“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” said John Ray, the new court-appointed CEO for FTX in bankruptcy.
So, what happened? How did a company which was once valued at $32 billion end up filing for bankruptcy and its co-founder and former CEO arrested on criminal charges? As the details of the failure of FTX trickle in, they provide a learning opportunity for other businesses: how can your business avoid the same mistakes?
What is FTX and what happened?
FTX is now a bankrupt company that was one of the world's largest cryptocurrency exchanges. FTX acted as a cryptocurrency derivatives exchange and enabled customers to trade digital currencies for other digital currencies or traditional money. It had also created its own token, known as FTT. The company, based in the Bahamas, was run by Sam Bankman-Fried, who co-founded the company in 2019 at the age of 27.
On November 2, 2022, news site CoinDesk revealed problems with FTX-affiliated trading firm Alameda Research. The revelations raised concerns with both lenders and customers about the company's leverage and solvency.
Shortly thereafter, a series of events led to a liquidity crisis, FTX filing for bankruptcy protection, and Bankman-Fried stepping down as CEO. He was later arrested in the Bahamas and extradited to the U.S. on multiple securities fraud charges.
The mismanagement of FTX left thousands financially devastated costing many investors their life savings. Others have lost hope in cryptocurrency causing a significant devaluation of the sector as a whole.
What can we learn from the collapse of FTX?
The FTX crypto collapse is a cautionary tale for small-medium businesses (SMBs) across industries. It's important to understand how the company fell apart and how their actions could have been avoided. While it is not possible to completely prevent all risks, there are steps that can be taken to minimize certain risk profiles in your organization. Below, our experts explore the top lessons that can be learned from this event:
No matter how big a company is, poor governance can throw it into chaos. At FTX, the Board of Directors was as good as non-existent. It consisted of just three individuals—one of which was the controlling shareholder, Mr. Bankman-Fried. Investors should be wary of boards which consist of mostly executives or management. It is the responsibility of the board to ensure there is regular financial reporting and to meet often to discuss and ask questions of management. That was absent here, causing a multitude of problems. This lack of oversight meant that the leadership team was not held accountable for their actions and could make decisions without any questions from an independent board.
This also underscores the importance of heavily scrutinizing your financial position. FTX was overleveraged with their wealth tied to one company and once investors lost confidence, it all fell apart quickly. “Being overleveraged is not a new lesson specific to the crypto industry,” said Mary Mathews Partner, Accounting Advisory Services at BDO Canada. “This is the same lesson banking institutions learned in 2008.”
Additionally, the company lacked a clear CFO. This should have raised eyebrows. A credible CFO might have notified stakeholders about its overleveraged position and prevented the improper transfer of client funds to Alameda Research.
Financial controls are essential for all businesses, but especially for those handling large sums of money. Without them, the risk of fraud increases exponentially. Financial controls can consist of:
- Internal controls: Policies, procedures and checks that companies implement to mitigate their risk profile. They include things like segregation of duties, dual signatures for transactions above a certain amount, and regular reconciliations of bank accounts.
- External controls: Independent audits conducted by an outside firm to ensure that the financial statements are not materially misstated and are in accordance with an accounting framework.
FTX had many issues in this area, including basic functions like who reports to whom, improper security controls, and HR issues. A Forbes article shared the bankruptcy report that found, “the use of an unsecured group email account…to access confidential private keys and critically sensitive data for the FTX Group companies around the world.” The report also stated bankruptcy managers were unable to locate any audited statements for Alameda or other key components of the FTX complex.
An independent audit is designed to identify a lack of internal controls, misappropriation of funds, and inaccurate financial statements—and disclose these to investors and regulatory authorities.
The executive team at FTX was young and relatively inexperienced. This lack of experience likely played a role in the mismanagement and a lack of oversight. “There is nothing wrong with a young executive team, however, they may have lacked the guidance and understanding of the benefits offered by a proper structure,” said Michael Crolla, Partner, Assurance and Accounting at BDO Canada. "You must make sure that a young management team has access to experienced strategic advisors and professionals who can guide them and ensure there are proper controls in place."
Ultimately, risk management comes from the top-down. A CEO’s approach to risk largely determines the company's appetite for and effectiveness at managing those risks. Many CEOs, especially in the tech industry, are facing increased scrutiny. The high-risk, high-reward attitude that has driven their companies to success is now being questioned. In recent years, we have seen the impact of unbridled growth and the failure of companies like Theranos come to mind. These incidents and the FTX collapse serve as a reminder that blind trust in an inexperienced, charismatic CEO can be a recipe for disaster.
The unfettered financial mismanagement, poor corporate governance, and fraud could not have happened without help from others. These activities were allowed to continue because outsiders failed in their proper due diligence.
“Investors threw money at FTX because they didn't want to miss out on the next big thing,” said Michael Crolla, Partner, Assurance and Accounting at BDO Canada. “They felt Bankman-Fried had that 'it factor' so they invested in him without the due diligence they might otherwise perform.”
Be wary of the hype; if a company claims it will deliver huge profits, this may be too good to be true. A poor or limited governance system is something you'll want to avoid when deciding where to invest.
How BDO can help
Ultimately, these are valuable lessons for all businesses to learn from. Even if you are not dealing with cryptocurrency, or even involved in the financial sector, we can all learn from the mistakes that FTX made. To avoid similar situations in your own business, it is vital to build systems and processes to ensure good governance, effective financial controls and skilled executive teams. BDOs Accounting Advisory team can help you build a strong financial framework to protect your business. To learn more about how BDO can help your business succeed, please contact our experts:
The information in this publication is current as of Feb. 15, 2023.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.
Disclaimer: We caution the reader that the investigation into Bankman-Fried and his associates is ongoing, and the content of this article is based on information made publicly available as of Feb. 8, 2023.