The FTX collapse: The governance red flags top-tier investors ignored
This article was originally featured in the September edition of the Governance Institute of Australia: Governance Directions journal.
‘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’ — John J Ray III
The recent failure of the FTX cryptocurrency exchange highlights the need for investors and market participants to do their due diligence when it comes to corporate governance. Assumptions around the competency of individual directors and the corporate governance standards in various jurisdictions left some FTX investors writing off hundreds of millions of dollars invested in FTX.
Prior to its collapse in November 2022, FTX was one of the world’s largest cryptocurrency exchanges with more than seven million registered users around the world. Founded in 2019 by Sam Bankman-Fried and Gary Wang, FTX Trading Ltd (trading as FTX.com) is a digital asset trading platform incorporated in Antigua and Barbuda. It is reported that FTX raised almost $2 billion, including from top-tier institutional investors, and grew to over 100 companies incorporated in various jurisdictions including Australia and Delaware. On 11 November 2022, Bankman-Fried filed for bankruptcy protection in Delaware in relation to FTX Trading Ltd and other affiliated companies and appointed John J. Ray III (Ray), who oversaw Enron’s bankruptcy proceedings, as the Chief Executive Officer. On that same day, the Australian FTX entities were placed into voluntary administration.
It is clear from Ray’s declarations to the US Bankruptcy Court that FTX lacked good corporate governance. Directors play a critical role in establishing and maintaining the standard of a company’s corporate governance. But who must be appointed as a director varies depending on the place the company is incorporated, as well as any internal corporate governance mechanisms that the company has implemented. The legislative requirements for the appointment of directors across Australia, Antigua and Barbuda and Delaware — three jurisdictions in which FTX had companies incorporated — vary significantly, raising red flags that investors should have considered more carefully.
What indicators of good governance should investors be looking for?
According to Governance Institute of Australia there are four key components to good governance: transparency, accountability, stewardship, and integrity. Together, these building blocks construct a governance structure that facilitates decision-making that encourages trust among stakeholders. A company must have a good culture to support the implementation of its governance structure, otherwise the company risks its governance structure merely being given lip service. While management plays a key role in driving culture at an operational level, it is the board who is responsible for overseeing the company, including the appointment and performance of key management personnel, as well as more broadly the strategic direction of the company. Careful consideration needs to be given as to the requirements to the appointment of directors and who is chosen to fulfil this critical oversight role. As, for example, investors may be surprised to learn that in some jurisdictions it is not a requirement for a director to be a human being.
Case study: The FTX board
FTX portrayed itself as at the forefront of consumer protection efforts in the crypto industry, with Bankman-Fried publicly championing federal legislative efforts to safeguard consumers and declaring the protection of investors and the public as a top priority for FTX. This gave the impression that FTX had implemented an effective governance structure to, amongst other things, protect consumer deposits from misuse. However, the filings in relation to the US bankruptcy proceedings have indicated otherwise.
‘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.’ — John J Ray III
Filings indicate that the management and governance of the FTX group was largely limited to Bankman Fried, Wang and Nishad Singh (FTX senior executives), each of whom were not long out of college and had no experience in risk management or running a business. Not only was there an absence of board oversight, FTX lacked independent or experienced finance, accounting, human resources, information security or cybersecurity personnel or leadership.
‘Many of the companies in the FTX Group, especially those organised in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings.’ — John J Ray III
Ray also identified that the FTX senior executives had directed the commingling and misuse of customer and corporate funds and intentionally moved FTX from jurisdiction to jurisdiction in attempt to enable and avoid detention of their wrongdoing. These findings indicate that the robust governance structure represented to stakeholders particularly regarding the protection of fiat currency and crypto deposits was merely lip service, with the FTX senior executives engaging in and encouraging behaviour contrary to their own purported procedures, principles and policies. It took less than ten days upon release of concerns regarding FTX’s dealings for FTX to shatter the trust of its consumers, resulting in FTX having to resort to filing for bankruptcy protection.
Who must be appointed as a director?
It is unusual that significant institutional investors did not have representation on the FTX board, particularly considering the lack of experience of the key decisionmakers of FTX. Though, as a shareholder of a company incorporated in Antigua and Barbuda, Delaware or Australia, institutional investors had, under the relevant laws, a right to vote on the appointment and removal of directors on the board. While each of these jurisdictions provide shareholders with the right to appoint and remove directors, there are greater constraints on who can be a director of an Australian company.
Directors of companies incorporated in Australia and Delaware must be natural persons. There is however no requirement for any directors of a Delawareincorporated company to reside in Delaware or in the United States. On the other hand, Australian companies must have at least one director that resides in Australia. The benefit of requiring directors (or, as the case is in Australia, for at least one director) to be resident to the place of incorporation is that it facilitates the enforceability of directors’ duties and accountability for the company’s actions.
In contrast, directors of Antigua and Barbuda-incorporated companies do not need to be a natural person. Instead, a director could be another company. The requirement for directors to be a natural person provides greater transparency by limiting the shield of anonymity provided by a company to facilitate determining the person who is in actual control of the company and increasing the accountability of directors. On the other hand, corporate directors introduce opacity into the corporate structure, increasing risks of illicit activity or jeopardising effective corporate insight.
In attempt to prevent unlawful activities such as fraud, money laundering and phoenixing activities, in addition to requiring directors to be natural persons, Australia has recently introduced a director identification number regime to further increase the accountability and traceability of directors of Australian-incorporated companies. This measure indicates that good corporate governance has wider economic and social implications as it goes towards supporting the integrity and efficiency of corporate and financial markets and in turn investor confidence and economic growth.
At a snapshot
What should investors do?
The collapse of FTX illustrates the consequences of poor corporate governance. The use of opaque legal and governance structures allowed the directors to largely be left unchecked by investors. This is a concern as the board plays a key role in the governance and strategic direction of a company, and in turn its long-term success. Yet investors ignored the red flags of FTX Trading Ltd being incorporated in a jurisdiction not known for having strong corporate governance and lacking a competent and experienced board, factors contributing to the collapse of FTX.
In an ideal world, shareholders should ensure that the boards of the companies they invest in, or are looking to invest in, are comprised of appropriately qualified people and that the constituent documents (such as the constitution for an Australian company) provide a framework to support good corporate governance more broadly. Shareholders should also undertake appropriate due diligence on the governance of a company, including the composition of the board and the company’s culture, to understand if there any potential red flags. The risks of not doing so, or ignoring any identified red flags, could lead to poor investment decisions (and in the case of one institutional investor an apology to fund investors).
 FTX Trading Ltd (Bankr D Del, No. 22-11068, 17 November 2022) slip op 2 .
 ‘Governance foundations’, Governance Institute of Australia (Web Page).
 FTX Trading Ltd (Bankr D Del, No. 22-11068, 17 November 2022) slip op 2 .
 FTX Trading Ltd (Bankr D Del, No. 22-11068, 17 November 2022) slip op 16 .
 See generally FTX Trading Ltd (Bankr D Del, No. 22-11068, 26 June 2023) slip op 5.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.