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FTX, a failure in Corporate Governance and effective risk management

18 November 2022 By Adam Kahlberg

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The FTX bankruptcy case has been a fascinating study in the failure of corporate governance providing a warning to the Cryptocurrency industry that a lack of regulation will not excuse poor financial management and that these exchanges are not immune to failure.

In the last week, the company engaged distressed company expert, John Ray III to take over control as the company’s CEO as it declares bankruptcy. Ray who has helped companies such as Enron wind up their business and dealt with fraudulent and criminal business activity will help wind up the company. In FTX’s Chapter 11 Bankruptcy filing, Ray provided some intriguing insight and warnings for other business and companies that may be in a similar boat, stating “Never in my career have I seen such a complete failure of corporate controls”. For market participants the information out of the filing is helpful in providing direction for potential investment and trading decisions going forward.

 

 

 

Overview

FTX, prior to its demise was the world’s second largest cryptocurrency exchange under the management of founder, Sam Bankman-Fried. The initial announcement of the company failing, lead to a drop in the price of Bitcoin by almost 25% and a panic in the market and FTX losing a rumoured 1 billion dollars in customer funds. Outlined below are some of the key issues that Bankruptcy filing found as being responsible for FTX becoming insolvent.

 

Cash Management  

The issues highlighted by Ray, included a lack of cash management controls. The company did not maintain accurate books and cash accounts and currently is not able to locate accurate accounts and transaction history to verify its positions. This means that currently, there is no clear indication of how much money the company on its balance sheet.

Disbursements and record keeping

The company’s management and control of its disbursement were so poor that it was not “appropriate for a business enterprise”. For example, there were no records of loan documents, for money used purchase homes for employees. In addition, wage requests made by employees were made and approved with the use of personalised emojis and messages that automatically deleted after a short period of time. The lack of record keeping was also evident in its management of the actual digital assets under it held. There was no record of the coins or digital assets that the firm was holding for its customers. This adherent lack of record keeping has made it increasingly difficult to work out the financial position of the company.

 

Auditing Failures

This also leads to the next major issue which was the auditing opinions. Although most segments of the business were audited, Ray, made it clear that none of the opinions should be relied upon by current and future stakeholders. In addition, there has so far been no indication of auditing performed on Alameda and Venture segments of FTX. The failure of the auditing process was an essential risk management measure that was missed.

 

Lack of Employee records

 

The failure in governance also extended to Human Resource Management within the company. No clear records of employees and contractors have been found and even now there is no clear indication of how many employees FTX, and its various subsidiaries had. In fact, the problems relating to employee records have been so poor that there has been difficulty even locating some of members of the workforce to verify their employment.

 

Ray ended the filing with perhaps the most damming statement of all which was that Sam Bankman Fried does not represent creditors and that his current actions are not only problematic but highly irrational including social media posts that he currently engages in. The lack of regards and contempt held for Bankman Fried is indicative of complete failure from the senior leadership team at FTX.

The situation at FTX has been brought about by a sector that hides itself behind low regulation and complex technical language that allows it to escape much scrutiny and criticisms. The environment of ambiguous leadership roles and no clear focus on compliance and risk lead to a situation whereby failure on such a large scale has been allowed to occur.

Disclaimer: Articles are from GO Markets analysts and contributors and are based on their independent analysis or personal experiences. Views, opinions or trading styles expressed are their own, and should not be taken as either representative of or shared by GO Markets. Advice, if any, is of a ‘general’ nature and not based on your personal objectives, financial situation or needs. Consider how appropriate the advice, if any, is to your objectives, financial situation and needs, before acting on the advice.