FTX was audited by two independent auditors. However, FTX Audit missed the Early Warning Signals of Shenanigans. In this post, the discussion revolves around the auditors and the missed red flags.
FTX Audit Fiasco
Sam Bankman-Fried (popularly called SBF) is a sharp boy with acumen for spotting opportunities. He started a company called Alameda Research to gain out of arbitrage. SBF figured out that cryptocurrency prices differ in various countries for the same pair. So, he started arbitrage trading in different countries in multiple pairs.
Also, he started raising money from multiple investors giving 15% fixed returns annually because arbitrage trading is considered a mechanism to earn money without any market risk.
To handle large trading volumes, FTX exchange was demerged from Alameda Research and investors like Binance. There is the allegation that SBF started a crypto exchange to use depositors’ funds to trade in the cryptocurrency market, and in the end, lost his fortunes to trading mistakes. At one-point FTX exchange was valued at 32 billion dollars.
But FTX reportedly lent over half of its customer funds to Alameda, which then used them to bet on other cryptocurrencies. Where it incurred losses. Caroline Ellison revealed in an interview, that the firm never used the stop loss mechanism and was overconfident about their trades. They did not close any trade even if we were in huge losses.
Alameda also used this money to help out other crypto firms struggling to weather an overall downturn in the market.
The real problem started when a media company Coindesk accessed FTX audit statements of West Realm Shires, also known as FTX US, and FTX Trading Ltd., the combined offshore Bahamas-based entity. Coindesk figured out that the biggest asset of the company was FTT, a native token of FTX Exchange. Alameda was huge but their assets were parked in the tokens created by their own sister concern.
After this article, Binance owner CZ tweeted that Binance is selling there 500 Million dollar worth of FTT coins. As this news gets published, most coin holders start selling their coins worth an estimated 5 billion dollars, creating a liquidity crunch for the FTX exchange. To overcome this, SBF approached the Binance CEO for help and CZ announced that Binance was acquiring the FTX exchange.
During its corporate due diligence, Binance found huge gaps in the FTX books of accounts. At least a sum of billion dollars was missing from the funds, these numbers widened later. The next day, the exchange declared that it opted out of the FTX acquisition. This caused investigations from various regulators.
Who were the FTX Auditors?
FTX is a private company, and an audit was not required unless an investor or bank asked for them or if FTX was considering an IPO.
Prager Metis CPAs, LLC and San Ramon Armanino, LLP, which performed FTX Audit for fiscal 2021 could not identify the loophole in financial statements. Probably there was nothing wrong arithmetically. Additionally, accounting rules for digital assets are not yet matured. The financial statements of the company are not available to the public hence it is difficult to state whether the auditors actually figured out anything.
FTX Audit firm having HQ in the metaverse, twitter buzzing with crypto-related tweets indicate that there was some kind of a rush to be the first mover in the crypto world. Auditors also mentioned, “Happy to Support FTX.US” and “Looking forward to our Next Adventure Together”, which shows that the concept of independence was probably compromised.
The second purely technical reason why I feel the auditors missed out on this discrepancy is that customer assets are an off-balance sheet item. It is quite likely that it was not reported on FTX’s financial statements and was out of the scope of auditors.
Failed FTX Audit
It is a suspicious aspect as we have witnessed the failure of Enron due to the off-balance sheet transactions before. Any auditor who has heard the Enron case should take due care while auditing for such companies.
Secondly, it is quite unlikely to presume that the auditors were not aware of the relationship between FTX and Alameda’s research. In such cases how auditors treated the related party transactions is a real question. It was an important aspect of the audit considering the fact that the balance sheets of Alameda were not audited.
The FTX audit firms were probably busy pretending that they are large firms and are capable of handling the audits of cryptocurrency companies. However, the truth was something else. Public Company Accounting Oversight Board, the regulator of the US audit profession, had found deficiencies in all four of the public company audits carried out by Prager Metis – The FTX Audit Firm.
How can episodes like this be avoided?
As a forensic auditor, there were significant red flags in the financial statements of the FTX. These red flags should have been identified earlier. The Non-availability of the exact employee names and the non-availability of the bank account statements show that there were numerous control issues in the financial statements. This also indicates that FTX Audit was completely faulty.
Additionally, the exchange operating out of the Bahamas and having the companies in countries like Antigua is another red flag.
SBF himself wanted the crypto regulations. In my opinion, there is a need for strong regulation which would monitor these exchanges, wallets, and remittance companies on blockchain and would also include the red flags in their scope.
Reg Flags of Shenanigans
There were some glaring red flags of the shenanigans in the FTX Case and no auditor could have missed it.
Loans to Promoters
FTX lent its co-founder & CEO Sam Bankman-Fried (SBF) over $1 billion for personal use. This is a huge amount for any standard. They also lent money to their Director of Engineering Nishad Singh $543 million. Additionally, FTX used customer funds to buy houses for workers in the Bahamas. Employees and executives effortlessly put their names on homes purchased with company funds.
The Exact Employee Count was not known
FTX didn’t keep proper records of whom they employed and what those employees did. Their total employee count was probably fake. In many cases, those who claimed to be employees were not having appointment letters.
No Cash Management
FTX had no cash management system. Every Stock exchange is required to maintain a certain amount of money to ensure that customer withdrawals are processed smoothly. There was no individual in the organization who knew how much money was actually required. Nobody had any idea how much cash was on hand at any given time, or even where all their cash was.
Accounting Software Manipulations
One of Bankman-Fried’s close aides, allegedly Wang, tweaked FTX’s accounting software. This enabled Bankman-Fried to hide the transfer of customer money from FTX to Alameda.
A screenshot of FTX’s book-keeping system showed that even after the massive customer withdrawals, some $10 billion in deposits remained, plus a surplus of $1.5 billion. This led employees to believe wrongly that FTX was on a solid financial footing. Similarly, Digital assets deposited by customers were not even recorded on the balance sheet.
FTX Audit missed this point, which raises the question mark on the capabilities of the auditors in auditing cryptocurrency companies.
Related Party Transactions
There were at least 130 Related entities. The names of these entities are given below. These names were declared in the bankruptcy filings.
- Alameda Aus Pty Ltd
- Alameda Global Services Ltd
- Alameda Research (Bahamas) Ltd
- Alameda Research Holdings Inc
- Alameda Research KK
- Alameda Research LLC
- Alameda Research Ltd
- Alameda Research Pte Ltd
- Alameda Research Yankari Ltd
- Alameda TR Ltd
- Alameda TR Systems S de R L
- Allston Way Ltd
- Altalix Ltd
- Analisya Pte Ltd
- Atlantis Technology Ltd
- Bancroft Way Ltd
- Bitvo, Inc
- Blockfolio Holdings, Inc
- Blockfolio, Inc
- Blue Ridge Ltd
- BTLS Limited Tanzania
- Cardinal Ventures Ltd
- Cedar Bay Ltd
- Cedar Grove Technology Services, Ltd
- Clifton Bay Investments LLC
- Clifton Bay Investments Ltd
- CM-Equity AG
- Corner Stone Staffing
- Cottonwood Grove Ltd
- Cottonwood Technologies Ltd
- Crypto Bahamas LLC
- DAAG Trading, DMCC
- Deck Technologies Holdings LLC
- Deck Technologies Inc
- Deep Creek Ltd
- Digital Custody Inc
- Euclid Way Ltd
- FTX (Gibraltar) Ltd
- FTX Canada Inc
- FTX Certificates GmbH
- FTX Crypto Services Ltd
- FTX Digital Assets LLC
- FTX Digital Holdings (Singapore) Pte Ltd
- FTX EMEA Ltd
- FTX Equity Record Holdings Ltd
- FTX Europe AG
- FTX Exchange FZE
- FTX Hong Kong Ltd
- FTX Japan Holdings KK
- FTX Japan KK
- FTX Japan Services KK
- FTX Lend Inc
- FTX Marketplace, Inc
- FTX Products (Singapore) Pte Ltd
- FTX Property Holdings Ltd
- FTX Services Solutions Ltd
- FTX Structured Products AG
- FTX Switzerland GmbH
- FTX Trading GmbH
- FTX Trading Ltd
- FTX TURKEY TEKNOLOJİ VE TİCARET ANONİM ŞİRKET
- FTX US Derivatives LLC
- FTX US Services, Inc
- FTX US Trading, Inc
- FTX Vault Trust Company
- FTX Ventures Ltd
- FTX Ventures Partnership
- FTX Zuma Ltd
- GG Trading Terminal Ltd
- Global Compass Dynamics Ltd
- Good Luck Games, LLC
- Goodman Investments Ltd
- Hannam Group Inc
- Hawaii Digital Assets Inc
- Hilltop Technology Services LLC
- Hive Empire Trading Pty Ltd
- Innovatia Ltd
- Island Bay Ventures Inc
- K-DNA Financial Services Ltd
- Killarney Lake Investments Ltd
- Ledger Holdings Inc
- LedgerPrime Bitcoin Yield Enhancement Fund, LLC
- LedgerPrime Bitcoin Yield Enhancement Master Fund LP
- LedgerPrime Digital Asset Opportunities Fund, LLC
- LedgerPrime Digital Asset Opportunities Master Fund LP
- Ledger Prime LLC
- LedgerPrime Ventures, LP
- Liquid Financial USA Inc
- LiquidEX LLC
- Liquid Securities Singapore Pte Ltd
- LT Baskets Ltd
- Maclaurin Investments Ltd
- Mangrove Cay Ltd
- North Dimension Inc
- North Dimension Ltd
- North Wireless Dimension Inc
- Paper Bird Inc
- Pioneer Street Inc
- Quoine India Pte Ltd
- Quoine Pte Ltd
- Quoine Vietnam Co Ltd
- SNG INVESTMENTS YATIRIM VE DANIŞMANLIK ANONİM ŞİRKETİ
- Strategy Ark Collective Ltd
- Technology Services Bahamas Limited
- Tigetwit Ltd
- Verdant Canyon Capital LLC
- West Innovative Barista Ltd
- West Realm Shires Financial Services Inc
- West Realm Shires Services Inc
- Western Concord Enterprises Ltd
- Zubr Exchange Ltd
One of the first questions that FTX Audit should have faced was why these entities are floated. What are the financial transactions with these companies?
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, it has emerged that FTX Audit was a complete failure.
