Who are the real villains in the FTX scandal?
Do you feel sorry for the investors who lost billions in the collapse of crypto exchange FTX? I do and I don’t.
I don’t feel sorry for them because it’s crypto, and anyone over the age of 12 will tell you that, although there is much promise for digital currencies, the industry remains unregulated, technologically immature and extremely volatile. Which means that it’s also extremely risky.
The people investing in crypto knew the risks but were all about short-cutting the path to prosperity in their quest to make quick bucks and look like geniuses. They got burned.
And yet, I do feel sorry for these people because they were following the advice and actions of seemingly credible firms run by seemingly very smart people who gave their seal of approval to FTX. It’s the same old story: Once again our financial “experts” have failed us.
One of those experts is Sequoia Capital, which has now joined a long list of banks, investors and super-smart people in the financial community that lost tens or hundreds of millions on FTX. As has happened so often throughout history, some of those super-smart people led millions of unsuspecting people into financial loss or ruin. The reasons are almost always the same: They ignored basic principles and common sense.
Sequoia reportedly lost more than $210 million in the collapse of FTX and its sister firm Alameda Research. Not because of a bad bet. It was because of seemingly inadequate due diligence. (For its part, Sequoia says it did its research but was misled by FTX’s founder and CEO, Sam Bankman-Fried.)
According to a Wall Street Journal report, the 50-year-old venture capital firm, in a rush to keep up with the Joneses clamoring over crypto opportunities, ignored the complete absence of internal controls, waved off the non-involvement of more credible external auditors and were unfazed by the age and inexperience of the company’s key leadership. Sequoia backed off when Bankman-Fried refused to give the firm a board seat, the Journal reported, and ignored the red flags of its intercompany relationships, and then famously gushed its love for the FTX founder by posting an adoring blog post about him on its website, which has since been removed.
According to Vanson Soo, a financial expert based in Hong Kong, the due diligence conducted many companies that invested in FTX somehow appears to have overlooked “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.”
“This is not something that happened overnight or in a context of a week,” John Ray, FTX’s new CEO, told Congress. “Literally, there’s no record-keeping whatsoever.”
Ray testified that the multibillion-dollar company used QuickBooks as its accounting system and said that FTX’s collapse “appears to stem from the absolute concentration of control in the hands of a very small group of grossly inexperienced and unsophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company that is entrusted with other people’s money or assets.”
According to the Wall Street Journal report, Sequoia apologized to its investors for losing their money. That’s it? Is this the kind of negligence we expect from a leading venture capital firm?
I can understand celebrities like Tom Brady and Kevin O’Leary losing money in this debacle. But when major investment or venture capital firms give their seal of approval to companies like FTX, it draws in other investments with other people’s money — even the pensions of schoolteachers in Canada. Their due diligence is relied upon not only by their own investors but other investors, banks and the general public.
What puzzles me and many other business owners is why. Why is it that we are required to provide years of tax returns, financial history and other documentation to a bank or investor when seeking a loan? Why are we required to pay our accountants tens of thousands of dollars for an audit and to comply with quarterly covenants? Why are we urged to upgrade our accounting systems? Why do we need to collateralize every dollar of our loans with hard assets like property, plants and equipment?
I’ll tell you why: because these requirements are what is necessary in a reasonable business transaction to minimize risk and make prudent business choices. Sequoia’s management knows this, of course.
The media, federal prosecutors and regulators are making Bankman-Fried the villain in all this. But to me, a business owner and certified public accountant, the real villains are the investment and venture capital firms that bought into FTX’s line. The let down the financial community with their irresponsible actions. These are some of the smartest people on the planet, armed with PhDs from Stanford and MIT. They speak at Davos, share their thoughts with the political elite and regularly advertise their brilliant achievements on their websites and in the media. We can understand if they make a wrong bet. But we’re in disbelief when they ignore the most basic of business rules, which the rest of us in the business community follow.
I do feel sorry for the individual investors in FTX. Because like them, businesses like mine want to trust our financial leaders. We put faith in the decisions made by major investment firms. And yet, once again, we’re disappointed by their behavior. When will we learn?
Gene Marks is founder of The Marks Group, a small-business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.