FTX collapse is a case study in bad governance
The collapse of FTX, a cryptocurrency exchange, will serve as a case study in bad governance for generations to come.
The sorry tale is yet another example of how poor leadership and a complete lack of governance can plunge a company into chaos.
Or at least that’s how the new CEO feels.
Quick facts – what do we know?
- FTX began operation in 2019. Its headquarters are in Nassau, Bahamas.
- In early November, a Coindesk article claimed that the company held a significant portion of its assets in its own crypto token, FTT.
- This sparked a ‘bank-run’ style panic.
- FTX filed for chapter 11 bankruptcy in a Delaware court on 11th November this year.
- FTX still owes $3.1 billion to its top 50 creditors.
- The collapse of FTX has sparked a general drop in the price of other major cryptos.
How did we get here?
John J. Ray III is the new CEO of FTX.
In his eyes, he has been handed a complete mess.
“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,” he said in a court filing.
Incidentally (if you’re old enough to remember), Ray is the same person who helped manage the American energy and commodities company Enron, which famously filed for bankruptcy in 2001 amid a massive accounting and audit scandal that prompted the introduction of new record-keeping and reporting laws.
And still, Ray thinks the FTX collapse is worse, labelling it a “catastrophic failure.”
What governance failures have surfaced at FTX?
The question should be, ‘what issues haven’t surfaced?’. FTX has only been in business for three years, and already, Ray claimed it was guilty of the following:
- Compromised systems integrity.
- Faulty regulatory oversight.
- No centralised control of the cash that it handled.
- An inaccurate list of bank accounts and account signatories.
- Inaccurate bookkeeping.
- Luxury purchases made by employees in the Bahamas with corporate funds.
- Inaccurate registering of these assets with government authorities.
Ultimately, Ray concluded that despite the volume of wealth that FTX handles and the company’s popularity in the global crypto market, control was in the hands of “a very small group of inexperienced, unsophisticated and potentially compromised individuals.”
“The situation is unprecedented,” he finished.
What does all this mean?
With his experience, Ray’s conclusion that bad governance is to blame likely carries a lot of truth.
The saga has once again proven that no matter how big a company is, lousy governance can efficiently finish it off. If anything, larger companies carry more risk because the fallout from the failure will be more significant.
Is this an isolated incident?
When we drill down to specifics, yes. But in general, no.
FTX is one of many digital finance firms that have flirted too heavily with the wrong side of governance and paid for it.
Other examples include:
- The massive collapse of the German finance and digital payments company Wirecard
- Another crypto exchange platform, Binance, has had to cease operating in many countries, including the US, UK and Netherlands, over lax money laundering controls. Critics often cite bad governance as a reason companies open themselves to the risk of financial crime.
Digital finance-based firms are especially vulnerable to bad governance in this way. They begin on a wave of popularity, and many grow rapidly without good leadership, security, or controls. When firms in this situation run into trouble, outcomes like FTX’s are possible.
What is the lesson for investors after the collapse of FTX?
FTX, once a leading exchange platform for cryptocurrencies, filed for bankruptcy in the USA, making global headlines.
So why did so many significant investment funds throw money at the business without proper due diligence?
The answer is old-fashioned hype.
One lesson we can learn from history is to be wary of hype. It would help if you also were suspicious of messianic CEOs who claim they can turn thin air into gold.
Even a cursory glance at the governance structures at FTX should have sent alarm bells ringing.
Did the CEO have a ‘critical friend’ around the board table, a non-executive director who could ask the difficult but necessary questions?
Who sat on the board of FTX? How often did they meet?
Before investing enormous sums into any business, it is incumbent on the investor to examine and investigate the organisation’s governance structures.
A company that has poor or limited governance should be avoided.