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What FTX’s Collapse Teaches Us About the Importance of Internal Controls and Related Party Disclosures

What happened at FTX?

“FTX disintegrated practically overnight after it was unable to meet a run on deposits that left the company with an $8 billion hole in its accounts. Within a week, the crypto exchange filed for bankruptcy on November 11, 2022.[1]” A large component of FTX’s collapse included large transfers of assets to and from its affiliated entity, Alameda Research.

In FTX’s Chapter 11 First Day Affidavit, the company appointed restructuring CEO John Jay Ray III, who oversaw Enron’s bankruptcy proceedings indicated that, “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. 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.”[2]

What does this mean for you and your company?

What happened at FTX was not due to the fact that crypto was involved. The collapse at FTX was due to a lack of internal controls.

Internal controls are not just for public companies. Having formalized processes and controls in place are paramount to running an effective and efficient company. Good governance starts with experienced management and experts supporting the different business functions, tone at the top, formal policies and procedures, risk management, and board oversight. Critical internal controls can include areas as simple as ensuring proper segregation of duties and board level oversight of management, as well as, controls over the initiation, approval, recording, and reporting of business transactions, including related party transactions. A core objective of the Chapter 11 proceedings will include “Implementation of Controls: the implementation of accounting, audit, cash management, cybersecurity, human resources, risk management, data protection, and other systems that did not exist or did not exist to an appropriate degree, prior to my appointment.[3]” If FTX had adequately designed and implemented and tested internal controls, the inability to meet deposit requirements could have been mitigated and bankruptcy may have been avoided altogether.

Another key component to the FTX collapse was its relationship with Alameda Research. Properly disclosing related parties provides necessary transparency to a company’s stakeholders. This also highlights the importance of maintaining an effective third-party risk management program.

As such, it is imperative that you choose financial reporting and risk advisory experts who understand digital assets, internal controls, and financial reporting requirements.

Our dedicated, skilled professionals collaborate with international and domestic token issuers, digital asset exchanges, including decentralized finance platforms, venture capital, funds, miners, media, blockchain and enterprise platforms, and other leaders. This allows us to find solutions for your unique accounting needs. If you have questions or need assistance in establishing an internal control or risk management framework, please contact Centri to learn how we can help.

[1] https://www.nytimes.com/2022/11/30/business/sam-bankman-fried-ftx-collapse.html

[2] Section 5 of Declaration of John J. Ray III in Support of Chapter 11 Petitions and First Day Pleadings – https://pacer-documents.s3.amazonaws.com/33/188450/042020648197.pdf

[3] Section 6(a) of Declaration of John J. Ray III in Support of Chapter 11 Petitions and First Day Pleadings – https://pacer-documents.s3.amazonaws.com/33/188450/042020648197.pdf