Category Due diligence

You may have read varied analyses and opinions on the recent FTX debacle including the due diligence failures and impacts highlighted in the Intelligence Online snippet captured in the picture below.

The flip side of a coin is the wake up call that pre-transaction due diligence must be more exhaustive and deep-dive to leave no stone unturned, and no longer a stroll-in-the-park, check-the-boxes exercise.

Whether confidence has taken a nosedive or demands (on due diligence) have been boosted depends on who’s talking but to borrow an old adage, if I may: It takes two to Tango. And in this case, the dancers are the investigator/consultant and the client.

The investigator/due diligence specialist brought onboard has a professional duty and obligation to give the best advice to the client. And as much as he/she wants the client to go “all out”, the reality is the client has constraints like budget, time, resources, etc, compliance and regulatory requirements aside. Hence the burden on the investigator is to work closely with the client and find the best cost-effective approach, ie. “according to budget”.

The client simply wants the best solution for what’s on the table, ie. The pivotal findings to decide on whether to proceed or to kill the (pending) transaction. The last thing the client wants is to be in the front page of the newspapers for all the wrong reasons.

Which brings me back to the case of Temasek, the state holding company owned by the Government of Singapore.

I wrote in a previous post how the global investment company with a portfolio of over S$400 billion defended in a statement its “extensive due diligence process on FTX” spanning around 8 months – how it reviewed FTX financials, the regulatory risks, etc, and the “qualitative feedback on the company and management team based on interviews with people familiar with the company, including employees, industry participants, and other investors”.

The statement added:

We recognise that while our due diligence processes may mitigate certain risks, it is not practicable to eliminate all risks.

It is apparent from this investment that perhaps our belief in the actions, judgment and leadership of Sam Bankman-Fried, formed from our interactions with him and views expressed in our discussions with others, would appear to have been misplaced.

The last paragraph above highlights something interesting.

Yes due diligence comes in many favors and the statement suggests Temasek did focus heavily on financial, legal and regulatory due diligence, and they also gathered “qualitative feedback” on the company and management team.

But that paragraph seems more of a defense and pushing the blame on FTX founder Sam Bankman-Fried, and it suggests two things: Temasek and their investigators overlooked Key Man Risk and had the Wrong Focus in their due diligence.

It’s fair to say everyone benefits from hindsight but I have elaborated in a previous post the Key Man Risk involved with a case like FTX.

Yes it takes two to Tango. The investigator and client should have recognized (with experience) from the outstart there is a potential Key Man Risk based on the background materials and knowledge of the FTX setup. That’s not to say financial (and other) due diligence are irrelevant – you may be familiar with the perils of auditing from “second or third” set of accounts?

If the due diligence have paid due attention to Key Man Risk, the public records and open source intelligence (OSINT) research and the human intelligence (HUMINT) gathering (what Temasek referred to as “qualitative feedback”) would have smoked out at least some of the staggering FTX failings that have 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.

Temasek has seemingly suffered from missing leads and glaring red flags they could have gotten from a due diligence focused on the Key Man Risk with FTX.

Yes the FTX collapse has delivered a blow to the corporate intelligence world. An extensive and expensive due diligence over eight months is a luxury many investors could not afford. Corporate investigators may be happily billing the clients with cookies-cutter approach that serves no purpose if the due diligence has the wrong focus. In the Temasek case, the due diligence approach as they have explained could run well beyond eight months to a year or two and they would still not find any red flags with FTX if they had the wrong focus – for example, what’s the point if exhaustive financial due diligence is examining cooked accounts?

The FTX collapse is a wake up call for all parties involved.

Source: Intelligence Online

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.

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.

This article was recently printed in CSuite Magazine published by Asia CEO COMMUNITY and CSuite Xchange.

By Vanson Soo

A corporate investigations specialist and Asia CEO Community member explains how business leaders can benefit from probing into the uncharted through intelligence gathering, investigations and due diligence.

It is not everyday that one would come across someone from my industry. “Not unless one is in deep troubles”, many would tend to wrongly conclude. This is a common and fundamentally flawed misconception. Our services go beyond getting clients out of troubles. The smart and savvy business leaders regularly utilize us for strategic and pivotal decisions, to formulate business plans and negotiations, and to get to the truth and mitigate risks. This is why I was told it would be intriguing to pen this article to introduce my profession to the Asia CEO Community.

A friend who is a seasoned business reporter introduced me to an industry peer several years ago after she learned we were in the same trade. “You guys are so weird” was how she ended the introductory email. Those five words have always left me wondering: if a journalist with the top echelon of global business news gives such a sweeping remark, how can one expect the men in the streets to comprehend what is intelligence, investigations and due diligence in the business world?

“Sounds like serious spook stuff” is one common reaction.

Our industry may sound exotic or unusual to some but this industry has been around and is more common than many would think. And it does not always have anything to do with troubles. On the very contrary, it is very relevant and prevalent in the business world. Consider the following scenarios.

– The Asia CEO of a listed conglomerate has been in lengthy discussions with the founder of a competitor about a potential acquisition but left with nagging suspicions he was not dealing with a decision maker. If the founder is controlled by someone behind the scenes, who is his “puppet master”?

– A global investment bank working on a potential public listing has found social media claims that the listco is running a “ghost factory”, a potential damaging red flag that the real business activities do not match the rosy financial figures submitted to meet the stock exchange listing requirements.

– A hedge fund portfolio manager is contemplating short selling opportunities on a listed entity after hearing some market rumors but he needs to verify the grapevine before placing his bets.

There is no trouble and all business as usual above but potential deep troubles if these parties do not do their homework thoroughly and get to the truth. What the Asia CEO, investment bank and hedge fund manager above need is to mitigate counterparties risks, as often times there is a tendency that one would only paint the bright picture and hide the skeletons in the cupboard.

These situations would call for pre-transaction due diligence, ie. two parties considering a pending transaction and one would want to verify the facts put on the table in case the counterparties were not forthcoming.

The above are just some examples of real and typical cases in need for pre-transaction due diligence, which comes in different flavors such as financial, legal, environmental, human resources, IT, and intellectual property due diligence. The type of pre-transaction due diligence for the examples above is investigative due diligence, ie. to examine the counterparties involved in the pending transaction and look for red flags that could translate into material risks before one signs on the dotted line. The counterparties may not always have dirt but if there is any, it is better to uncover them before committing to the transaction.

Thanks to global headlines of mega corporate failures such as Enron, Worldcom and the likes, which have subsequently led to increasingly demanding corporate governance and related regulations, pre-transaction due diligence have been growing ever rapidly since the turn of the century, and further spurred on by the more stringent financial crime compliance environment. So the corporates and financial institutions would be compelled by regulations to conduct due diligence exercises before signing off on a pending transaction like a merger and acquisition, joint venture, public listing, greenfield operations, etc.

The C-Suite executives, general counsel and key decision-makers of a corporation, investment, private or commercial bank, private equity, hedge fund, and family office, as well as high net-worth individuals are the typical parties to demand for pre-transaction due diligence services. That is why I was disturbed by that passing remarks by my journalist friend.

Now onto the more “sexy stuff”, as one would say.

By that, I am referring to post-transaction cases as per our industry speak. Typically they are undesirable situations stemmed from multiparties business transactions/agreements, leading to allegations that warrant the hire of investigators to provide pivotal smoking-gun evidence for their lawyers to prevail in or out of courts. The investigators would deploy various means of investigations as appropriate, including public records and open source intelligence research, forensic investigations, intelligence gathering, gumshoe leg-works like site visits and surveillance, etc.

At the blink of an eye, many people would often associate my profession with the cloak-and-dagger cases involving or characteristic of mystery, intrigue or espionage, ie. spycraft, that most people would relate from movies and novels. Indeed, post-transaction investigations are often full of twists and turns, involving a lot of hard works in the field, sans the James Bond or Hollywood type glamorization.

There are many different types of post-transaction matters. The following are some of the common ones.

– A company received a whistle-blower letter that its factory in Southeast Asia is bloated with frauds and embezzlement involving many of its current and former employees, contractors, suppliers, distributors and vendors, some of which with ties to the local government and supervisory authorities to run parallel and competing businesses, siphoning clients and resources away from the company. The company hired investigators to examine these allegations with the aim of finding smoking-gun evidence to help the lawyers press criminal charges against the alleged parties.

– The stock exchange suspended trading of a listed company after market rumors sent its share price into a tailspin, which eventually led the company into liquidation and endless lawsuits from shareholders alleging management of frauds and various wrongdoings. One institutional investor hired a law firm to file suit against the board but the lawyers found some of the executives may have fled the country with an array of footprints and assets for investigators to trace globally.

– A high net-worth individual found some of his business associates may have abused their appointment as directors and business nominees to secretly strip and divert his companies interests into the hands of some offshore entities through some fancy paperwork he was never aware of. The business tycoon hired investigators to assist his in-house counsel in a global forensic trail to trace the documents and map out the complex manipulations and misrepresentations responsible for his dire situation and financial losses.

Now it should become obvious that in both pre- and post-transaction situations, the sky is the limit with risks, and the losses can be bottomless. The resources spent on investigative services are often minor relative to what is at stake.

The corporate slogan of my practice sums up nicely what a business leader requires for every business situation:

More truth less risk
Take a closer look.

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Vanson Soo is the founder of Vanuscript Consulting, a Hong Kong-based independent practice in intelligence, investigations and due diligence covering the Asia Pacific region with a special focus on Greater China.