FTX's collapse last year has become a landmark case of fraud, highlighting the dangers of a business moving too fast without guardrails to prevent a failure. Once a titan in the nascent cryptocurrency industry, FTX's bankruptcy - one of the biggest and fastest in US history, teaches legitimate businesses far beyond the crypto industry about the importance of having a culture of integrity and appropriate controls for sustainable growth.
A Promising Beginning and a Punishing Ending
In 2019, Sam Bankman-Fried, a 31-year-old Massachusetts Institute of Technology graduate, founded FTX, a digital currency exchange market. He touted FTX as a stable and responsible company in the new and loosely regulated world of crypto, an industry that remains questionable for many. At its peak, FTX allegedly had over 9 million customer accounts and was valued by venture capitalists at $32 billion.
Beneath this façade, FTX had serious internal issues, and it collapsed just three and a half years after it started.
Reports emerged in 2022 revealing that, among other things, FTX had, without disclosure to its customers, funneled customer deposits into Alameda Research, a sister hedge fund also founded and controlled by Bankman-Fried. This co-mingling of funds between entities was a breach of customer trust and basic monetary management principles. It caused a rush of customers to try and withdraw their FTX crypto holdings quickly, and FTX was unable to meet the demand.
Within two weeks, the company abruptly declared bankruptcy in November 2022.
One year later, Bankman-Fried was found guilty of stealing billions of dollars from customers. During the trial, prosecutors presented evidence and testimony showing Bankman-Fried was the architect of the scheme to siphon FTX money to repay debt incurred by Alameda Research, cover risky investments, and buy luxury real estate, among other things. Bankman-Fried now faces the prospect of spending the rest of his life in prison.
Growth At All Costs – A Culture Killer
Sam Bankman-Fried's leadership style played a crucial role in shaping FTX's corporate culture and its eventual downfall. His approach was characterized by a relentless pursuit of growth and a disregard for basic tenets of corporate governance and ethical decision-making. His tone set from the top permeated throughout the company and created a culture where risky financial maneuvers and ethical shortcuts became the norm.
The absence of standard corporate governance structures (like independent boards for his multiple related companies) meant that Bankman-Fried's decisions went mostly unchallenged. This centralized decision-making approach and lack of transparency created an environment ripe for ethical lapses. Glaring conflicts of interest went unaddressed and led to a massive financial fraud that is still being unwound.
This FTX culture, established by Bankman-Fried, sowed the seeds of the company's downfall.
Lack of Controls – The Death Knell
Poor culture alone may cripple a company, but when coupled with a complete lack of controls, it proves to be deadly.
After FTX fell into bankruptcy, John J. Ray III was appointed as FTX’s new Chief Executive Officer. Ray, who has over forty years of legal and restructuring experience, summed it up to the bankruptcy court:
"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. From compromised systems of integrity and faulty regulatory oversight abroad to the concentration of control in the hands of a very small group of inexperienced, unsophisticated, and potentially compromised individuals, this situation is unprecedented."
The statement is shocking given that Ray supervised Enron through its bankruptcy and served as either Chief Executive Officer or the Chief Restructuring Officer in several other large corporate failures, including Residential Capital, Nortel and Overseas Shipping.
In his declaration to the bankruptcy court, Ray wrote that part of his remit would be to implement controls and basic corporate standards. Missing from the company were rudimentary oversight and risk management practices - from the board level to auditing, accounting, cash management, human resources, and data protection.
The shocking lack of governance at FTX should serve as a note of caution to other would-be entrepreneurs in any industry about the importance of guardrails.
- Oversight. As Ray detailed in the bankruptcy filing, there were hundreds of companies in the FTX group, and many lacked appropriate oversight at the board level. Some of the companies had never had board meetings, and they lacked independent board members, relying instead on Bankman-Fried and a small group of insiders. This lack of independent oversight was not just a departure from best practices but also a significant risk factor that enabled the unchecked execution of high-risk strategies.
- Cash controls. Control of cash was lackadaisical and decentralized. Ray could not locate an accurate list of bank accounts or account signatories when he came in. A centralized cash management system is one of the most basic tenets of good governance. Without it, a company has no idea what its true financial picture is.
- Disbursement controls. At FTX, these controls consisted of employees submitting payment requests through an online ‘chat’ platform. After submission, various supervisors would approve requests by responding with emojis. While this may be okay between friends where one requests payment from another for a personal meal or trip on a platform like Venmo, it is not an appropriate disbursement control for a business.
- Accounting. Ray reported to the bankruptcy court that FTX had no accounting department. The function had been entirely outsourced. Outsourcing support staff may be an appropriate strategy when a company is young. However, to be successful, a core leader, such as a functioning Chief Financial Officer, should be an employee of the company and supervise the outsourced staff.
- Human Resources. To the extent this function existed, it was dysfunctional. Records were unclear, lines of responsibility were fuzzy, and employees and outside contractors were combined. A clear picture of who works for the company and who does not is the baseline for any company’s Human Resources department. Otherwise, a company does not have the ability to appropriately compensate individuals, which is the basis of any working arrangement, whether employee or contractor.
- Security controls. FTX lacked security controls across the board, including using an unsecured group email account to access confidential private keys and critically sensitive data around the world. Anyone in business should understand the need for basic security controls over anything done online. The risk of an unsecured group email being forwarded or hacked is not a matter of if anymore but when.
Lessons Learned and Moving Forward
The downfall of FTX provides crucial lessons for the finance industry and the broader business world. It underscores the importance of strong governance structures, ethical leadership, and transparency in business. In the finance industry specifically, the absence of effective controls and oversight allows money to be moved around in an unchecked manner, and it raises the risk of not only malfeasance, as was the case here, but money laundering.
Businesses should use the fall of FTX as an opportunity to re-examine their own internal financial controls, governance structures, and culture of integrity. It is always better to learn from the mistakes of others and use them as opportunities to improve than to endure the hardship of learning from your own mistakes.
In the end, FTX lacked two essential ingredients for success - a culture of integrity and controls. To successfully sustain and grow a business of any size in any industry, you need both.
