Kara Sears
The collapse of FTX, the third-largest cryptocurrency exchange, in 2022 sent shockwaves through the crypto industry, stoking widespread mistrust among the public and toppling cryptocurrency services that did business with it.
FTX's downfall was triggered by reports that its affiliated trading firm, Alameda Research, derived most of its value from speculative cryptocurrency tokens. This revelation led to a surge in customer withdrawals, pushing FTX and Alameda into bankruptcy.
The U.S. government brought civil and criminal charges against Sam Bankman-Fried, the founder and former CEO of FTX, and top executives for misappropriating over $8 billion in customer deposits. Bankman-Fried was convicted and sentenced to 25 years in prison for stealing $8 billion from customers.
FTX's collapse has raised questions about the regulatory framework governing the crypto industry. While some have called for greater government oversight, others have pointed to the lack of clear and consistent rules as enabling market participants to enjoy regulatory arbitrage.
One regulatory framework that could have been applied to FTX is the Dodd-Frank Wall Street Reform and Consumer Protection Act, which mandates that certain entities create break the glass plans or living wills to prepare for potential failure. This requirement is intended to reduce and better manage financial risks and has been credited with improving the efficiency and prudential supervision of designated entities.
While FTX was not designated as an entity requiring a living will, its collapse has highlighted the need for stricter regulation in the crypto industry to protect customers and prevent systemic risk.
| Characteristics | Values |
|---|---|
| Founder of FTX | Sam Bankman-Fried |
| Date FTX was founded | 2019 |
| Date FTX collapsed | November 2022 |
| Reason for collapse | Misappropriation of customer deposits |
| Amount misappropriated | $8 billion |
| Criminal charges against SBF | Wire fraud, money laundering, conspiracy to commit commodities fraud, conspiracy to commit securities fraud, conspiracy to commit money laundering, conspiracy to defraud the Federal Election Commission and commit campaign finance violations |
| SBF's sentence | 25 years in prison |
| Amount SBF was ordered to pay | $11 billion |
What You'll Learn
Criminal charges and lawsuits
On 12 December 2022, Sam Bankman-Fried, the founder and former CEO of FTX, was arrested in the Bahamas on multiple fraud charges with FTX. He was indicted by the US District Court on eight criminal charges, including money laundering, wire fraud, campaign finance violations and securities fraud.
On 13 December 2022, the US Department of Justice (DOJ), the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) announced civil and criminal charges against Bankman-Fried. The DOJ unsealed an indictment charging Bankman-Fried with eight criminal counts, including wire and securities fraud, money laundering, and unlawful campaign finance contributions.
On 21 December 2022, Bankman-Fried was extradited to the US to face criminal charges. He was released on a record-breaking $250 million bond and placed under house arrest at his parents' home.
On 22 December 2022, Bankman-Fried was arraigned in a Manhattan federal court and pleaded not guilty to all criminal charges.
On 23 February 2023, the DOJ filed an additional four criminal charges related to unlicensed money transmission and other categories of fraud against Bankman-Fried.
On 28 March 2023, Bankman-Fried was charged with a foreign bribery charge.
On 20 July 2023, prosecutors accused Bankman-Fried of attempting to tamper with a witness, his ex-girlfriend Caroline Ellison, by leaking the contents of her diary to the New York Times. Ellison succeeded him as CEO of Alameda when he launched FTX.
On 26 July 2023, a federal judge placed Bankman-Fried under a gag order, prohibiting him from communicating with the public and the media.
On 11 August 2023, Bankman-Fried's bail was revoked and he was sent to prison.
On 2 October 2023, Bankman-Fried's criminal trial began.
On 2 November 2023, Bankman-Fried was found guilty on all seven charges.
On 28 March 2024, Bankman-Fried was sentenced to 25 years in prison and ordered to pay $11 billion.
On 9 September 2023, FTX filed a lawsuit against Bankman-Fried's parents, Joseph Bankman and Barbara Fried, on suspicion of embezzling millions of dollars from the business for personal gain and "pet causes".
On 15 November 2022, FTX investors filed a class-action lawsuit against FTX and its celebrity endorsers. The civil suit claimed FTX used "false representation and deceptive conduct" and accused FTX of using a Ponzi scheme to misuse funds and move customer money between entities.
Other lawsuits
On 27 December 2022, a group of FTX customers filed a complaint against FTX and its former management. The complaint was filed on behalf of all customers in order to have customer-creditors treated separately from other general unsecured creditors and secured creditors.
On 28 December 2022, an ad hoc committee of non-US customers of FTX.com filed a complaint against the company. The arguments and relief sought were substantially similar to those in the previous complaint.
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Misappropriation of customer funds
The collapse of FTX in November 2022 was triggered by a CoinDesk article revealing that the balance sheet of its sister company, Alameda Research, was heavily dependent on FTX's digital token, FTT. This article sparked a mass withdrawal of funds from FTX, which led to the company's bankruptcy.
However, the root cause of FTX's downfall was the misappropriation of customer funds by its founder and CEO, Sam Bankman-Fried. It was discovered that FTX had transferred billions of dollars of customer funds to Alameda Research, which was then used to make risky bets and prop up the trading firm. This was a direct violation of FTX's terms of service, which stated that none of the crypto in customer accounts was "the property of, or shall or may be loaned to, FTX Trading".
The U.S. Department of Justice indicted Bankman-Fried on multiple charges, including wire fraud, conspiracy to commit commodities fraud, and conspiracy to commit securities fraud. In November 2023, he was found guilty on seven federal counts and sentenced to 25 years in prison. He was also ordered to pay a forfeiture of over $11 billion.
The fallout from the FTX scandal extended beyond just the company and its customers. The collapse of FTX had a detrimental impact on the cryptocurrency industry as a whole, causing a surge of customer withdrawals from other cryptocurrency platforms and leading to the bankruptcy of several other companies in the space. The scandal also prompted calls for greater government oversight and regulation of the cryptocurrency industry.
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Misleading investors and lenders
The collapse of FTX in November 2022 was a result of a series of fraudulent activities and misleading statements by its founder and former CEO, Sam Bankman-Fried.
Bankman-Fried was charged with multiple counts of fraud, including wire fraud, commodities fraud, securities fraud, and campaign finance fraud. He was also charged with making false representations and deceptive conduct, and using a Ponzi scheme to misuse funds and move customer money between entities.
Bankman-Fried and his co-conspirators lied about FTX's financial health to investors, customers, and lenders, and hid a billion-dollar hole in its balance sheet with fake financial statements, inflated valuations of speculative tokens, and cryptocurrencies borrowed from lenders.
FTX's balance sheets were never audited because it was a private company. Without these audits, there was no record of cash flow or assets to show the company could cover liabilities or customer assets.
FTX's collapse had a domino effect on the cryptocurrency industry, causing widespread mistrust among the public and toppling cryptocurrency services that did business with it.
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FTX's corporate governance
The collapse of FTX has been described as a "case study in bad governance" and a "wake-up call, reminding us that governance and culture always matter".
FTX's new CEO, John J. Ray III, who previously managed the liquidation of Enron, described the situation at FTX as "unprecedented", with a complete failure of corporate controls and [...] trustworthy financial information.
Some of the specific issues that have been identified at FTX include:
- 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
- Lack of independent governance
- Concentration of control in the hands of a very small group of inexperienced, unsophisticated, and potentially compromised individuals
- Absence of an audit committee, board meetings, or an internal audit function
- Employee ranks were rife with conflicts of interest
- A custom-software “backdoor” was used to conceal the misuse of customer funds
- Related-party transactions raised red flags
- Expenses were approved via personalized emojis in online chats
- Many communications were set to auto-delete
The fallout from FTX's collapse has also raised questions about the corporate governance practices of its investors.
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FTX's accounting and financial controls
Firstly, FTX did not have an in-house accounting department and outsourced all accounting functions. This is highly unusual for a company of FTX's size and complexity, and it made it difficult for the new CEO, John Ray III, to obtain accurate financial information following the bankruptcy.
FTX also failed to produce balance sheets showing assets and liabilities, which is standard financial reporting procedure. This was due to the lack of an accounting department and experienced personnel to handle financial reporting, risk management, audits, and accounting procedures.
The company's financial statements were audited by Prager Metis, a small firm that is inspected by the audit regulator, the Public Company Accounting Oversight Board (PCAOB), only once every three years. Prager Metis has a poor track record with the PCAOB, and there are questions about why FTX chose this firm instead of a larger, more reputable company.
The choice to hire two different audit firms, Prager Metis and Armanino LLP, to produce opinions on consolidated results is also questionable. It suggests that FTX's founder, Sam Bankman-Fried, wanted to prevent any single firm from seeing the whole picture.
The audited financial statements themselves contained several red flags that should have raised concerns. Firstly, neither audit report provided an opinion on the internal controls over accounting and financial reporting. Secondly, despite enormous siphoning off of firm assets by related parties and favourable tax planning, neither FTX Trading nor FTX US paid any federal income taxes, even though they appeared to be profitable.
The most significant red flag was the number of complex, round-trip, and utterly confounding related-party transactions documented in just two years. These transactions involved FTX Trading and a control person, such as Bankman-Fried, who was acting outside of his role as the owner/control person at FTX.
Another red flag was the use of the FTX FTT token as currency for acquisitions. As notable crypto startups like BlockFi and Voyager Digital ran into financial trouble, Bankman-Fried often stepped in as a white knight, using FTT tokens to make acquisitions. This further entangled FTX with other companies and made its financial situation even more precarious.
In summary, FTX's accounting and financial controls were severely lacking, with the company failing to implement even the most basic standards. The lack of in-house accounting, poor choice of audit firms, and suspicious related-party transactions all contributed to FTX's rapid collapse and highlight the need for stronger regulations and oversight in the cryptocurrency industry.
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Frequently asked questions
Yes, FTX was found to have broken the law in several ways. The company was accused of wire fraud, wire fraud conspiracy, commodities fraud, securities fraud, money laundering, and campaign finance violations.
FTX filed for bankruptcy in November 2022 and is in the process of liquidating its assets to repay customers. The company's founder, Sam Bankman-Fried, was convicted of fraud and money laundering and sentenced to 25 years in prison.
It was discovered that FTX misappropriated billions of dollars of customer funds, which were used for personal expenses, investments, and political contributions. Bankman-Fried was also found to have concealed the misuse of customer deposits and provided false financial information to lenders and investors.
Yes, there were several red flags that indicated potential issues with FTX. The company's aggressive marketing campaigns, lack of financial transparency, and close relationship with the trading firm Alameda Research raised concerns. Additionally, the lack of audits and proper financial controls contributed to the mismanagement of funds.
The collapse of FTX had a significant impact on the cryptocurrency market, leading to a decline in demand for cryptocurrencies and raising concerns about the stability and security of the industry. The fallout from FTX also highlighted the need for increased regulation and consumer protection in the cryptocurrency space.
