We are all familiar with the many accounting and auditing scandals in South Africa and across the world. Unfortunately, scandals are all too commonplace in the world of crypto − from international incidents like Mount Gox to local occurrences such as Mirror Trading International and, most recently, FTX.
The numerous crypto scandals warrant a conversation about professional scepticism that is lacking in the get-rich-quick mindset that seems to have taken over the crypto landscape. At the time of writing, the largest scandal in the crypto industry is unfolding – that of the FTX exchange and Alameda Research.
Founded by MIT graduate Sam Bankman-Fried in 2019, FTX was a crypto exchange platform where predominantly retail investors (individuals) could trade in various crypto assets. Also founded by Sam, Alameda Research was a crypto trading firm. Formerly known as the ‘crypto golden boy’, Sam quickly rose to stardom in the industry as he was perceived to be exceedingly smart and quirky. Sam engaged with the media widely and associated with well-known celebrities like Katy Perry and Tom Brady as well as former politicians such as Tony Blair and Bill Clinton. Styling himself as an ‘effective altruist’, Sam promised to donate most of his wealth to charities. By 30 years old, he was already worth an estimated $20 billion.
As part of his FTX crypto exchange, a crypto asset or token called FTT was minted (created). Like most crypto assets, the value of the FTT token is determined speculatively with no real asset backing. Given that Sam held both an exchange and a trading firm under his purview, one would logically and reasonably expect that there would be a clear separation between the entities. While the FTX exchange specifies that customer funds placed on the exchange to trade in crypto remain the property of the customer, this does not appear to have been the case.
A CoinDesk report revealed that most of the assets of Alameda Research were in the FTT token. While this is not illegal, it raised concerns that Alameda Research is very closely connected to the FTX exchange and that most of its assets are made up of a crypto asset created by a group company (not an independent asset like a fiat (government-backed) currency or another crypto asset). It was eventually revealed that Sam and the FTX exchange, along with Alameda Research, spent customer funds for their own purposes, including making donations to politicians, paying for celebrity endorsements and purchasing fixed property. This is illegal and unethical, given that most of these transactions were funded with investor money.
Here is a brief timeline of the key events surrounding the FTX exchange scandal:
- 2 November 2022 − CoinDesk reported on the ‘unusually close’ relationship between the FTX exchange and Alameda Research.
- 6 November 2022 − The CEO of Binance (the world’s most popular crypto exchange) and Changpeng Zhao (also known as CZ) liquidated their FTT tokens holdings. Most investors noted this and lost faith in the FTX exchange. Consequently, many started selling off their own FTT tokens. The price of FTT tokens fell significantly, spurring further divestments. However, not all customer funds were available as some had been illegally spent as discussed earlier, throwing the FTX exchange into a liquidity crisis.
- 8 November 2022 − The FTX exchange halted all non-fiat withdrawals. Sam asked CZ for assistance with the liquidity crisis and he tentatively agreed to acquire the FTX exchange.
- 9 November 2022 − After reviewing the financial records of the FTX exchange, CZ backtracked and publicly posted on Twitter (now X.com) that the sale was not going to go through.
- 11 November 2022 − The FTX exchange, formerly valued at an estimated $32 billion, filed for bankruptcy and Sam resigned as CEO.
- 12 December 2022 − Sam was arrested by the Bahamian authorities and charged with seven counts of fraud and conspiracy by the United States government.
- 2 November 2023 − After a month-long trial, Sam was found guilty by a New York jury of all seven charges brought against him.
After the FTX exchange’s collapse, a new CEO and bankruptcy overseer, John Ray III, was appointed. John, an attorney with decades of experience, was formerly the bankruptcy overseer of Enron. In relation to the FTX exchange, John scathingly noted: ‘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.’
The FTX exchange, unbelievably, had no board of directors or any other monitoring body or function. It was controlled by Sam and his close associates, who all allegedly lived together in the Bahamas. Furthermore, the FTX exchange ran its accounting on QuickBooks – software targeted at individuals and smaller businesses – and Sam often communicated using applications where the messages auto-deleted. There were no lasting records of decision-making and no clear segregation of duties. The tone at the top and an appropriate control environment were non-existent. It is difficult to believe that such a situation did not raise alarms with institutional investors and lenders who would reasonably be expected to know better. Perhaps they, too, were swept up by the get-rich-quick mindset.
Investors, many of them individuals, including a teacher’s pension fund, lost any money they had invested in the FTX exchange. This was possible, despite it appearing that the exchange’s 2021 financial statements were audited by firms Armanino LLP and Prager Metis CPAs LLP. Auditors are required to act in and protect the public interest. The role of assurance in the crypto industry must be considered to ensure that such a scandal does not happen again.
As professional accountants, it is incumbent upon us to critically evaluate crypto dealings with renewed scepticism. Given the nascent state of regulation in the crypto industry and its reactive (as opposed to proactive) nature, it is vital for everyone to assess risk and risk appetites accordingly. The crypto industry is overwhelmingly beset by scams and schemes. Scepticism and resisting the siren song of the get-rich-quick mindset are paramount.
Author
Asheer J. Ram, CA(SA), MCom (Wits)
