Could Two Common Financial Controls Have Prevented the Fall of FTX?

January 2, 2023

At a glance

  • Main takeaway: In two weeks’ time, FTX went from the foundation of the cryptocurrency industry to a cautionary tale. If two common financial controls – a board of directors and a CFO were in place, the outcome could have been much different.
  • Impact on your business: Use the fall of FTX as an opportunity to examine your own internal financial controls and ensure they’re as strong as they can be to effectively mitigate risk at your organization.
  • Aprio’s Technology and Blockchain CPA Services team can help you assess your internal controls and accounting needs.

Schedule a consultation with Aprio today.

The full story:

FTX was more than just an apparently sound company. It was the foundation of the cryptocurrency industry. In two weeks’ time, it went from a multi-billion crypto exchange to a pile of ash. As the supernova that was Sam Bankman-Fried and FTX implodes, it’s worth analyzing what could have been done to prevent the disaster that has shocked the crypto world.

Notably, if two common financial controls – a board of directors and a CFO were in place, the outcome could have been much different.

Recap: How we Got Here

John J. Ray III, the new CEO appointed to shepherd FTX through bankruptcy called the situation the biggest mess he’s ever seen, saying in a court filing, “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.” That statement was shocking given that Ray guided Enron through its bankruptcy-induced reorganization.

FTX founder and disgraced CEO, Sam Bankman-Fried, is now under investigation by the Southern District of New York, the Securities Exchange Commission, the Commodities and Futures Trading Commission, Authorities in the Bahamas where FTX is based, and the House of Representatives Oversight Committee’s Subcommittee on Economic and Consumer Policy, which is seeking internal documents and communications from Bankman-Fried to understand how FTX unraveled so quickly and disastrously.

But before the downfall, there were two common financial controls missing. Their absence should have alerted investors and regulators alike to invest in FTX with caution.

The Lack of a Board of Directors and CFO at FTX Were Huge Red Flags

In the bankruptcy filing, Ray said, “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 system integrity.”

Some of the failures immediately surfacing at FTX include unreliable financial statements, mishandling of confidential data, diversion of corporate funds to purchase homes for employees, record-keeping and a lack of centralized control of company cash.

Early approximates put FTX’s cash available at about $564 million, far short of the $8 billion that Bankman-Fried told investors his company would need. And Ray has noted a complete absence of record-keeping, due in part to Bankman-Fried’s use of applications that auto-delete after a short period of time for communication.

Another warning sign comes in a lack of audits performed on financial statements. Ray noted one audit came from a firm describing itself as, “the first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland.” Further, many companies in the FTX Group did not have appropriate corporate governance, hold board meetings, or maintain an accurate list of bank accounts and account signatories according to Ray.

Simply put, the way to avoid disaster of this magnitude is by following well-known best practices and structures designed to prevent fraud. All of these issues could have been hedged with a properly functioning, ethical CFO and Board of Directors.

The bottom line

Strong internal controls prevent the unusually close relationships, poor corporate culture and compromised systems that exposed FTX shareholders to elevated risks. Aprio’s Blockchain Tax/KYC/AML/BSA Practice can guide you in implementing the proper internal controls to mitigate risk for your company.

Aprio’s Blockchain Tax Practice team can help you mitigate risk at your organization. Schedule a consultation today!

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Disclosures

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.

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About the Author

Emily Cheshire

Emily is the leader of Aprio Cloud’s Blockchain and Cryptocurrency Team, providing outsourced accounting, technology solutions and blockchain consulting to CEOs and CFOs of venture-backed startups and growing companies.

David Recchion