What D'ya Got Part 2 - FTX is Everywhere
What D’Ya Got Part 2 or It Depends (on who you search)
FTX and the Biggest Due Diligence Lesson So Far
Everyone loves a good serving of schadenfreude, taking pleasure in someone’s misfortune. But you know what fable people really love? The Emperor’s New Clothes. To sit back, smug, and watch everyone admire what is clearly idiotic, and at the end, be able to swoop in with a big told you so. That sells. Both the press and social media are filled right now with stories about the demise of FTX and its founder, Samuel Bankman-Fried.
Until a few weeks ago, people’s general understanding of crypto or bitcoin, to the extent that everything was “bitcoin”, was a mix of I don’t have a clue, and why did I not buy. One person was the poster child for all things crypto. He was Samuel Bankman-Fried or SBF. He ran various companies but especially something called FTX. Profile after profile gushed over SBF and his genius. Meanwhile, FTX’s logo was plastered on Major League Baseball umpires. Tom Brady and Larry David were spokesmen. Moreover, it collected investments from some of the biggest, savviest venture capitalists around. It was huge until, of course, it was not. The pleasure is schadenfreude, but the moral is Emperor’s New Clothes. How could you not see it?
The collapse of FTX is being compared to the collapse of Theranos. Theranos was another high flying company, led by an executive with an outsized presence. Theranos was a fraud and its face, Elizabeth Holmes, is looking at a very long term in prison. Theranos is much cited as a due diligence failure; things they promised turned out to be fake. It was an Emperor’s New Clothes situation because, like FTX, a lot of “names” became associated with it. How could they get suckered it was asked. Yet, if you dig into Theranos, it is clear that a lot of the red flags were not in the public record, and the key Wall Street Journal expose only came when internal whistleblowers leaked information. FTX and SBF, on the other hand, have some clearer lessons, some easy to spot due diligence errors.
I am not going to detail all the things missed regarding FTX, nor am I going to go all Charlie Munger, crypto is a con here. Instead, I want to focus on one huge lesson. It all comes down to who you research.
Most critiques of due diligence, the process used to check people and companies out before doing business with them, investing, extending credit, taking on a new client or vendor, is unrealistic. That is all due diligence exercises have limits. The limits come in three varieties:
· Cost
· Timeframe
· Sources
The adage is you can have it fast, cheap, or good but not all three. In the real world, it’s rarely thought that way. People tend to have an idea about how much they want to spend on something or on how much they think something is worth. Regardless, the cost or the budget is almost always the driver of projects and due diligence is just a project. A key way to manage the due diligence budget is to decide how many people to research. Due diligence assignments are often priced on a per person basis, so it is clear how adding or subtracting a name matters. Even if the project is billed other ways, the total amount of names will impact the cost. FTX is a good example what may happen if you limit who you research.
I want to have the courage of my convictions here, and I have the benefit, with FTX, of knowing how the story turned out (or is turning out). To use my favorite life teacher, poker, it’s easy to sound like a genius when you can see a person’s hole cards. I’m trying to say that I know you cannot research everyone. I also know that a major issue with FTX likely occurred because of who was researched. Who was not.
One of the most interesting and informative articles on FTX in the last few weeks was on Forbes. They put up an item on November 10, listing various parties involved with FTX. They included investors like BlackRock and Sequoia Capital; professional service firms like Deloitte, PricewaterhouseCoopers, Sullivan & Cromwell, and vendors like Stripe and Amazon Web Services. Which ones did any due diligence? And when these parties did their due diligence, who did they look at?
On Twitter, Ana Mostarac (@Anammostarac) had a brilliant thread the other day on the qualifications of FTX key executives. My favorite finding of hers, and one that has since been heavily amplified, is that Daniel Friedberg, Chief Regulatory Officer of FTX, was in-house counsel at an online poker site called Ultimate Bet. Ultimate Bet was notorious for defrauding its users. If you go on Twitter now, some have pivoted to Friedberg as the hidden power behind FTX. That he did with FTX what he had already done to Ultimate Bet. That’s probably a stretch, but his association with Ultimate Bet is a red flag that only would have been known, let alone addressed, if the research scope included Friedberg.
There will be a lot of posts from a lot of people in the coming weeks, months, years on FTX because schadenfreude and the Emperor’s New Clothes never lose their satisfaction. There will also be lessons to learn. One that’s already clear from FTX – think hard about who you want to research when setting your due diligence scope. Who you research will have a major impact on what you find. When the question comes, what d’ya got, the answer will be, it depends on who you searched.