Words of Caution for Educators Using ChatGPT
Considerations in Deciding Whether to Blow the Whistle

The Story of FTX and Sam Bankman-Fried

An Example of Hubris, Incompetence, and Greed

I always tell my students that the best way to learn about ethics, or the lack thereof, is through a case study. What follows is a mini-case study of the FTX fraud.

Last week Sam Bankman-Fried was found guilty of misappropriating and embezzling  billions of dollars of his customers’ money for himself by using Alameda Research, the hedge fund closely associated with the cryptocurrency exchange, FTX. From 2019 until early in 2022, Bankman-Fried and his co-conspirators stole billions and used that money for his personal benefit, including to make personal investments and to cover expenses and debts of Alameda.  

Sam Bankman-Fried was found guilty. U.S. attorney Damian Williams, who prosecuted the U.S. Department of Justice’s case against Sam Bankman-Fried for securities fraud, wire fraud, and money laundering, said in a statement after the verdict that found Bankman-Fried guilty that he “perpetrated one of the biggest financial frauds in American history – a multibillion-dollar-scheme designed to make him the king of Crypto.”


In a short period of time, cryptocurrency had gone from a small, alternative investment to one worth hundreds of billions of dollars collectively. The cryptocurrency exchange industry is a pretty tight market. Early on, Crypto exchanges realized they had to differentiate themselves from the competition, so they drew on what they knew best – cryptocurrencies – and started to issue some of their own. These are known as exchange tokens.

By minting these tokens, then keeping a bunch for themselves, Crypto exchanges generated a huge amount of wealth. That wealth was created not by selling off equity or issuing debt – it was created by introducing the value of the token to the users of the exchange and making a handful of keynote speeches and announcements to build excitement for the mint. Exchange tokens also enhance the liquidity of an exchange.

Initially, the market believed the FTX implosion was the result of an old-fashioned bank run on the exchange's reserves. However, as time went by and more facts emerged, the story around the company became criminal.

In November 2022, the Futures Exchange (FTX), one of the biggest digital currency exchange platforms, collapsed due to the criminal charges placed on its founder, Samuel Bankman-Fried (SBF).

Bankman-Fried was responsible for multiple criminal acts, including wire fraud, money laundering, securities fraud, and multiple counts of conspiracy to commit fraud and money laundering. The actions by SBF caused the downfall of FTX, which led to losing billions of dollars in investor and lender accounts.

Findings from leaked internal documents identified the close relationship between Alameda Research and FTX. Both were founded by SBF, and there was significant anxiety about the extent and nature of their close dealings. The FTT token was essentially created from thin air by FTX, inviting questions about the real-world, open-market value of FTT tokens held in reserve by affiliated entities.

Although it was a major moneymaker for FTX and helped keep SBF’'s hedge fund afloat, in the end the FTT Token proved to be the company's undoing. After an article in CoinDesk, a news site specializing in bitcoin and digital currencies, raised questions about FTX's financials, Changpeng Zhao, the CEO of Binance, decided to offload his company's sizable FTT holdings. That spooked investors, and as word spread, the token's value cratered.

Auditing and Internal Control Issues

In testimony before the U.S. Congress, Bankman-Fried pointed out that he was not aware of the relationship between FTX and Alameda Research, nor the sizable amount of funds transferred between FTX and Alameda. After a number of market crashes, more than $10 million was wiped out in a matter of days, leaving FTX unable to liquidate that position and generate the money owed.

Bankman-Fried was using client assets as collateral for the debt. With $5 billion of withdrawals in one day, FTX and the 139 companies in its group had to file for bankruptcy. Using client money as collateral, Alameda Research was trading billions of dollars from FTX accounts and leveraging the exchange’s token as collateral. Three sources familiar with the company told CNBC that they were blindsided by FTX’s missteps and that only a small cohort knew about the potential misuse of customer deposits.

Governance and Internal Controls

According to Charles Wert writing about the FTX collapse, FTX had many governance failures that led to its collapse, including the accountability of executives, a lack of audibility and transparency for decisions made, and conflicts of interest. These factors created a culture of deniability, irresponsibility, ethical blindness, and a failure of leadership.

At the core of FTX's failure was a lack of proper governance and oversight from its founder, Bankman-Fried, and the management team. Despite having numerous investors and advisors, the company didn't have a board of directors. Without adequate oversight from a board, there are no executives to make decisions without sufficient accountability or appropriate consideration of stakeholders' interests.

FTX's lack of governance contributed to its demise, as was a lack of transparency regarding ownership and control. According to numerous reports, no one entity held majority ownership or control over the platform. Instead, it was owned by multiple companies, individuals, and entities, making it difficult for any one party to be held accountable for decisions made on behalf of FTX.

The primary issue leading to the downfall of FTX was the lack of a secure framework for financial transactions on the platform. Without appropriate controls, hackers could exploit weaknesses in FTX's system and steal large sums of money from users' accounts. Additionally, FTX did not have adequate oversight mechanisms to identify suspicious activity and red flags that could have been prevented if detected early on.

Inadequate internal control practices led to increased fraudulent trading activities, damaging FTX's reputation among investors and causing them to withdraw their funds from the platform. Furthermore, there were limited options available for customers who experienced losses or technical issues while using FTX services, as they could not get support from anyone at FTX or receive compensation for the damages incurred.

An effective governance structure must have a system of checks and balances to protect against fraud or abuse of power. Additionally, organizations should establish policies that promote ethical decision-making and develop procedures for resolving conflicts between the board, management team, and stakeholders. Finally, organizations need to be prepared for changes in technology or market conditions by having personnel trained on new systems or processes as required. FTX failed on all counts. The buck stops with SBF who lacked the leadership skills to steer the ship through troubled times and live up to his and FTX’s fiduciary responsibilities.

Regulation Crypto

As a trading platform, crypto exchanges were owning cryptos in their balance sheets. They needed to do so to create liquidity and allow trading. Since the assets were not widely owned by institutions, the market was limited to those “exchanges” and traders. It was easy to shuffle assets and transactions between the crypto trader and the crypto exchange. The responsibility for legitimizing crypto assets in their various forms falls under securities regulation while the legitimization of crypto exchanges falls under exchange regulation.

Examining the regulatory issues, Goerge Ugeux, a former Vice President of the New York Stock Exchange, points out that this structure led inevitably to a complete absence of reporting to a centralized point of price discovery. Transparency was nowhere to be found No one seemed to oversee the financial statements of FTX U.S. Nobody looked at the financial stability impact of those crypto “exchanges,” leaving the market dominated by one firm, Binance.

Three questions bare on whether the regulators met their fiduciary responsibilities: (1) Did regulators ever look at the risks for retail investors, the core of their mission? (2) Did regulators ever consider that crypto-assets – undefined, volatile, and explosive multibillion dollar securities sold through “private placements” – should be limited to “accredited investors”? (3) Why did the SEC wait until August 2022 (six months after it started investigating FTX U.S) to act?

The Financial Stability Oversight Council (FSOC) is charged with identifying risks to the financial stability of the U.S., promoting market discipline, and responding to emerging risks to the stability of the U.S. financial system.

Th question is whether those officials believed that a $2 trillion, volatile asset would not be a possible financial stability risk. This very issue was addressed by Senator Elizabeth Warren in a letter to the Secretary of the Treasury, as the chair of the FSOC. The letter warned,

“I have become increasingly concerned about the dangers cryptocurrencies pose to investors, consumers, and the environment in the absence of sufficient regulation in the United States. However, as the demand for cryptocurrencies continues to grow and these assets become more embedded in our financial system, the Council must determine whether these trends raise concerns beyond investor and consumer protection and extend to broader systemic vulnerabilities that could threaten financial stability.”

Regulators left retail investors without information or protection. They could have protected them by limiting the access to crypto assets to accredited investors. They could have warned the public. They could have explicitly disavowed the use of exchanges for cryptos. They did not. Not only was there little oversight, but due diligence, which is a duty and needs to be thorough, was also lacking. Most important, SBF failed in his fiduciary responsibilities.

The new CEO of FTX, John J. Ray, realized in three days.

“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,” Ray said in court. “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.”

The bankruptcy proceeding on November 17, 2022, started with remarks from the new CEO, John J Ray who led the restructuring of the collapsed exchange:

FTX’s exchanges are “expected to have significant liabilities arising from crypto assets deposited by customers . . . However, such liabilities are not reflected in the financial statements prepared while these companies were under the control of Mr. Bankman-Fried.” The Alameda division also “did not keep complete books and records of their investments and activities,” so their balance sheets were not reliable .Rescue attempts were hindered by “the absence of lasting records of decision-making.” There was no daily reconciliation of crypto positions. A software backdoor “conceal[ed] the misuse of customer funds.”

Resolution of Legal Matters

On December 13, 2022, the SEC charged SBF with orchestrating a scheme to defraud equity investors in FTX. According to the SEC’s complaint, since at least May 2019, FTX raised more than $1.8 billion from equity investors, including approximately $1.1 billion from approximately 90 U.S.-based investors. In his representations to investors, SBF promoted FTX as a safe, responsible crypto asset trading platform, specifically touting FTX’s sophisticated, automated risk measures to protect customer assets. The complaint alleges that SBF orchestrated a years-long fraud to conceal troublesome transactions from FTX’s investors.

The complaint further alleges that Bankman-Fried used commingled FTX customers’ funds at Alameda to make undisclosed venture investments, lavish real estate purchases, and large political donations.

"We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto," said SEC Chair Gary Gensler.

"The alleged fraud committed by Mr. Bankman-Fried is a clarion call to crypto platforms that they need to come into compliance with our laws. Compliance protects both those who invest on and those who invest in crypto platforms with time-tested safeguards, such as properly protecting customer funds and separating conflicting lines of business. It also shines a light into trading platform conduct for both investors through disclosure and regulators through examination authority. To those platforms that don’t comply with our securities laws, the SEC’s Enforcement Division is ready to take action."

On February 13, 2023, a U.S. judge put two regulators' civil lawsuits against SBF on hold until the conclusion of the Department of Justice's criminal case. U.S. District Judge Kevin Castel granted a Justice Department motion to stay the lawsuits filed by the Securities and Exchange Commission and the Commodity Futures Trading Commission. The reason was that valuable evidence could be discovered in the Justice Department case that might strengthen the cases for the two regulatory agencies.

On November 2, 2023, a month’s-long trial ended with the jury finding SBF guilty of wire fraud and conspiracy to launder money. Prosecutors said SBF “Misappropriated and embezzled” billions of dollars of his customers’ money for himself by using Alameda Research, the hedge fund closely associated with FTX. From 2019 until early in 2022, SBF and his co-conspirators stole billions and used that money for his personal benefit, including to make personal investments and to cover expenses and debts of Alameda.

SBF’s sentence could be as long as 110 years. He is likely to appeal the verdict. The sentencing was tentatively set for March 28, 2024.  

While the FTX Group's failure is novel in the unprecedented scale of harm it caused in an emerging industry, many of its root causes are familiar: hubris, incompetence, and greed.

Blog posted by Steven Mintz, PhD on November 7, 2023. Find out more about Steve’s professional activities on his website (https://www.stevenmintzethics.com/). You can sign up for his newsletter and connect on LinkedIn (https://www.linkedin.com/company/ethics-sage/about/.)