Top Lessons Investors Should Take Away From The Collapse Of FTX

The U.S. attorney’s office for the Southern District of New York officially charged cryptocurrency exchange FTX’s founder Sam Bankman-Fried (SBF) with eight counts of fraud and conspiracy, calling the collapse of FTX “one of the biggest financial frauds in American history.” The U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission also sued SBF for fraud on the same day. These lawsuits came just the day after the Royal Bahamas Police Force arrested SBF. 

Although the FTX case dealt with cryptocurrency, the crime SBF was alleged to have committed was no different than Bernie Madoff’s, which was stealing money from customers. Federal prosecutors accused him of “misappropriating FTX.com customers’ deposits … and violating campaign finance rules for conspiring with others to make illegal political contributions.” The SEC accused SBF of building “a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto” and using customers’ money (without their knowledge nor permission) to support his trading firm Alameda, and “undisclosed private venture investments, political contributions, and real estate purchases.”

During his congressional testimony, FTX’s new CEO, John Ray, called SBF’s crime “plain old embezzlement.” He further warned that FTX has already incurred a loss north of $7 billion, and its U.S.-based customers might not get their investment back. The public should learn four lessons from this case to better protect their assets in the future and avoid becoming victims of another con.

Be Aware of Early Warning Signs

Fraud never happens overnight. There are always red flags. A firm that engages in fraudulent activities lacks transparency, and the fraudster in charge ensures only a few in the inner circle have knowledge of the firm’s complete business operations and accurate financial information. The recordkeeping in such a firm is intentionally lacking to make external auditing almost impossible. For example, current CEO John Ray said that FTX was “unusual in the sense that literally there’s no recordkeeping whatsoever.” FTX was once valued as a $32 billion company, yet the company relied on the chat service Slack and accounting platform QuickBooks for recordkeeping. According to Ray, QuickBooks is not a suitable accounting tool for “a multibillion-dollar company.” The SEC also alleges that “From its inception, FTX had poor controls and risk management procedures. Assets and liabilities of all forms were generally treated as interchangeable, and there were insufficient distinctions between the assignment of debts and credits to Alameda, FTX, and executives.” 

Another warning sign investors should look for is whether the firm has an overly complex corporate structure. For instance, SBF owned or managed over 100 companies under FTX Group’s umbrella. A supposed audit of FTX’s 2021 financial statement revealed that “FTX and’ related parties’” engaged in “tangled relationships” worth over $250 million and that “numerous FTX employees were working for those related parties.” Complicated corporate structures and cross-ownerships indicate that the company and its founder may have something to hide because complexity is often deployed to obscure the movement of funds and make them hard to trace.

It is a red flag if the company’s founder