The One Super-Big Lesson of FTX

People keep asking me what lessons the compliance and audit community might learn from the spectacular collapse of cryptocurrency platform FTX Corp. The more I contemplate FTX’s shortcomings, however, the more I believe the answer to that question is simply “all of them.” 

Just read the bankruptcy petition filed on Nov. 17 by newly named CEO John Ray. The document doesn’t really catalog bad governance practices employed by FTX’s prior management, as much as it raises its hands in bureaucratic surrender and admits that FTX had no corporate governance at all. “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information,” Ray stated at the top of the filing, and then went on to prove the point for another 29 pages. 

So sure, we can hop-scotch through what those missing controls were. For example:

• No centralized control of cash. FTX had no complete and accurate list of its bank accounts, and paid scant attention to the creditworthiness of its banking partners. As of the bankruptcy filing on Nov. 17, Ray wasn’t even sure how much cash FTX actually had.
• No reliable financial reporting. Yes, FTX did undergo a financial audit for at least two of the four operating units within its empire; but because FTX’s own recordkeeping was so shoddy, nobody can be sure the few audited financial reports FTX had compiled are reliable.
• No personnel oversight. FTX’s prior management relied on a mix of full-time employees and contract labor, without keeping an authoritative list of either one. “Repeated attempts to locate certain presumed employees to confirm their status have been unsuccessful to date,” Ray wrote — and considering the mess those people left behind, I almost don’t blame them.
• No spending controls. When employees wanted to spend company money, they just texted a request to a group chat of FTX managers. Said managers would then reply with an emoji, and that was the entire approval process.
• No books and records. FTX and its subsidiary units had no real board meetings, which therefore means no minutes of debates and decisions. Most important decisions were made by now-former CEO Sam Bankman-Fried, who communicated with apps that automatically deleted messages after a certain time. He encouraged other managers to do the same.

You get the idea. We can’t say any of the above controls “failed” in the traditional sense of the word, because the controls weren’t there at all — at least, not in any sense that a serious-minded executive would recognize. Bankman-Fried duped investors into giving him lots of money, which he then used to live the high life while play-acting the role of chief executive. 

The Purpose of Corporate Governance

So when I say the lessons to learn here are all of them, I mean that the downfall of FTX reminds us of why we have corporate governance in the first place. FTX is a negative image of corporate governance, showing us the sorts of internal controls that are supposed to exist in a company — cash controls, HR controls, approval processes, financial reporting, and so forth — by documenting their absence at FTX itself. 

Today, for example, came news in a second bankruptcy hearing that a “substantial amount” of FTX’s assets is now missing, and quite possibly stolen. James Bromley, a lawyer advising FTX’s new management team, told the court: “FTX was in the control of inexperienced and unsophisticated individuals, and some or all of them were compromised individuals.” 

That is what corporate governance is meant to weed out. It’s OK to be an inexperienced and unsophisticated individual; at some point in their lives, entrepreneurs from Jeff Bezos to Steve Jobs to Thomas Edison all were. But corporate governance channels the raw entrepreneurial talent in such individuals, so their vision can scale and endure and make lots of people rich. 

At FTX, we just had the weird and wildly-coiffed figure of Bankman-Fried, play-acting serious CEO while he and his inner circle really just took investor money and then spent it on whatever impulse coursed through their brains at that particular moment. One article from the Wall Street Journal portrayed Bankman-Fried and that inner circle as a bunch of overgrown kids charging through a hive-mind life, all of them living and working together in a luxury penthouse. Holy hell, the mess is almost beautiful to behold in its painful, exquisite wrongness. 

One Final, Pitiful Point

At least Bankman-Fried and his henchmen can be dismissed as human spreadsheets: phenomenal computing power, zero wisdom or restraint. Left unto their own devices (which they were, and which they wanted, which is why they crawled into the world of crypto), of course they were going to end up in a mess like this. 

I’m actually more annoyed with the venture capital firms and other ostensibly serious investment funds that poured money into FTX as it grew in the late 2010s and first two years of the 2020s. Those investors should have known better. Their job, literally, is to make wise investments on behalf of college funds, pension funds, and other limited partners. 

So I was intrigued to see that Sequoia Partners, one of the giants in the Silicon Valley venture capital world, apparently has apologized to those limited partners for flushing $150 million of their money down the FTX toilet. Sequoia now promises that in the future, the firm “will be in a position” to have even early-stage startups audited by Big 4 firms. 

That’s one step in the right direction. Let’s hope more investment funds exercise such restraint and judgment. Indeed, it’s striking to see that VC firms generally did avoid Theranos and its fraudster founder Elizabeth Holmes, now serving 11 years in federal prison. Why avoid her, but not Bankman-Friend? One wonders.