In case any of us forget the importance of good corporate governance, have a look at the administrator John Jay III’s declaration* on the collapse of FTX, a company once valued at $32 billion. The governance was so bad, you might smile at some of this, but remember that a vast number of people have lost a lot of money. I’ve added a few signposts for each quotation from the report, and a few conclusions at the end:
A damming summary;
“Nearly every situation in which I have been involved has been characterized by defects of some sort in internal controls, regulatory compliance, human resources and systems integrity.
“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.”
It’s good to have a functioning board
“Many of the companies in the FTX Group, especially those organized in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings.”
But do keep an eye on cash
“The FTX Group did not maintain centralized control of its cash. Cash management procedural failures included the absence of an accurate list of bank accounts and account signatories, as well as insufficient attention to the creditworthiness of banking partners“
“Effective cash management also requires liquidity forecasting, which I understand was also generally absent from the FTX Group historically.”
And don’t rely on the auditors to spot trouble
“The FTX Group received audit opinions on consolidated financial statements for two of the Silos – the WRS Silo and the Dotcom Silo – for the period ended December 31, 2021”
“As a practical matter, I do not believe it appropriate for stakeholders or the Court to rely on the audited financial statements as a reliable indication of the financial circumstances of these Silos.”
Know who you employ
“The FTX Group’s approach to human resources combined employees of various entities and outside contractors, with unclear records and lines of responsibility. At 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. Repeated attempts to locate certain presumed employees to confirm their status have been unsuccessful to date.”
Chat functions and emojis don’t constitute proper controls
“The Debtors did not have the type of disbursement controls that I believe are appropriate for a business enterprise. For example, employees of the FTX Group submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis.”
Don’t buy houses for your employees
“I understand that corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors. I understand that there does not appear to be documentation for certain of these transactions as loans, and that certain real estate was recorded in the personal name of these employees and advisors on the records of the Bahamas.”
Keep a note of your assets, even the digital ones
“The FTX Group did not keep appropriate books and records, or security controls, with respect to its digital assets”
“The FTX Group had billions in investments other than cryptocurrency, as suggested above in the descriptions of the four Silos. However, the main companies in the Alameda Silo and the Ventures Silo did not keep complete books and records of their investments and activities.”
Watch out for thieves
“The Debtors have cryptocurrency, digital assets and other critically sensitive data in repositories that have been the subject of unauthorized attempts to access.”
Don’t try to create money when you’ve just gone bust
[There was] “dilutive ‘minting’ of approximately $300 million in FTT tokens by an unauthorized source after the Petition Date and (c) the failure of the co-founders and potentially others to identify additional wallets believed to contain Debtor assets.”
Keep records of decisions & don’t just delete them
“One of the most pervasive failures of the FTX.com business in particular is the absence of lasting records of decision-making. Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same.”
Think before you speak
“Mr. Bankman-Fried, currently in the Bahamas, continues to make erratic and misleading public statements. Mr. Bankman-Fried, whose connections and financial holdings in the Bahamas remain unclear to me, recently stated to a reporter on Twitter: “F*** regulators they make everything worse” and suggested the next step for him was to “win a jurisdictional battle vs. Delaware”.”
Are there any lessons for the rest of us?
- Beware of start-ups and make sure that they have adequate governance and controls.
- Frauds often look spectacularly successful…until they suddenly collapse (think of Enron, Bernie Madoff, Theranos and Wirecard).
- Don’t let employees use messaging systems for work, only company email.
- Don’t assume that auditors will find fraud (they generally don’t).
- Good governance really matters – not box ticking, but real controls and involvement.
- Entrepreneurs are fun, exciting and can create great value, but high quality, experienced executives and directors are vital to capturing that value and keeping you out of jail.
* ‘DECLARATION OF JOHN J. RAY III IN SUPPORT OF CHAPTER 11 PETITIONS AND FIRST DAY PLEADINGS’ IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE. Filed 17 Nov 2022