The U.S. attorney’s office for the Southern District of New York officially charged cryptocurrency exchange FTX’s founder Sam Bankman-Fried (SBF) with eight counts of fraud and conspiracy, calling the collapse of FTX “one of the biggest financial frauds in American history.” The U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission also sued SBF for fraud on the same day. These lawsuits came just the day after the Royal Bahamas Police Force arrested SBF.
Although the FTX case dealt with cryptocurrency, the crime SBF was alleged to have committed was no different than Bernie Madoff’s, which was stealing money from customers. Federal prosecutors accused him of “misappropriating FTX.com customers’ deposits … and violating campaign finance rules for conspiring with others to make illegal political contributions.” The SEC accused SBF of building “a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto” and using customers’ money (without their knowledge nor permission) to support his trading firm Alameda, and “undisclosed private venture investments, political contributions, and real estate purchases.”
During his congressional testimony, FTX’s new CEO, John Ray, called SBF’s crime “plain old embezzlement.” He further warned that FTX has already incurred a loss north of $7 billion, and its U.S.-based customers might not get their investment back. The public should learn four lessons from this case to better protect their assets in the future and avoid becoming victims of another con.
Be Aware of Early Warning Signs
Fraud never happens overnight. There are always red flags. A firm that engages in fraudulent activities lacks transparency, and the fraudster in charge ensures only a few in the inner circle have knowledge of the firm’s complete business operations and accurate financial information. The recordkeeping in such a firm is intentionally lacking to make external auditing almost impossible. For example, current CEO John Ray said that FTX was “unusual in the sense that literally there’s no recordkeeping whatsoever.” FTX was once valued as a $32 billion company, yet the company relied on the chat service Slack and accounting platform QuickBooks for recordkeeping. According to Ray, QuickBooks is not a suitable accounting tool for “a multibillion-dollar company.” The SEC also alleges that “From its inception, FTX had poor controls and risk management procedures. Assets and liabilities of all forms were generally treated as interchangeable, and there were insufficient distinctions between the assignment of debts and credits to Alameda, FTX, and executives.”
Another warning sign investors should look for is whether the firm has an overly complex corporate structure. For instance, SBF owned or managed over 100 companies under FTX Group’s umbrella. A supposed audit of FTX’s 2021 financial statement revealed that “FTX and’ related parties’” engaged in “tangled relationships” worth over $250 million and that “numerous FTX employees were working for those related parties.” Complicated corporate structures and cross-ownerships indicate that the company and its founder may have something to hide because complexity is often deployed to obscure the movement of funds and make them hard to trace.
It is a red flag if the company’s founder lives a lavish lifestyle. SBF might have come across as someone who didn’t care about material wealth since he often appeared in T-shirts, shorts, and sneakers in public. But he had been living large before his arrest. He and his company FTX reportedly owned a real estate empire in the Bahamas worth $256 million, including a $30 million penthouse where SBF lived with nine colleagues and a $16.4 million vacation home for his parents. Although it was not always the case, those who committed financial fraud tend to be excessive spenders because, after all, they are spending other people’s money. And deep in their hearts, fraudsters know they will get caught sooner or later, so they want to enjoy all the luxuries they can before the jig is up.
Don’t Be Fooled By an Exec’s Personal Brand
Fraudsters tended to project a larger-than-life persona because they hoped that such an image would dissuade people from performing essential due diligence on their business operations and financial soundness. Bernie Madoff had an impressive resume: former chairman of the Nasdaq stock market, a renowned community leader, and was actively involved in philanthropy. He intentionally made it known that he wouldn’t take just anyone’s money, and his investment company was almost an exclusive club for some of the biggest names in the nation, including Steven Spielberg. The more Madoff played hard to get and embellished his exclusivity, the more potential investors desperately wanted to beg him to take their money. Even “sophisticated” investors were so enamored by Madoff’s persona that they failed to ask to examine his investment methodology and ask fundamental questions.
Similarly, SBF built up a persona that he was some “wiz-kid” who didn’t care about money and only wanted to focus on humanity’s “greater good.” He claimed that he practiced effective altruism and aimed to give away all his money. He even set up an FTX future fund to focus on minimizing threats to humanity’s long-term future. SBF had become one of the most prominent political donors to the left in two short years. According to The Wall Street Journal, “he and his associates contributed more than $70 million to election campaigns in recent years. He personally made $40 million in donations ahead of the 2022 midterm elections, most of which went to Democrats and liberal-leaning groups.” As the left’s darling, SBF was frequently on stage with Democratic Party heavyweights like Bill Clinton, which further enhanced his reputation and prestige.
SBF’s persona fooled some of the most experienced investors in the country. For example, Sequoia Capital, the largest venture capital firm in the U.S., did a glowing personal profile on SBF back in September, praising SBF for having a “savior complex.” After FTX filed for bankruptcy in November, Sequoia quietly removed SBF’s profile from its website and marked down its investment in FTX from around $214 million to $0.
Investors should have known that an exciting persona is not a replacement for sound economics.
Don’t Blindly Follow Celebrity Endorsements
SBF didn’t just con professional investors and politicians. He quickly grew his start-up cryptocurrency exchange FTX from nothing to a company worth $32 billion, largely thanks to celebrity endorsement. FTX paid celebrities, including football star Tom Brady and his ex-wife Gisele Bundchen, basketball stars Shaquille O’Neal and Stephen Curry, and the list continues. These celebrities got paid handsomely by vouching for FTX and SBF. Since FTX filed for bankruptcy, they have remained silent. However, some FTX investors who lost money haven’t let these celebrities off the hook so easily and have filed a class-action lawsuit against some of them, hoping to recoup some losses.
Rather than blindly following celebrities, investors are better off doing their homework before investing their hard-earned money in new business adventures.
Don’t Count on Regulators to Catch Bad Guys
Remember Harry Markopolos, the Boston money manager who nudged the SEC to investigate Madoff as early as 1999? His hunch was simple: Madoff’s consistent and impressive investment returns were mathematically improbable. The SEC claimed it conducted a thorough investigation, including putting Madoff under oath in 2006. Yet, in the end, the SEC’s experts accepted Madoff’s deceptions and let him run freely until his house of cards fell on its weight during the 2008 financial crisis.
Similarly, the SEC and the Commodity Futures Trading Commission failed to prevent FTX from defrauding billions of customers’ money even though the firm exhibited many red flags. Instead, SBF reportedly “regularly met with regulators and lawmakers, weighing in on how the crypto industry should be regulated.” This is no different than asking the wolf to design a rule on how to guard the hen house.
Federal regulators have yet to have a successful track record regarding catching some of the worst scammers in U.S. history.
For investors, the FTX’s collapse is a painful reminder that no one cares more about your money than you. Don’t be fooled by the founder’s persona and misled by celebrity endorsement. Don’t count on regulators to keep your investment safe. Before investing your money, do your homework, ask probing questions, demand to see audited financial statements, and be aware of red flags.
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