FTX Collapse
Rivals the Greatest Ponzi Schemes in History
By Victor
Sperandeo with the Curmudgeon
Introduction:
In last week’s column we noted that political
corruption was a major growth area in the U.S.
In this post, we examine the FTX crypto-exchange scandal as the latest
example of personal and company corruption with an added dose of fraud and theft.
-->This maybe a scam on the level or possibly
greater than Bernie Madoff’s Ponzi scheme or the Enron fiasco.
Backgrounder:
The now bankrupt FTX is where many crypto
investors traded and held their cryptocurrency, similar to
the New York Stock Exchange for stocks. It was founded by Sam Bankman-Fried (SBF)
who is also the founder of Alameda Research, a hedge fund that traded
and invested in cryptocurrencies and crypto companies. Since founding FTX in 2019, SBF had control
of a maze of 134 different companies in his “fiefdom.”
Within the traditional financial sector, FTX
and Alameda Research would be separate firms entirely or at least have
divisions and firewalls in place between them. But in early November 2022, news
outlets reported that a significant proportion of Alameda’s assets were a type
of cryptocurrency released by FTX itself.
A few days later, news broke that FTX had allegedly
been loaning customer assets to Alameda for risky trades without the consent of
the customers and issuing its own FTX cryptocurrency (called “FTT”) for Alameda
to use as collateral. As a result, criminal and regulatory investigators began
scrutinizing FTX for potentially violating securities law.
That led to a “bank run” on FTX as large crypto investors
and individuals began to sell off cryptocurrency held on FTX’s exchange. FTX quickly lost its ability to meet customer
withdrawals and halted trading. On Nov. 14th FTX was also hit by an
apparent insider hack and lost $600 million worth of cryptocurrency. That same day, FTX, Alameda Research and over
130 other affiliated companies founded by SBF filed for bankruptcy.
That action may leave more than a million suppliers,
employees and investors who bought cryptocurrencies through the exchange or
invested in these companies with no way to get their money back.
On November 23rd, the Wall Street
Journal reported that a substantial amount of FTX’s assets were either
missing or stolen. A lawyer for the failed crypto exchange said in court
that potentially billions of dollars in funds passed through FTX, which he
called the “personal fiefdom” of Mr. Bankman-Fried.
Customers’ funds on the exchange are frozen, and they’re
losing hope they will ever get much if anything back. The size of the gap
between FTX’s obligations to its customers and available assets it could use to
help pay them still isn’t known. Individual and institutional customers number
in the millions. The 50 largest creditors alone are owed more than $3 billion,
court papers show.
Venture Capital (VC) investors
piled roughly $2 billion into FTX amid last year’s boom in crypto investment.
Eager to get into the hot startup, they overlooked traditional corporate
controls such as external board oversight that are typical for such large
investments. Please refer to Sequoia
Capital’s $150 million FTX write-off described below.
Reactions and Quotes:
“FTX was in the control of inexperienced and unsophisticated
individuals, and some or all of them were compromised individuals,” said James
Bromley, counsel to FTX’s new management, at its first appearance in
Delaware bankruptcy court after filing the largest-ever crypto chapter 11 case
earlier this month.
"This is the direct result of a rogue actor breaking
every single basic rule of fiscal responsibility," said Patrick Hillman,
chief strategy officer at Binance, FTX's biggest competitor.
John J. Ray, the
restructuring specialist who replaced Mr. Bankman-Fried as CEO of FTX and
helped oversee some of the biggest bankruptcies ever including Enron’s, said in
a filing that he had never seen “such a complete failure of corporate controls
and such a complete absence of trustworthy financial information as occurred
here.”
Ray also offered his verdict on the previous management team,
including disgraced founder and former CEO SBF:
“From compromised systems integrity and faulty regulatory
oversight abroad, to the concentration of control in the hands of a very small
group of inexperienced, unsophisticated, and potentially compromised
individuals, this situation is unprecedented. There is no paper trail.”
The iconic VC firm Sequoia Capital apologized to its
fund investors for the $150 million it lost on its FTX investment. Sequoia, an
early backer of Apple Inc., Alphabet Inc.’s Google, and Airbnb Inc. is seen as
the gold standard in the venture industry for its high investment bar. Earlier
this month, Sequoia wrote off its entire investment in FTX—one of the largest
investments in the company by a venture-capital firm.
Where Was the Due Diligence?
Major professional investors in FTX did not do proper
due diligence. For example, Paradigm
Capital invested $278 million, Temasek $275 million, Sequoia Capital $214
million, SoftBank $100 million, Ontario Teachers $95 million, BlackRock $420
million, Tiger Global, $38 million.
There were many other large investors in FTX that will be forced to
write-off their entire investment in the bankrupt firm.
The SEC has issued guidance on what to look
for in potential Ponzi schemes including “guarantee of returns or unregistered
investment vehicles.” Why wasn’t that
guidance followed by FTX large investors?
Investors deposited cash to buy FTT with an 8% yield,
but the money was kept on the FTX exchange (not in a cold wallet). Bankman-Fried loaned the FTT cash value to
his Alameda Research hedge fund where the money disappeared.
This begs the question why hasn’t Bankman-Fried been
arrested or at least summoned to court for questioning?
At long last, committees in the U.S. House of
Representatives and Senate have scheduled hearings next month on FTX’s
collapse, with Bankman-Fried as a potential witness.
What Is a Ponzi Scheme?
From Investopedia: “A Ponzi scheme is a
fraudulent investing scam promising high rates of return with little risk to
investors. A Ponzi scheme is a fraudulent investing scam which generates
returns for earlier investors with money taken from later investors. This is similar to a pyramid scheme in that both are based on using
new investors' funds to pay the earlier backers.”
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FTX Buys Political Cover:
The key INNOVATION in this scam/fraud is that
Bankman-Fried bought political cover (see Sidebar: FTX Donations to
PACs below) in the highest places. He also used Hollywood and major sports
names to promote his reputation and FTX/FTT.
Indeed, the buying of mass political cover is the interesting part of
this story.
FTX, its executives and its philanthropic arm spent
or pledged hundreds of millions of dollars in political and charitable
contributions, consulting fees, investments in media outlets and even real
estate.
A network of political action committees (see Sidebar
on PACs below), nonprofits and consulting firms funded by FTX or its
executives worked to court politicians, regulators and others in the policy
orbit, with the goal of making Bankman-Fried the authoritative voice of crypto,
while also shaping regulation for the industry and other causes, according to
interviews, email exchanges and an encrypted group chat viewed by The New York Times.
FTX blurred the lines between corporate affairs and
political activity and prompted concerns among some involved about whether the
money was being spent effectively and in compliance with strict campaign
finance laws, while leaving some potential beneficiaries feeling like there was
a quid pro quo.
“It was relentless and all-encompassing,” said Dennis
Kelleher, the president of Better Markets, a nonprofit that fights for more
regulation of financial firms.
SBF to Speak at NY Times Dealbook
Summit:
What has now turned into a farce is Bankman-Fried’s
invitation to speak at the NY Times Dealbook Summit on
November 30th in New York city. “I’ll be speaking with [Andrew Ross
Sorkin] at the @dealbook summit next Wednesday (11/30),” SBF tweeted on 11/23.
SBF will be right alongside luminaries like U.S. Treasury
Secretary Janet Yellen, former Vice President Mike Pence, Israel PM Benjamin
Netanyahu, Ukrainian President Volodymyr Zelensky, Amazon CEO Andy Jassy,
Meta/FB Mark Zuckerberg, etc.
SBF’s tweet got a great number of harsh responses
with people asking why the former FTX CEO was allowed to speak at such an
event. For example:
So not only is this man not going to jail, but he is also being positioned as a
distinguished speaker!
That’s beyond outrageous and insolent. It’s a kick in the groin to the over 1 million
investors that lost ~8-to-10 billion due to FTX fraud!
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Sidebar: FTX
Donations to Political Action Committees (PACs):
FTX contributed to a super-PAC fighting for control
of the Senate in the November 2022 midterm election just days before the
company’s collapse. The Senate Leadership Fund, which is
aligned with Senate Republican Leader Mitch McConnell and was the top
spender in the 2022 midterms, received the $1 million donation on Oct. 27,
according to its most recent filing with the Federal Election Commission.
FTX – U.S. also gave $750,000 to the Congressional
Leadership Fund and $150,000 to the American Patriots PAC, both of which
supported House Republican candidates. It gave $100,000 to the Alabama
Conservatives Fund, which backed Republican Katie Britt’s successful run for
the state’s open Senate seat.
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Beachfront Property:
Also alarming is that FTX, the parents of its founder
and CEO, and top executives of the
insolvent cryptocurrency exchange have bought at least 19 properties worth
nearly $121 million in the Bahamas over the past two years, Reuters reported, citing property records.
Separately, attorneys for FTX said on Tuesday that
one of the company's units spent $300 million in the Bahamas buying homes and
vacation properties for its senior staff.
Cartoon of the Week:
Image Credit: Dana Summers, Copyright 2022 Tribune Content Agency
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Victor’s Conclusions:
This is a very complex story with lots of theories of
events that are hard to believe.
Therefore, it’s best to let it play out before any speculation on the
conclusions. To me it is a reflection of how the U.S.
has deteriorated in the rule of law, the morals of society, and the absolute
crashing of our culture.
As I have said many times in these posts, America is
in dire decline.
End Quote:
In 1647 Baltasar Gracián wrote “Oráculo Manual y Arte de
Prudencia” (“The Art of Worldly Wisdom”) which included a germane discussion of
fools stubbornly clinging to incorrect beliefs. Here is a translation of
Baltasar’s Spanish remarks into English:
“Every blockhead is thoroughly persuaded that he is
in the right, and everyone who is all too firmly persuaded is a blockhead, and
the more erroneous is his judgment the greater is the tenacity with which he
holds it.”
Baltasar Gracián
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Be well, stay healthy, try to find interesting
activities. Wishing you peace of mind and contentment. Till next time………
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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