- J Huang and S Pettigrove
FTX bankruptcy details "hubris, incompetence, and greed"
The US bankruptcy administrators of collapsed crypto-exchange FTX issued a report this week detailing widespread management and control failures at the exchange once led by Sam Bankman-Fried (SBF). The administrators' lawyers also said in a hearing that they have recovered US$7.3 billion of "distributable assets".
In the report, the debtor entities, now led by veteran restructuring advisor John Ray III, said:
while the FTX Group’s failure is novel in the unprecedented scale of harm it caused in a nascent industry, many of its root causes are familiar: hubris, incompetence, and greed.
Ray filed the report in the US Bankruptcy Court for the District of Delaware. It contains damning details about FTX's alleged control failures.
1. Lack of management and governance control
The report states that management of the FTX Group was largely limited to a small group led by SBF and which included Nishad Singh and Gary Wang (who have already pled guilty to criminal charges).
According to the report:
These individuals, not long out of college and with no experience in risk management or running a business, controlled nearly every significant aspect of the FTX Group
FTX Group lacked independent or experienced finance, accounting, human resources, information security, or cybersecurity personnel or leadership, and lacked any internal audit function whatsoever. Board oversight, moreover, was also effectively non-existent.
Further, the company did not maintain an organizational structure nor a complete list of employees at the time of its bankruptcy filing.
2. A lack of financial and accounting controls
Ray says that the FTX Group did not have an appropriate accounting system noting that 56 entities did not produce financial statements of any kind and 35 entities used QuickBooks - an accounting software designed for small businesses and freelancers - as their accounting system.
The report further criticizes the firm's external accountants:
There is no evidence that the FTX Group ever performed an evaluation of whether its outside accountants were appropriate for their role given the scale and complexity of the FTX Group's business, or whether they possessed sufficient expertise to account for the wide array of products in which the FTX Group transacted
Another issue cited in the report was the submission of expenses and invoices on Slack, which were then approved with emoji.
These informal, ephemeral messaging systems were used to procure approvals for transfers in the tens of millions of dollars, leaving only informal records of such transfers, or no records at all
3. A lack of digital asset management, information security, and cybersecurity controls
Ray alleges that FTX:
failed to implement basic, widely accepted security controls to protect crypto assets.
The failure by FTX to enforce the simple security measure of multi-factor authentication (or MFA) among its staff and corporate infrastructure is particularly ironic, given that
the FTX Group recommended that customers use MFA on their own accounts, and Bankman-Fried, via Twitter, publicly stressed the importance of...MFA, for crypto security
The report further states that FTX Group did not have any mechanism to identify promptly if someone accessed the private keys of central exchange wallets holding hundreds of millions or billions of dollars in crypto assets. Due to the lack of such controls, Ray's team first learned of a US$ 3.5 billion breach of the exchange last November from Twitter.
On a more uplifting front, Ray's team has identified:
recovered and secured in cold storage over $1.4 billion in digital assets, and have identified an additional $1.7 billion in digital assets that they are in the process of recovering.
At a hearing this week, the debtors' lawyers Sullivan & Cromwell said the total assets available for recovery now sit at US$7.3 billion, as shown in the chart below:
The bankruptcy administrators are targeting a preliminary restructuring plan by July and a final plan approved by the Court in the middle of 2024.
The additional recoveries by the US bankruptcy administrator will boost hopes of increased payouts to creditors of FTX Trading. The interim report nevertheless provides a depressing list of traditional control failures and mismanagement which are not exclusive or exceptional to cryptocurrency exchanges or start-ups. It increasingly appears that the spectacular collapse of FTX was largely due to these failures rather than crypto specific business risks.