Bankruptcy Proceedings Reveal Shocking Lack of Controls at Disgraced Cryptocurrency Exchange FTX (IV of IV)

Matt Stankiewicz, Partner at The Volkov Law Group, wraps up his blog series on FTX, highlighting some of the more interesting facts from the company’s recent bankruptcy filing.  He can be reached at [email protected].

On top of all the legal trouble for FTX’s founder and CEO, Sam Bankman-Fried (“SBF”), the company has also filed for bankruptcy and SBF has been ousted as CEO.  John J. Ray III, an attorney and bankruptcy professional, has stepped into the role of CEO to navigate the company through these proceedings.  Interestingly enough, Mr. Ray is the same attorney who served as chairman of Enron Creditors Recovery Corp., the company tasked with recovery creditor funds from Enron after that famous scandal. 

It’s worth discussing the bankruptcy proceedings, as the initial fillings indicate a litany of compliance failures, failures so glaring and so ridiculous that compliance professionals will just shake their heads in disgust.  Part of this discussion is just for entertainment purposes.  Otherwise, it also presents a look at a company that grew too fast and thought themselves to be untouchable.  Some of this material may be a good source of relevant examples for your next training session. 

pieces of bitcoins on laptop keyboard

In its initial filing, FTX indicated that it has more than 100,000 creditors with liabilities in the range of $10 billion to $50 billion.  All of FTX’s various businesses were included in the proceedings, including FTX US.  Prior to the filing, SBF had indicated that FTX US was fully solvent.  However, it turns out, as with most of SBF’s statements, this was not completely true, and as such US customers are now in limbo as the proceedings work their way through the court system. 

In a court filing from November 17, 2022, Mr. Jay outlines a variety of the internal control failures that led to the demise of the company.  Somewhat amazingly, the man that oversaw the Enron scandal stated in no uncertain words that this situation was the worst he’s ever seen:

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 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.

When you see a statement like that, especially from the guy that came in to clean up Enron, you know the rest of the filing is going to be interesting.

My personal favorite comes from the discussion regarding disbursement controls.  FTX employees submitted reimbursement requests through an online chat platform, where various supervisors would approve disbursements solely by the use of various emojis. Many of these chat logs were set to auto-delete after a certain time, so some records could not be recovered.  Furthermore, many of these transactions were for personal loans to employees used to by real estate or other personal items. Many of these so-called loans lacked any formal documentation, despite being of significant value.  SBF himself received a loan of $1 billion, while another executive—Nishad Singh—received $543 million.

At a close second behind the reimbursement policy, is the fact that FTX apparently failed to maintain a record of the employees who worked at the company.  The filing notes that “[a]t this time, the Debtors have been unable to prepare a complete list of who worked for the FTX Group as of the Petition Date, or the terms of their employment.”  This also means that there were no clear delineations of responsibility amongst the employees and no way of knowing who reported to who.

bitcoins and u s dollar bills

Next, FTX did not have any type of sophisticated cash management system and did not maintain centralized control of its cash.  The company apparently did not even maintain an accurate list of bank accounts controlled by the company.  At a high level, the company had no way of knowing how much cash they had on hand at any given point.  This is also likely due to the fact that much of their decisions were made through chats that deleted after a set period.  Considering how frequently they dipped into customer funds for various reasons, it’s likely they were not concerned with these accounts since they always gave themselves access to liquid assets.

The new CEO expressed substantial concerns regarding the audited financial statements for several of the companies.  The filing noted that FTX relied upon an audit firm Prager Matis, which holds itself out to be the “first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland.”  In addition to these statements appearing to be wholly unreliable, FTX did not even have a formal accounting department despite the size and scope of the company.  Instead, they outsourced the entire function and relied on Quickbooks for day-to-day operations.  Shockingly (or maybe not so shocking considering all we’ve learned to this point), “[b]alances of customer crypto assets deposited were not recorded as assets on the balance sheet and are not presented.”

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