The FTX Bankruptcy, Lack of Corporate Controls, and the Coming Regulatory Scrutiny
On November 11, 2022, FTX Trading Ltd. and over 130 of its related and affiliated companies filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. Related proceedings have commenced in the Bahamas and in the United States Bankruptcy Court for the Southern District of New York. Currently, there is a dispute over where the cases will be administered.
While the amount of monies involved is immense, with creditors being owed in excess of $3 billion, the truly astonishing aspect of these cases is largely the complete lack of internal and corporate governance controls. These failures have allowed for numerous allegations of fraud, mismanagement, and malfeasance against FTX and its equity owners, primarily now former CEO, Samuel Bankman-Fried. They have also gained the attention of regulators, who have not seen this level of failure since the early 2000s and Enron.
On November 11, 2022, Mr. Bankman-Fried resigned from multiple positions and was replaced by restructuring specialist John J. Ray III, as the new CEO. Mr. Ray, a veteran of many noteworthy cases including the Enron and Nortel cases, has over 40 years of legal and restructuring experience and stated to the Bankruptcy Court 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.”
Many people ask how bad these failures were and how do companies avoid making similar failures? Many of the issues arising in the FTX matter can be attributed to the lack of basic, common-sense corporate governance protocols and internal controls. Some of the alarming problems that have been identified by Mr. Ray thus far include:
- Missing and/or incomplete financial records.
- The failure of many of the entities to have meetings of their boards of directors.
- The failure to maintain centralized control of cash, including the absence of accurate lists of bank accounts and account signatories and lack of attention to the creditworthiness of banking partners.
- Cash management and record-keeping failures, including the inability to even know the precise amount of cash in corporate accounts and a complete failure of liquidity forecasting.
- Questionable audits for some entities and potentially missing audits for other entities.
- The lack of an accounting department.
- Inappropriate financial disbursement controls.
Many of the problems identified constitute such a disregard for common sense and basic business practices as to be grossly negligent, as well as violative of regulatory requirements. In fact, Mr. Bankman-Fried, who is no longer employed by the companies and remains outside of the United States recently stated in Twitter direct messages with a Vox reporter, “F*** regulators they make everything worse.”
As the FTX matter proceeds, more failures of corporate governance and internal controls will undoubtedly be revealed. What can be taken away from the FTX matter is the importance of internal controls to all businesses. Good corporate governance is not only imperative but also critically important to the effective functioning and success of a business entity. When internal controls and best practices for corporate governance are missing or ignored, matters affecting a business can deteriorate rapidly and with unpredictable results, as was seen in the FTX bankruptcy.
Moreover, the failure to follow such practices and controls can result in not only breaches of fiduciary duties opening parties to liability, but also can result in regulatory problems.The FTX matter is almost certain to increase scrutiny of corporate governance and internal controls by regulators, shareholders, auditors, and lenders, as well as by acquiring parties in the context of mergers and acquisitions. For companies that recall the Enron debacle and the aftereffects, the post-FTX regulatory environment may look very similar to the post-Enron regulatory environment of the early 2000s. Given this heightened scrutiny, companies need to review their current protocols, policies, and procedures to ensure the use of best practices and compliance with regulations.
Companies seeking legal counsel related to reviews of internal controls and corporate governance can reach out to Post & Schell’s Corporate Practice Group or contact Group Principals F. Traynor Beck at email@example.com/215-587-1148 or Brian W. Bisignani at firstname.lastname@example.org/717-612-6041.
Disclaimer: This post does not offer specific legal advice, nor does it create an attorney-client relationship. You should not reach any legal conclusions based on the information contained in this post without first seeking the advice of counsel.