Earlier Thursday FTX CEO John Ray III filed a declaration with the United States Bankruptcy Court for Delaware, the latest in the implosion of one of the world’s largest cryptocurrency exchanges.
Ray, who helped shepherd Enron through its own bankruptcy, minced no words about the state of the company or the behavior of the former executive team, describing it as one of the worst examples of corporate controls he’d ever encountered. It was a damning remark from someone who has 40 years of legal and restructuring experience.
Here are some of the most significant revelations from Ray’s filing:
1. A total lack of financial and corporate controls
“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.”
Ray opened his filing torching former management, including former CEO Sam Bankman-Fried, for the failure by leadership to catch and address a stunning, multi-billion dollar hole in the Alameda-FTX balance sheets. The losses for investors may reach as high as $8 billion. But with nonexistent or deficient accounting, auditing, and disbursement systems, it will take Ray and his forensic investigators “some time” to uncover the truth.
2. Slipshod accounting will require forensic analysis.
“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 [companies].”
FTX’s new chief said he had “substantial” concerns about the financial positions he was presenting to the court. FTX’s implosion revealed a massive hole in the company balance sheets, but until blockchain analysis and forensic accounting are completed, Ray said it was not “appropriate for stakeholders or the Court to rely” on the numbers presented.
Accurate financials are a key metric for valuing and investing in a company. Venture capital firms poured billions into posterchild Bankman-Fried and his companies, valuing them at in the tens of billions of dollars.
A standard aspect of any venture capital investment is a due diligence (DD) period, where books are opened and audited financials are shown to prospective investors. Ray’s assertion that the financial statements for many of FTX’s subsidiaries are unreliable raises fresh questions about the diligence performed by some of the world’s biggest venture firms.
3. Penthouses, perks and personal items
“In the Bahamas, 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.”
Other reports have detailed lavish perks allegedly given to FTX employees in the Bahamas. Ray’s filing indicated that corporate funds were used to purchase homes for employees and advisors, sometimes in their name. Loans were not recorded from FTX to those individuals — as is typical with similar arrangements at other companies. Instead, individuals were given the deeds to these properties, according to Ray, free and clear, in their own names.
Notably, Bankman-Fried’s $40 million penthouse briefly hit the market in the aftermath of the bankruptcy. It has since been removed from public listing.
4. Emojis for expenses
“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 online ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis.”
Despite an entire industry devoted to expense controls and reimbursements, Bankman-Fried’s team used internal messaging to release corporate funds into the hands of employees around the world. It isn’t immediately clear what platform FTX used, although the company is known to have used Slack for internal communications.
5. An advantage for Alameda
Unacceptable management practices included the use of an unsecured group email […] to access confidential private keys and critically sensitive data […] the absence of daily reconciliation of positions on the blockchain, the use of software to conceal the misuse of customer funds, the secret exemption of Alameda from certain aspects of FTX.com‘s auto-liquidation protocol, and the absence of independent governance […]”
Alameda Research, the secretive trading firm at the heart of Bankman-Fried’s empire, executed trades on FTX alongside other institutional and individual traders. The two firms were closer than publicly acknowledged, however, in light of Ray’s declaration that Alameda was exempted from “certain aspects” of FTX’s auto-liquidation protocol.
It isn’t immediately clear what aspects Ray meant. In crypto trading, liquidation is most analogous to a margin call, where a levered position is closed out by an exchange due to a dramatic shift in an underlying asset’s price.