Was the FTX collapse worse than Enron?
The Enron collapse was from before my time professionally but has been a case study in what not to do in every accounting/auditing textbook since.
Given that it was over 20 years ago, a brief recap… the downfall of Enron was centered around losses trading derivatives in the energy market. Those losses were hidden in hundreds of “Special Purpose Entities”, which were not disclosed in the financial statements. The inappropriate accounting treatment (probably just fraud) and auditors’ failure to provide any oversight, didn’t directly cause the failure of Enron, but it did allow insiders to profit while the average investor was wiped out. For more on the Enron scandal, see the links at the bottom of this article
So let’s compare and contrast the two scandals to put the FTX collapse in historical context.
- FTX appears to have actually been profitable, despite reckless spending (FT Story).
- SBF claimed that accounts were “mislabeled” and it led to an $8 Billion miscalculation of the risk that FTX was exposed to. This claim is almost too absurd to even include.
- Size and scope. Enron was worth over $70 billion at its peek and was around for over 15 years. FTX had a meteoric rise to a questionable valuation of $30 Billion within 3 years and collapsed in a few days.
- Theft – The FTX transfer of user funds to Alameda, is nothing short of theft. Enron was poorly run in many ways, but they were still fundamentally doing the business that shareholders expected. While legally FTX depositors were unsecured creditors, that is not how 99% of users viewed the platform. Even in the world of Celsius, Voyeur, and Blockfi, who lost user funds to risky investments, FTX stands alone in moving funds to a trading firm owned 90% by SBF.
- Who lost funds? – Enron was very much a stock owned by the average American investor and was very likely included as a small part in a broader portfolio. FTX loses were split between two very different groups; FTX equity holders and account holders. The first group is largely made up of VCs and influencers, who will be just fine. The second group may have lost a large portion of their net worth.
- Financial Controls – Enron’s fraud was really centered around their financial reporting. Enron’s financial reporting was used to cover up the poor, but legal, activity of its business. It is hard to say exactly how much FTX’s financial were overstated, with them being private. You’d expect that VC’s valuing the company at $30B would have done some due diligence, but that just might not have been the case. Cory Klippsten, CEO of Swan Bitcoin, said he noticed potential issues within an hour of reviewing the financials.
- Internal Controls – if it is true that SBF had a backdoor to make adjustments to FTX’s accounting system (The Block), then it is safe to say that the company’s internal controls were essentially non-existent. Internal controls are established to prevent or reduce the likelihood that one person or group could commit fraud or steal company funds. The potential that one person had the ability to control 100% of the funds for an exchange with billions of users funds is an indictment on anyone responsible for accounting oversight at the organization and their auditors.
- FTT Token Valuation – probably the biggest difference between FTX and Enron, was FTX’s ability to create their own token and then borrow against it. The token also provided a reason for VCs to overlook potential issues with the financials.
- Jail Time? – top executives at Enron were sentenced to jail time over their roles in the scandal. Will SBF any others at FTX receive a similar punishment?
So which was worse?
It could be recency bias, but from a fraudulent activity perspective, FTX seems much worse. It appears the fraud was intentional and premediated at least with SBF and possibly many others within FTX and the broader crypto ecosystem. SBF wants everyone to believe it was all a big mistake, we’ll see how that claims ages….
So what is the lesson for accountants/auditors?
Accountants are fundamentally responsible for giving an accurate representation of the financial health and performance of a company. CPAs employed by a company may not be independent, but their responsibility is still to the general public. Auditors are another layer that is supposed to highlight potential issues and ensure they are fixed or report otherwise. Clearly none of that happened at FTX, just like it didn’t happen twenty years earlier at Enron. An open transparent public ledger could help reduce the risk of fraud in a hyperbitcoinized future, but today accountants and auditors are needed to help build trust in the current system.
If history is any guide, additional regulation is likely coming. Enron and other scandals in the early 2000’s led to Sarbanes-Oxley. The financial crisis of 2008, led to Dodd-Frank. Many bitcoiners would see regulations of “Crypto” as a good thing, but I would caution that government oversight is rarely well targeted or effective. A set of regulations that makes it harder for new exchanges to be created, but that strengthens existing exchanges, all while giving SBF, Mashinsky, and Do Kwon a slap on the risk seems most likely to me.
FTX, although different from Enron in many ways, is nothing new and it won’t be the last time people lose their money due to fraud. What can be done about? One answer is to build better institution that are more localized and accountable to it’s stakeholders. That process is long and imperfect, but there are many building those businesses today in the bitcoin space. In the meantime, hold bitcoin in self custody, so you don’t have to trust a centralized third party.