FTX Trading Ltd – [Update] New FTX CEO John J Ray III Blasts Legacy Governace and Controls as “Complete Failure;” Highlights “F*** Regulators” Approach of Predecessor Sam Bankman-Fried in Takedown of Erstwhile Crypto Posterchild

Register, or to view the article

November 17, 2022 – In a declaration filed in support of first day filings [Docket No. 24], the Debtors’ newly minted CEO, John J. Ray III, provides his chilling initial impressions as to the historical business practices of his new employer and eviscerates the reputation of his predecessor, Samuel Bankman-Fried ("SBF"), who resigned in the early hours of November 11th; leaving Mr. Ray and a quickly assembled team of professionals to bring some semblance of order to the process of sifting through the wreckage of what is a corporate and financial meltdown for the ages. 

In touching on his professional bona fides, Mr. Ray makes it clear that he has some insight into corporate and financial malfeasance (eg, Enron and Nortel) before opening his substantive assessment of his first week on the job: 

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.”

Mr. Ray concludes his declaration with words as carefully chosen as those (above) with which he opens it, citing an SBF Tweet to bury any remaining illusions that SBF is/was a champion of crypto's evolution towards regulatory maturity. He also makes it very clear that his Debtors will purse bankruptcy in a Delaware courtroom.

"Mr. Bankman-Fried, currently in the Bahamas, continues to make erratic and misleading public statements. Mr. Bankman-Fried, whose connections and financial holdings in the Bahamas remain unclear to me, recently stated to a reporter on Twitter: 'F*** regulators they make everything worse' and suggested the next step for him was to 'win a jurisdictional battle vs. Delaware'."

Highlights

  • Debtors' Businesses Will Be Addresed as Four Silos, Each Now with a New Independent Director
  • Debtors Loaned BlockFi FTT Tokens Valued at $250 million as of September 30, 2022
  • Mr. Bankman-Fried Resigned Reluctantly at 4:30am on Friday 11th after Consulting, Inter Alia, with his Father Professor Joseph Bankman of Stanford Law School 
  • Debtors Had Almost Non-Existent Corporate Governace
  • "Crypto Hedge Fund" Alameda Research, Traded and Speculated in Digital Assets for the Account of its Owners [Messrs. Bankman Fried and Wang]
  • Alameda Research Made $1bn Loan to Mr. Bankman Fried
  • Debtors Outsourced Accounting Function; One of Rare Auditors "First-Ever CPA Firm to Officially open its Metaverse Headquarters in the Metaverse Platform Decentraland"
  • Debtors Unable to Provide Complete List of Employees or Contract Terms
  • Payments Processed Via Chat Room and Approved with Emojis
  • Debtors Have Now Secured Approximately $740mn of Cryptocurrency in New Cold Wallets 
  • $372mn of Unauthorized Transfers Initiated on Petition Date
  • $300 million in FTT Tokens Minted By Unauthorized Source after Petition Date 
  • Mr. Bankman-Fried Auto-Deleted His Work Product, Encouraged Employees to Do Likewise
  • Debtors Building Deep Investigative Team

Key Takeaways (Drilling Down)

Four Silos

Mr Ray divides the Debtors' business operations into four silos: (a) the “WRS Silo,” a group composed of Debtor West Realm Shires Inc. and its Debtor and non-Debtor subsidiaries, which includes the businesses known as “FTX US,” “LedgerX,” “FTX US Derivatives,” “FTX US Capital Market­­s,” and “Embed Clearing,”; (b) the “Alameda Silo,” a group composed of Debtor Alameda Research LLC and its Debtor subsidiaries; (c) the “Ventures Silo,” a group composed of Debtor Clifton Bay Investments LLC, Debtor Clifton Bay Investments Ltd., Debtor Island Bay Ventures Inc. and Debtor FTX Ventures Ltd; and (d) the “Dotcom Silo,” a group composed of Debtor FTX Trading Ltd. and its Debtor and non-Debtor subsidiaries, including the exchanges doing business as “FTX.com” and similar exchanges in non-U.S. jurisdictions.

Appointment of Independent Directors 

Each of the silos will now be overseen by a new independent director (the Dotcom Silo gets two, see further below as to background on each), including: (i) Mitchell Sonkin (WRS Silo) a Senior Advisor to MBIA Insurance Corporation, (ii) Matthew R. Rosenberg (Alameda Silo) a Partner at Lincoln Park Advisors, (iii) Rishi Jain (Ventures Silo) a Managing Director and Co-Head of the Western Region of Accordion, (iv) The Honorable Joseph J. Farnan (Lead Independent Director for Dotcom Silo) formerly a United States District Judge for the District of Delaware from 1985 to 2010 and (v) Matthew A. Doheny (Dotcom Silo) President of North Country Capital LLC.

WRS Silo

The WRS Silo includes FTX US, an exchange for spot trading in digital assets and tokens. FTX US was founded in January 2020. FTX US is available to U.S. users and, according to statements by Mr. Bankman-Fried, had approximately one million users as of August 2022….the WRS Silo has made loans and investments, including a loan of FTT tokens to BlockFi Inc. in a principal amount of FTT tokens valued at $250 million as of September 30, 2022.

Alameda Silo

As to the Debtors' largest silo, Mr Ray provides: “In short, the Alameda Silo was a ‘crypto hedge fund’ with a diversified business trading and speculating in digital assets and related loans and securities for the account of its owners, Messrs. Bankman-Fried (90%) and Wang (10%)….To my knowledge, none of these financial statements have been audited. The September 30, 2022 balance sheet for the Alameda Silo shows $13.46 billion in total assets as of its date. However, because this balance sheet was unaudited and produced while the Debtors were controlled by Mr. Bankman-Fried, I do not have confidence in it and the information therein may not be correct as of the date stated [This also true as to the other three silos]…. Related Party Loans Receivable of $4.1 billion at Alameda Research (consolidated) consisted primarily of a loan by Euclid Way Ltd. to Paper Bird Inc. (a Debtor) of $2.3 billion and three loans by Alameda Research Ltd.: one to Mr. Bankman-Fried, of $1 billion; one to Mr. Singh, of $543 million; and one to Ryan Salame, of $55 million.

Bankman-Fried Resignation

“At the same time [the evening of November 10th-11th], negotiations were being held between certain senior individuals of the FTX Group and Mr. Bankman-Fried concerning the resignation of Mr. Bankman-Fried and the commencement of these Chapter 11 Cases. Mr. Bankman-Fried consulted with numerous lawyers, including lawyers at Paul, Weiss, Rifkind, Wharton & Garrison LLP, other legal counsel and his father, Professor Joseph Bankman of Stanford Law School. A document effecting a relinquishment of control was prepared and comments from Mr. Bankman-Fried’s team incorporated. At approximately 4:30 a.m. EST on Friday, November 11, 2022, after further consultation with his legal counsel, Mr. Bankman-Fried ultimately agreed to resign, resulting in my appointment as the Debtors’ CEO.” NB: Mr. Bankman-Fried’s “Omnibus Corporate Authority” (filed with the lead Petition) allowing for the appointment of Mr. Ray, is actually dated November 10th and not the 11th.  

Corporate Governance

"Many of the companies in the FTX Group, especially those organized in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings…. The appointment of the Directors will provide the FTX Group with appropriate corporate governance for the first time.”

Cash Management

The FTX Group did not maintain centralized control of its cash. Cash management procedural failures included the absence of an accurate list of bank accounts and account signatories, as well as insufficient attention to the creditworthiness of banking partners around the world.”

Financial Reporting

"The FTX Group received audit opinions on consolidated financial statements for two of the Silos – the WRS Silo and the Dotcom Silo – for the period ended December 31, 2021. The audit firm for the WRS Silo, Armanino LLP, was a firm with which I am professionally familiar. The audit firm for the Dotcom Silo was Prager Metis, a firm with which I am not familiar and whose website indicates that they are the 'first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland.' I have substantial concerns as to the information presented in these audited financial statements, especially with respect to the Dotcom Silo. As a practical matter, I do not believe it appropriate for stakeholders or the Court to rely on the audited financial statements as a reliable indication of the financial circumstances of these Silos….The Debtors have not yet been able to locate any audited financial statements with respect to the Alameda Silo or the Ventures Silo….The Debtors do not have an accounting department and outsource this function."

Human Resources

"The FTX Group’s approach to human resources combined employees of various entities and outside contractors, with unclear records and lines of responsibility. At this time, the Debtors have been unable to prepare a complete list of who worked for the FTX Group as of the Petition Date, or the terms of their employment. Repeated attempts to locate certain presumed employees to confirm their status have been unsuccessful to date.  

Disbursement Controls

"The Debtors did not have the type of disbursement controls that I believe are appropriate for a business enterprise. For example, employees of the FTX Group submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis….In the Bahamas, I understand that corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors. I understand that there does not appear to be documentation for certain of these transactions as loans, and that certain real estate was recorded in the personal name of these employees and advisors on the records of the Bahamas."

Digital Asset Custody

"The FTX Group did not keep appropriate books and records, or security controls, with respect to its digital assets. Mr. Bankman-Fried and Mr. Wang controlled access to digital assets of the main businesses in the FTX Group (with the exception of LedgerX, regulated by the CFTC, and certain other regulated and/or licensed subsidiaries). Unacceptable management practices included the use of an unsecured group email account as the root user to access confidential private keys and critically sensitive data for the FTX Group companies around the world, the absence of daily reconciliation of positions on the blockchain, the use of software to conceal the misuse of customer funds, the secret exemption of Alameda from certain aspects of FTX.com’s auto-liquidation protocol, and the absence of independent governance as between Alameda (owned 90% by Mr. Bankman-Fried and 10% by Mr. Wang) and the Dotcom Silo (in which third parties had invested)….The Debtors have located and secured only a fraction of the digital assets of the FTX Group that they hope to recover in these Chapter 11 Cases. The Debtors have secured in new cold wallets approximately $740 million of cryptocurrency that the Debtors believe is attributable to either the WRS, Alameda and/or Dotcom Silos. The Debtors have not yet been able to determine how much of this cryptocurrency is allocable to each Silo, or even if such an allocation can be determined. These balances exclude cryptocurrency not currently under the Debtors’ control as a result of (a) at least $372 million of unauthorized transfers initiated on the Petition Date, during which time the Debtors immediately began moving cryptocurrency into cold storage to mitigate the risk to the remaining cryptocurrency that was accessible at the time, (b) the dilutive ‘minting’ of approximately $300 million in FTT tokens by an unauthorized source after the Petition Date and (c) the failure of the co-founders and potentially others to identify additional wallets believed to contain Debtor assets.

Information and Retention of Documents

"One of the most pervasive failures of the FTX.com business in particular is the absence of lasting records of decision-making. Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same."

Investigative Team

"The investigative effort underway is led by myself and a team at Sullivan & Cromwell that reports directly to me, including a former Director of Enforcement at the SEC, a former Director of Enforcement at the CFTC, and a former Chief of the Complex Frauds and Cybercrime Unit of the United States Attorney’s Office for the Southern District of New York….Since Friday, the Debtors have been in contact with dozens of regulators throughout the United States and around the world, and will continue to be as these cases continue."

Corporate Communications

"Finally, and critically, the Debtors have made clear to employees and the public that Mr. Bankman-Fried is not employed by the Debtors and does not speak for them. Mr. Bankman-Fried, currently in the Bahamas, continues to make erratic and misleading public statements. Mr. Bankman-Fried, whose connections and financial holdings in the Bahamas remain unclear to me, recently stated to a reporter on Twitter: 'F*** regulators they make everything worse' and suggested the next step for him was to 'win a jurisdictional battle vs. Delaware'.”

Independent Directors

Mr. Ray notes the appointment of five independent directors and provides the following bios:

  • WRS Silo: Mitchell I. Sonkin: Mitchell Sonkin is currently a Senior Advisor to MBIA Insurance Corporation in connection with the restructuring of the Firm’s insured portfolio exposure of the Commonwealth of Puerto Rico’s $72 billion of outstanding debt. He is also currently Chairman of the Board of the ResCap Liquidating Trust, successor to ResCap and GMAC Mortgage Corporations. Before joining MBIA, Mr. Sonkin was a senior partner at the international law firm, King & Spalding, where he was co-chair of King & Spalding’s Financial Restructuring Group and a member of the firm’s Policy Committee. He has over 40 years of experience in U.S. and international bond issuances, corporate reorganizations, bankruptcies and other debt restructurings and has served as a bankruptcy-court-appointed examiner. In particular, he has played a significant role in numerous municipal, utility, insurance, airline, healthcare debt and international debt restructurings including the Anglo/French Euro Tunnel debt reorganization. 
  • Alameda Silo: Matthew R. Rosenberg: Mr. Rosenberg is a Partner at Lincoln Park Advisors, a financial advisory firm that he founded in 2014. He has more than 25 years of restructuring, corporate finance, principal investing, operating and board experience. Prior to founding Lincoln Park Advisors, he was a partner at the restructuring and investment banking firm Chilmark Partners, a partner in two private equity funds, the Zell/Chilmark Fund and Chilmark Fund II, the Chief Restructuring Officer of The Wellbridge Company and a member of multiple corporate boards. His restructuring advisory experience includes such companies as OSG, Supermedia, Nortel, Trinity Coal, USG Corporation, JHT Holdings, Inc., Covanta Energy, Sirva, Lodgian, Inc., ContiGroup Companies, Inc., Fruit of the Loom, Ltd. and Recycled Paper Greetings.
  • Ventures Silo: Rishi Jain: Mr. Jain is a Managing Director and Co-Head of the Western Region of Accordion, a financial and technology consulting firm focused on the private equity industry. He has more than 25 years of experience supporting management teams and leading finance and operations initiatives in both stressed and distressed environments. Prior to joining Accordion, Mr. Jain was part of Alvarez & Marsal’s corporate restructuring and turnaround practice for over 10 years and served in a variety of senior financial operating roles. His most notable assignments have included helping lead the restructuring, liquidation and wind down of Washington Mutual and its predecessor entity, WMI Liquidating Trust. He also navigated the restructuring of Global Geophysical Services in its chapter 11 and eventually the liquidation and wind down in its second chapter 11 filing.
  • Dotcom Silo: The Honorable Joseph J. Farnan (Lead Independent Director): Mr. Farnan served as a United States District Judge for the District of Delaware from 1985 to 2010. He served as Chief Judge from 1997-2001. During his tenure, Mr. Farnan presided over numerous bench and jury trials involving complex commercial disputes. Prior to his appointment to the federal bench, Mr. Farnan was appointed to several positions in local, state and the federal government returning to private practice in 2010 with the formation of Farnan LLP, a law firm focused on complex commercial matters, including chapter 11 proceedings, securities litigation, antitrust litigation and patent litigation. Additionally, Mr. Farnan serves as an arbitrator, mediator, independent director and trustee of businesses contemplating or filing chapter 11 bankruptcy.
  • Dotcom Silo: Matthew A. Doheny: Mr. Doheny is President of North Country Capital LLC, an advisory and investment firm focused on challenging advisory assignments and investing private investment portfolios in special situation opportunities. He has held this position since January 2011. Mr. Doheny has served on the board of directors or as Chief Restructuring Officer of numerous stressed and distressed companies, including Yellow Corp., MatlinPatterson, GMAC Rescap and Eastman Kodak. He was also Managing Director and Head of Special Situations Investing at HSBC Securities Inc. from 2015 to 2017. Previously, Mr. Doheny served as Portfolio Manager in Special Situations at Fintech Advisory Inc. from 2008 to 2010 and as Managing Director of the Distressed Products Group at Deutsche Bank Securities Inc. from 2000 to 2008.

Read more Bankruptcy News