Due diligence? Temasek invests in FTX with no accounting dept in company

Due diligence? Temasek invests in FTX with no accounting dept in company

Bloomberg published an opinion piece on Wednesday (14 Dec) stating that the lack of a serious accounting system or even basic internal controls had contributed to the downfall of cryptocurrency exchange FTX.

The article was written by two accounting professors, Michelle Hanlon and Nemit Shroff, from the MIT Sloan School of Management.

“As professors of accounting, it’s a continual challenge convincing students that our courses are important when they’re tempted by sexier-sounding classes with titles that include words like ‘innovation’, ‘artificial intelligence’ or ‘fintech’. ‘Introduction to Financial Accounting’ doesn’t pique the interest of the typical 20-year-old,” Hanlon and Shroff wrote.

“The FTX debacle has given us our best argument yet. It enshrines all the reasons a solid accounting system and well-structured internal controls are critical to a business and its investors, creditors, customers, suppliers and other stakeholders.”

Apparently, FTX didn’t even implement any internal controls at all, which are needed, especially for financial institutions that maintain custody of customer assets.

“If FTX had implemented such controls even at a minimal level, many of the company’s deficiencies would have become known sooner and the large-scale meltdown might have been prevented,” the professors said.

FTX’s bankruptcy filing indicated that it had no in-house accounting department and failed to take even the most basic measures, such as segregating duties and establishing a system to keep track of accounts.

The filing also stated that corporate funds were used to purchase homes and other personal items for employees and advisors and that FTX used software to conceal the misuse of customer funds.

Due diligence failure

The professors wondered how it was possible for FTX to raise a total of US$1.8 billion in funding over seven rounds, and be valued at US$32 billion, given that there was a complete failure of corporate controls without even an accounting department in the company.

“It’s true that FTX’s investors should have demanded greater accountability, such as attestations of internal controls by both management and a reputable independent auditor,” the professors continued.

“That they didn’t doesn’t mean that they’re responsible for FTX’s failure; it simply means they failed at their own due diligence,” said the professors.

“One can only speculate why sophisticated investors didn’t do more to protect their investment. Perhaps the potential for large gains outweighed the risk of loss on a few investment decisions. Even so, investors would certainly have reduced their exposure by demanding some visibility into accounting safeguards.”

Indeed, Temasek Holdings, one of the prominent investors in the company, was said to have spent eight months, from February to October last year, doing its supposedly thorough due diligence before investing US$275 million in FTX over three rounds of funding.

Yet, Temasek couldn’t even detect that there was no accounting department in the company or whether the absence of one mattered in its decision to invest in the company.

And when FTX collapsed, Temasek quickly issued a statement blaming former FTX CEO Sam Bankman-Fried, “It is apparent from this investment that perhaps our belief in the actions, judgment and leadership of Sam Bankman-Fried, formed from our interactions with him and views expressed in our discussions with others, would appear to have been misplaced.”

Ho Ching, the wife of PM Lee, also commented about the FTX losses on her Facebook page, saying that Temasek can afford to be contrarian.

“Temasek can afford to be contrarian bcos it has its own balance sheet and can think long term,” she wrote.

“With a long term stance, and all the pros and cons that come with that stance, Temasek is not fazed by the twiddles and sentiments of the market.”

A review will be conducted by Temasek on its decision to invest in FTX. However, it will be conducted by an internal team on its investment team, which made the decision.

Director of crypto investment team, a top FinTech influencer in Singapore

It’s not known who in Temasek was responsible for doing the due diligence of FTX investment, but according to LinkedIn, Antony Lewis, who joined Temasek in 2020, is the Director of the crypto and blockchain venture investment team.

On his LinkedIn, Lewis wrote, “I work in Temasek’s blockchain venture building and investment team. We are focused on building game-changing commercial businesses using decentralised technologies, and invest in these technologies too.”

“Previously I worked at enterprise blockchain firm R3 as Director of Digital Assets, and Director of Research. I was regarded as the firm’s subject matter expert in tokenised money and central bank digital currencies,” he added.

“In 2015 and 2016, I was recognised as a Top 100 influencer in FinTech in Asia at www.fintechasia100.com and a top 30 Singapore FinTech influencer. In 2017 I was an Asia top 8 blockchain influencer according to BlockShow (that can’t actually be true though can it) and this FinTech list too:”

Bankrupted FTX and FTX US, first direct investment handled by crypto investment team in Temasek

Speaking at the fifth Ethereum Community Conference on 19 July this year, Lewis shared his involvement in the sovereign wealth fund’s investment into the crypto business before the fall of FTX.

“So the ones that we’ve disclosed FTX and FTX US and Immutable from Australia, Consensus and Amber. So we continue to invest in single names, we continue to invest in funds through the cycle,” said Mr Lewis.

He added, “In fact, there’s never been more activity. We are pretty active now. The team is scaled up. We have the investing team. We also work with other teams in the organisation.”

“So it’s been it’s been a pretty interesting journey convincing the organization, and convincing management and everyone around that coins aren’t just a massive Ponzi and scam, although many of them maybe. And then, of course, the selection of like what you invest in is, is the core of what we do as an investment team.”

Answering a question from the audience about consideration for investment into crypto, Lewis said, “So our first direct investment was FTX and FTX US, and you know, when we first started the legal and we were like, oh, this is all illegal, they’re doing all of this unregulated legal stuff.”

“Well, if an activity is unregulated, you don’t need a license, you can just go and do that. Doesn’t mean you’re doing anything illegal. It just means it’s not a licensed activity.” said Lewis.

“So, you know, they’re playing in these spaces where you don’t need a license, you’re not going to get a whole bunch of licenses. As so these companies are all skilling up and all becoming more compliant as it becomes kind of business-critical.”

He added, “I think in that process, a whole bunch of people in different departments learned more about crypto and I think when you first come into it doesn’t for certain types of people, especially more conservative folks, there’s immediate like, no, everything is bad.”

“but as you learn more, you’ll actually know that’s not the case. It’s also you have a much more nuanced view. I think as the view becomes more nuanced or educated and at the same time, regulations are changing and in some cases becoming more crypto friendly, if not crypto aware, right?”

“The words they’re using in regulation are becoming more like crypto words. The word, Stablecoin wasn’t anything like five years ago. So as the regulatory landscape changes as we upskill all our stuff, I think you can be a lot more nuanced about saying yes to investments as opposed to no.”

If Lewis was involved in doing due diligence for FTX, it’s not known if he knew that the company had no accounting department set up.

In any case, the whole FTX saga led the 2 MIT professors to conclude, “Accounting classes may never sound thrilling to most young students and entrepreneurs, but FTX’s collapse proves the necessity of learning the principles of sound accounting for any business.”

Meanwhile, Bankman-Fried was arrested on Monday (12 Dec) in the Bahamas and charged with eight criminal counts in the US.

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