Category Cryptocurrency exchange

Shhh… (FTX) High Returns With No Risk?

Source: Business Times, 16 November 2022

“High Returns With No Risk”. That was allegedly a selling point in the late 2018 – early 2019 promotional materials of Alameda Research, the small hedge fund founded by Sam Bankman-Fried whose cryptocurrency exchange FTX hit every global headlines for all the wrong reasons the past fortnight before filing for bankruptcy last week.

And yet this outright eye-brow-raising preposterous promise was bought by many professional investors including major global financial institutions like Singapore flagship state holding company Temasek Holdings, who is known to have participated in all three rounds of FTX fundraising and now reportedly writing off its entire US$275 million investments (see pic above).

While the loss is pittance and would not cause a noticeable dent to its net portfolio of S$403 billions, many questions were being asked over its leadership and also whether Temasek conducted proper due diligence.

Temasek in its Statement on FTX on 17 Nov defended its “extensive due diligence process on FTX” spanning around 8 months:

During this time, we reviewed FTX’s audited financial statement, which showed it to be profitable. In addition, our due diligence efforts focused on the associated regulatory risk with crypto financial market service providers, particularly licensing and regulatory compliance (i.e. financial regulations, licensing, anti-money laundering (AML)/ Know Your Customer (KYC), sanctions) and cybersecurity. Advice from external legal and cybersecurity specialists in key jurisdictions was sought, with legal and regulatory review done for the investments.

Separately, we also gathered qualitative feedback on the company and management team.

A thorough and proper due diligence? Or yes but with the wrong focus, or oversight, considering what were missed but now emerged: missing funds through “back doors”, imprecise accounting of the value of FTX’s crypto assets, unacceptable management practices, using corporate funds to buy homes in the personal name of employees, etc

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

According to court documents filed by the new FTX CEO John Ray III, the administrator brought onboard with some 40 years experience in legal and restructuring experience that included the infamous 2001 collapse of Enron.

Shhh… FTX Crypto Crash and the Perils of Key Man Risk

FTX founder Sam Bankman-Fried

Key Man Risk rings out loud as the world grapple this week with the sudden rapid collapse of FTX, one of the world’s largest cryptocurrency exchanges.

One may argue no amount of in-depth due diligence would have mitigated the risks of investors losing their monies in this crypto equivalent of a classic case of bank run, not till at least after digital currencies news portal CoinDesk raised the red flags , based on leaked financial documents, that the bulk of the assets of Alameda Research are held in FTT, a digital token minted by the former’s sister firm FTX. While FTT and FTX appeared unrelated on paper, Alameda Research is the hedge fund founded by FTX founder Sam Bankman-Fried.

“Today, I filed FTX, FTX US, and Alameda for voluntary Chapter 11 proceedings in the US”, Bankman-Fried tweeted 11 November following his “I *ucked Up” Twitter announcement the day before.

The investors in FTX include institutional investors like major sovereign funds, pension funds, hedge funds, etc. These are major financial institutions who conduct various types of pre-transaction due diligence as part of compliance and regulatory requirements. Often times especially when things turned dire, the key question is not whether they did but what and how much they covered in the risks mitigation process – a mere cursory check-the-box due diligence exercise or one that leaves no stone unturned?

To illustrate, I have once assisted a major hedge fund in investigating a red chip the client was contemplating to position, long or short. Much like FTX the outperforming company was founded by an individual whose background resembles the many rags to riches stories one may doubt but well primed for a Hollywood script. The client’s research team unearthed some but very limited insights with their focus on analysts notes and stock exchange disclosures, ie. Window dressings materials.

With in-depth investigative due diligence through open source intelligence research plus exhaustive cloak-and-dagger like intelligence gathering with well-placed sources, our findings highlighted various serious red flags with roots traced to the founder, including behind-the-curtain transactions between what seemed initially like unaffiliated entities – much like the CoinDesk relevations about FTX and FTT.

Key man risk, that’s the takeaway for the client. The pivotal findings have helped them to manage what could otherwise resemble FTX’s journey from crypto white knight to pariah in a matter of days.