hasn’t done enough. “We’ve worked well with the states,” Gensler said in a recent call with reporters. “I think the firms could have done a lot more to protect the public. I think the firms could do a lot more still to protect the public. And that’s why I continue to say, come in, work with us, find a path to registration, comply with the laws.”
Others say the states deserve credit, and Washington criticism, for the way crypto has been addressed. “The states were on very solid ground, acting courageously and swiftly, and the SEC should have really followed those footsteps as fast as they could,” said John Reed Stark, a crypto critic who formerly headed the SEC Office of Internet Enforcement.
Borg chalks up state regulators’ successes to a nimbleness not shared by the SEC. If the federal agency pivots at a battleship’s pace after each change of administration, “the states are kind of like PT boats that can zip in and out.” Plus, with the SEC, “there are political considerations from Congress.” Borg, whose agency is financed by industry fees, does not have that problem. “Should they move faster? That’s not my call to make,” he said. “I can only work with them as fast as they’re willing to work with us.”
A ground-level view
On a recent weekday morning, Borg walked into the Farmers Market Cafe, a diner in downtown Montgomery, and spotted some familiar faces in the corner. The breakfast regulars gathered around the table included former state lawmakers and retired lawyers, and when Borg approached to greet them, the traces of his native Queens, N.Y., accent melted into a mellifluous Alabama drawl.
“Y’all be good,” he said, walking away. Later, chatting with one of them at the cash register, the man mentioned he had information that might be helpful for an investigation Borg was conducting unrelated to crypto. Borg told him to find time to stop by his office, a few blocks away.
Borg said the ground-up approach he and other state regulators take to monitoring the markets gives them a potential edge over their federal counterparts in spotting emerging threats in digital assets. “Chances are, from the retail market, we’re going to see it first,” he said.
That was the case back in early 2014, when Borg’s office started fielding complaints from customers of a Tokyo-based bitcoin exchange called Mt. Gox who were having trouble getting their funds from the platform. Borg said he tried to reach the administrators of the exchange, at the time the largest of its kind in the world, and they did not respond. “Those are all red flags, especially when they don’t talk to regulators,” he said.
Mt. Gox announced in early February that year that it was temporarily halting customer withdrawals to get a “clear technical view” into what it described as a programming flaw. Hours before it collapsed a few weeks later, Borg issued the first of what would become a series of warnings about the dangers of investing in crypto. “The risk of using Bitcoin may be off the charts!” he said in the alert. “When using Bitcoin for investing, it is difficult to seek any protection or recourse for losses due to fraudulent schemes.”
Looking back, he said, Mt. Gox’s implosion provided “the first wake-up call” that what was going on in the crypto world was probably going to affect mom-and-pop investors.
Developments over the next few years confirmed the hunch, as a wave of start-ups began raising money from the public through what became known as initial coin offerings, or ICOs. The method allowed companies to avoid the rigorous disclosures the SEC requires of firms that sell stock to raise capital, even though regulators argued many were effectively doing the same thing. Others turned out to be frauds.
By 2018, coin-issuing ventures had raised $6.9 billion through ICOs. Borg, then serving as president of the North American Securities Administrators Association — the group representing state and provincial financial regulators in the United States, Canada and Mexico — launched a coordinated campaign to crack down on the offerings. “Operation Cryptosweep,” as the watchdogs dubbed it, kicked off 330 probes of ICOs, from Vancouver to Atlanta, resulting in 85 enforcement actions.
Nearly all of the projects violated the law, Borg said, because they failed to register with the SEC or state financial regulators. His argument rests on a seemingly technical matter that has taken on central significance in the debate over how the crypto economy is regulated: the legal interpretation of what counts as an investment contract.
Advocates of stricter crypto oversight point to a standard the Supreme Court established in a 1946 case involving Florida fruit. Back then, a businessman named William John Howey sold parcels in citrus groves he owned outside Orlando to investors on the understanding he would lease the land back from them, grow and sell the produce, then share the profits.
The court found the arrangement was legally equivalent to a stock sale, and Howey violated securities law by not registering it with the SEC. The decision gave rise to what became known as the Howey test, handing securities regulators jurisdiction over any deal in which investors pool money in a project managed by others with the expectation of a profit.
Crypto entrepreneurs who argue they are developing breakthrough technology to fundamentally transform the financial system bristle at the suggestion they are hawking the digital version of stakes in a citrus farm. But Borg and his counterparts contend most crypto projects meet the definition, including the lending platforms they began raising alarms about last year, starting with BlockFi. The company was not registered as an investment company or a bank, though it was offering retail customers annual yields as high 9.25 percent on deposited crypto the firm then lent to institutional traders willing to pay a premium for it.
“That’s no different from a security,” Borg said. More ominously, with no regulators peering into the company’s books, it was not clear to whom the firm was lending, on what terms, and what collateral it held to back up customer deposits in the event it ran into trouble. BlockFi declined to comment for this story.
Wolves at the door
Borg had seen it before. He first made his name as a regulator going after another financial juggernaut that recruited amateur investors with promises of outsize returns. In 1995, he was a year into the job as Alabama’s top financial cop when the office started getting calls from locals with stories about getting defrauded by penny-stock peddlers at a firm called Stratton Oakmont, later memorialized in “The Wolf of Wall Street.”
The operation functioned by paying brokers commissions to cold-call people across the country and sell them shares in all-but-worthless companies. That gave state securities regulators jurisdiction over what turned out to be a corner of the financial market that was too lightly overseen by the SEC. Borg stepped in, spearheading the formation of the multistate task force that ultimately shut the firm down.
Like Stratton Oakmont chief executive Jordan Belfort (played by Leonardo DiCaprio in the Hollywood version), Borg hails from Queens and demonstrated an entrepreneurial instinct early. Born to Maltese immigrants who fled the tiny European island in the wake of World War II, he supported himself through City College and Hofstra Law School with a floor-cleaning business. But he also pursued public service, landing an internship in law school with New York Attorney General Louis Lefkowitz, a glad-handing moderate Republican who became known as “the people’s lawyer” and held the job for a record 22 years.
After law school, Borg joined a small law firm in Manhattan. One client, a truck axel manufacturer, was based in Montgomery, bringing Borg south on work trips. When he realized he could afford both a place on nearby Lake Martin and another on the Gulf Coast for the cost of his New York rent, he moved down for good in 1977 and went to work for the business.
Borg did another in-house stint, for an Alabama bank, then joined a local law firm, at one point securing a settlement for a couple who lost money investing with a Stratton Oakmont spinoff called Biltmore Securities. His performance in that case caught the eye of state authorities looking to breathe new life into Alabama’s financial watchdog, and they persuaded Borg to take the challenge.
Borg set about building momentum and concentrating power. By enforcing licensing requirements on financial professionals, he grew the office’s dedicated funding stream, so it no longer needed appropriations from the state legislature. Successful prosecutions of fraudsters brought in more money, and good press, which helped keep elected officials from meddling. Wins begot wins: He added staff, including veteran federal prosecutors, and hashed out arrangements with law enforcement allowing his agency to bring its own criminal cases in court, an unusual privilege.
The regulator last year returned roughly $14 million to the state’s general fund and slightly more in restitution to victims of financial crimes. And Borg now counts 62 employees in his office, up from 13 when he arrived. For comparison, roughly 4,500 people show up to work at the SEC every day.
Rotunda’s agency in Texas, meanwhile, counts 76 staffers. Yet only 29 of them work in enforcement, meaning he has roughly one person policing financial crime for every 1 million people in his state. For the last five years, those regulators have been disproportionately focused on crypto. It has been “the single biggest product subject to investigation by our agency” in that period, Rotunda said. “I’ve been in securities regulation for 17 years, and I’ve never seen anything like it.”
For Rotunda, the ability of the crypto lending platforms to spread rapidly into every corner of the state hit home when his office began probing them, and he learned one of his staffers had invested with Celsius. He hived off the employee from the investigation, but the discovery underlined the stakes. “If you can get a securities regulator to invest in something like this, you can really get anybody,” he said.
Once BlockFi reached its settlement deal in February, with a roster that had grown to include 32 states and the SEC, Celsius and Voyager seemed bound to follow suit. “There was discussion along that line,” Borg said. “The impression we got from them and their lawyers was, ‘Let’s see how we can go about getting this settled.’”
Instead, in May, the collapse of the TerraUSD stablecoin sparked a wider crypto market crash. Both Celsius and Voyager maintained customer deposits were safe as fallout from the downturn spread. But the reckoning revealed the companies had lent too much to institutional borrowers while maintaining too little collateral to back it up. Both froze accounts and then declared bankruptcy in July in the face of a wave of customer demands for withdrawals.
Now, the states are getting creative to secure relief for devastated depositors. Texas regulators have officially joined the bankruptcy proceedings for both companies, a move Rotunda said gives his office an opportunity to advocate in the process. And Borg said he is exploring the possibility that customers could be eligible for payouts from a finance industry-funded nonprofit that helped victims of the Bernie Madoff fraud.
The state regulators are also investigating the twin collapses to reconstruct precisely what happened and who may need to be held accountable. They hold a weekly conference call, typically on Thursdays, to coordinate efforts.
The state watchdogs are also looking into other crypto companies, probes they so far cannot discuss. Borg may not see all of them through. He said he is planning to retire next year and hand the reins over to his chief deputy, Amanda Senn. In the meantime, he said the market downturn “may be the shakeout that brings a better system down the road, but a lot of folks are going to get hurt.”