The FTX cryptocurrency scandal has made clear how rapid technological progress goes hand-in-hand with old-fashioned financial misconduct.

Moreover, a slowing economic outlook, rising geopolitical tensions, and behavioural changes wrought by technology mean that the scale and number of such abuses will rise.

Nothing is new here, though, and the old rules still apply. Those organisations which can respond quickly and vigorously will be those that mitigate damage.

SVA has substantial experience in investigating and handling such issues. We can assist in protecting companies from financial and reputational harm or by reacting swiftly to crisis. The urge to spend huge sums on law firms before tracking assets is a common mistake.

The FTX scandal

FTX, a cryptocurrency exchange, rose rapidly to stardom, before collapsing into a liquidity crisis and insolvency in November 2022. Its rise and fall recalled that of Enron in 2001, whereby another high-technology trading platform turned out to offer much less than touted.

No doubt, in the months ahead, investigators will slowly uncover questionable transactions. The US Commodity Futures Trading Commission (“CFTC”) has already identified failings such as conflicts of interest, commingling of funds, and a lack of proper financial statements. Indeed, what seems to be a lack of internal controls resulted in this juddering collapse. None of these claims are new or unexpected in SVA’s experience.

Investors will now have to settle for what little is left behind, and can be seized. Singapore’s sovereign wealth fund, Temasek, has already written down a USD275 million investment, and is investigating the apparent failures of its own diligence process examining FTX.

The scandal’s implications

The FTX collapse has provided a neat example of how investors and regulators miss risks in an evolving field. In the case of FTX, fears about the use of cryptocurrencies in money laundering may have diverted attention from old-fashioned concerns about product integrity and the viability of the trading platform.

Of course, such fears were entirely warranted. Criminal syndicates do use digital currencies, and law enforcement is only now learning how to respond. Indeed,

INTERPOL on 24 November 2022 announced that combined law enforcement efforts had led to the arrests of close to 1,000 suspects, and the seizure of some USD130 million in cryptocurrencies, in similar frauds.

However, the implosion of the FTX exchange also showed that the platforms themselves can be ruinously problematic in their own right.

In that sense, the FTX collapse bears comparison not just with Enron, but also with other technology-related collapses, such as the Wirecard case in Germany, or the Theranos case in San Francisco. In those examples, the promise of technology and associated complexity not only drew in investors, but also served to disguise large-scale malfeasance.

In short, the FTX case emphasises, once again, how important is due diligence, even (or, perhaps, especially) when investing in high-profile companies. After all, the FTX case has made clear how investors seeking genuine, if risky, frontier investments can find themselves overlooking, or even excusing, the most egregious behaviour.

The role of technology

The FTX scandal is also just the latest illustration of how rapid, and lasting, changes in behaviour, facilitated by technology, are worsening financial crime.

Perhaps most obvious has been a shift towards remote working, meaning that staff may rely (at least part of the time) on insecure internet connections operated on shaky home systems. Such systems are vulnerable to penetration by cyber-criminals.

However, technology is also broadening the array of tools available to fraudsters. Cryptocurrencies are one such tool.

Another is deepfake technology. Its use has become a problem, for instance, in the “e-sports” domain (a tech-savvy crew, if any) – suggesting that the threats to slower paced businesses will intensify over time.

Deteriorating outlook

In addition to the above, the FTX case is a neat reminder that all such cheating is on the rise – not least as the holiday season is drawing near.

This year, slowing growth, rising interest rates, and accelerating inflation have all trimmed revenues and depressed asset prices. Accounting fraud is thus liable to intensify, as executives seek to inflate receivables, or overstate asset values, perhaps in an effort to win bonuses ahead of Christmas or Chinese New Year.

Moreover, in such a climate, companies may find themselves lured into questionable investments, in a bid to bolster the bottom line. Multinational companies are particularly at risk here, as in-country teams seek to demonstrate their value by forging ill-conceived deals – or may even have ties that engender corruption.

The downside of such deals may also not be immediately visible. FTX’s collapse has revealed how detail and dash can obscure recklessness – at least, for a time. Ultimately, though, rising interest rates and declining access to credit generally reveal the extent of the rot.

An ancillary concern is that governments are eroding protections. The European Court

of Justice ruled to reduce transparency on beneficial ownership of assets in registries in November 2022, for instance, and China and the US remain locked in disagreement over audit standards. Such disputes leave space for cheats.

Mitigating measures – SVA’s suggestions

Companies can protect themselves from financial crime, though, and those executives who act quickly and vigorously will be those that limit harm.

• Management should bolster internal compliance mechanisms, so as to identify fraud and other financial crime early. A dependence on audits – external or internal – will provide only limited protection; SVA has investigated many financial crimes at companies audited just the year before. Practical and experienced investigators always prove more effective than process-driven compliance or audit staff “ticking the boxes”.
• Strengthening the integrity of data systems, implementing tighter control over staff approvals, and otherwise bolstering protections for confidential information are also all crucial. Staff should be trained, drilled, and supervised, to act cautiously.
• Companies should monitor and record transactions more closely, establishing sound audit trails and gathering all documentation – in retrospect, if necessary. Such actions not only deter, but also expose, deception.
• Adherence to robust due diligence standards is as important as ever. Boards should require background investigations, and ensure that oversight is in the hands of a relatively “neutral” party – and not under the control of a local deal team. Boards should also “refresh” older due diligence, to take account of the changing fortunes of counterparties, or rising political or commercial risks.
• Acting decisively is important. Once a risk is identified, companies should undertake a thorough investigation, and report in full. Attempts to “sweep matters under the carpet” will only lead to bigger problems. Third parties such as SVA can provide an independent perspective, and so assist boards in handling internal stakeholders.
• Companies should launch external asset search and tracing measures, and recovery actions, so as to recoup stolen funds. Many companies now take out fidelity, or other, insurance measures to cover costs in such circumstances.
• Executives should report frauds to the relevant authorities, and assist in subsequent investigations. Doing so not only will help their case, but also benefit those seeking to protect the commercial environment as a whole.

SVA

SVA (www.stevevickersassociates.com) is a specialist risk mitigation, corporate intelligence and risk consulting company.

The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world. SVA’s staff have a wealth of experience in investigating and dealing with frauds and financial crimes.

If you wish to protect your business from the negative consequence of fraud or other financial crimes, please do not hesitate to contact us at the numbers below. We can be of assistance to your organisation in handling these complicated issues.