ACCT 660 Week 4 Individual Research Project Part 1 Example

The Collapse of FTX: Company Background, the Fraud, Its Discovery and the People Involved

Introduction

In November 2022, FTX, then among the biggest venues anywhere for trading digital assets, collapsed within about ten days, leaving customers unable to withdraw billions of dollars. Within a year its founder, Samuel Bankman-Fried, had been convicted of fraud in federal court. The case fits this project closely. The fraud occurred between 2019 and 2022, well within the last ten years, and information technology was central to it: according to regulators and the company's own bankruptcy administrators, features written into the exchange's software allowed an affiliated trading firm to draw on customer funds without the limits that applied to everyone else. This paper sets out the background of the company, the scheme, the role of technology, how the fraud was concealed and discovered, and the people involved.

Company Background

Bankman-Fried founded the trading firm Alameda Research in 2017 and, with Gary Wang, founded the exchange FTX in 2019 (U.S. Securities and Exchange Commission [SEC], 2022). FTX allowed customers to deposit cash and crypto assets and to trade them, including through borrowed-money products. The company grew quickly, moved its headquarters to the Bahamas, and raised more than $1.8 billion from equity investors, including about $1.1 billion from investors in the United States (SEC, 2022). It advertised heavily, signed sports sponsorships and presented itself as a safe, regulation-minded exchange.

FTX operated through two main platforms. The international exchange, FTX.com, run by FTX Trading Ltd., served customers outside the United States and offered a wide range of crypto assets and derivatives traded on margin. A separate company, often called FTX US, served American customers under a narrower set of products. The structure mattered later, because the bankruptcy covered both groups and investigators had to sort out which customers' assets had gone where. Both platforms relied on the same small group of engineers and executives, and the same founder controlled them.

The exchange's public image was a large part of its value. Bankman-Fried testified before Congress, spoke often about the need for regulation of the industry and was widely described as a responsible figure in a sector known for risk. Investors, customers and the press accepted that image with limited scrutiny. For an examiner, the image is part of the background of the fraud, because it lowered the guard of the people who might otherwise have asked hard questions about the relationship between the exchange and Alameda.

Alameda Research remained a separate company on paper but was owned largely by Bankman-Fried and was run from 2021 by Caroline Ellison as a co-chief executive and then chief executive. Alameda traded on FTX and acted as a market maker for the exchange. FTX also issued its own token, FTT, and Alameda held a large share of the tokens in circulation. That close relationship between an exchange and a trading firm controlled by the same person was the structural weakness on which the fraud depended.

The Scheme

The core of the fraud, as alleged by the SEC and proven at trial, was that FTX customers' deposits were used by Alameda for its own purposes. The SEC complaint alleged that from the start, Bankman-Fried diverted customer funds to Alameda and used them for venture investments, real estate purchases in the Bahamas, political donations and loans to himself and other executives, while telling investors and customers that FTX kept customer assets safe and separate (SEC, 2022). Prosecutors described the missing customer money at the time of the collapse as about $8 billion (U.S. Attorney's Office for the Southern District of New York [USAO], 2024).

Customer money reached Alameda by more than one route, and two of them stand out. First, in FTX's early period, when it lacked its own bank accounts, customers were directed to wire cash deposits to bank accounts controlled by Alameda. Those deposits were recorded in an internal FTX account rather than being moved to FTX, and the cash remained with Alameda. Second, and more important for this project, Alameda was given privileges within the exchange that allowed it to withdraw and spend customer assets held on the platform.

The Role of Information Technology

The technology element of the case lies in specific settings in FTX's software. The SEC alleged that Bankman-Fried directed changes to FTX's code that exempted Alameda from the exchange's automatic liquidation process, which closed out the positions of ordinary customers whose balances fell below required levels, and that allowed Alameda to maintain a negative balance in its account (SEC, 2022). Combined with a line of credit far larger than any other customer's, these settings meant that Alameda could withdraw assets it did not have, and the assets it withdrew belonged to other customers. The rules that protected the exchange from every other trader were switched off, in code, for one trader.

The bankruptcy administrators confirmed the picture from the inside. John J. Ray III, who replaced Bankman-Fried as chief executive when the companies filed for bankruptcy, reported to the court that the exchange's code contained features that gave Alameda these exemptions and that they were concealed from customers and investors (Ray, 2023). His first interim report also described systems that made the fraud easier to commit and harder to detect: a small group of insiders controlled the code with little oversight, private keys giving access to large amounts of crypto assets were stored without adequate security, and the companies relied on accounting software designed for small businesses and on messaging applications set to delete messages automatically (Ray, 2023).

Technology mattered in a second way as well. Because the exchange's own systems recorded customer balances, customers who logged in saw their full balances on screen, even when the assets behind them had been withdrawn. The software produced an appearance of safety that the underlying assets did not support, which allowed the scheme to continue as long as customers did not all ask for their money at once.

Governance and Oversight Before the Collapse

The scheme operated in an environment with little independent oversight. FTX had no board of directors in the ordinary sense, no independent audit committee and no internal audit function capable of examining the founder's decisions. Its financial statements were audited by smaller accounting firms, and the audits did not reveal the commingling of customer funds with Alameda's. Key decisions were made by a few people who were also friends and roommates, and the companies' records were incomplete enough that the bankruptcy team had to rebuild them from bank statements and blockchain data (Ray, 2023).

The absence of oversight is a recurring theme in large frauds. When the people who control a company also control its records, its systems and the information given to outsiders, the usual checks have no independent footing. In FTX's case, the same people who wrote the code also decided what customers and investors would be told about it. That concentration of control is the reason the technology element of this case is so important: the code was not tampered with by an outsider, it was written by insiders to do exactly what it did.

Concealment

Several steps hid the shortfall. Alameda's financial reports to its lenders were altered to understate its borrowing from FTX, conduct Ellison later admitted in her guilty plea and described at trial, where she testified that versions of the balance sheet hiding those amounts were prepared for lenders in 2022. FTX's investors were told that the exchange had sound risk controls and that Alameda was treated like any other customer, statements the SEC alleged were false (SEC, 2022). The absence of an independent board, an internal audit function and reliable accounting records meant that no one inside the companies was positioned to challenge these statements. In his first sworn statement to the bankruptcy court, Ray, a veteran of earlier corporate collapses, described the control failures and the lack of reliable financial information at FTX as the worst he had encountered (Ray, 2022).

Discovery

The fraud was exposed by a combination of journalism, a competitor's reaction and a classic run. On November 2, 2022, the news outlet CoinDesk published a report on a leaked Alameda balance sheet showing that a large share of its assets consisted of FTT, the token FTX itself had created, and other illiquid tokens tied to Bankman-Fried's companies (Allison, 2022). The report raised the question of whether Alameda, and by extension FTX, was as solid as claimed.

A few days later, the chief executive of Binance, a rival exchange that held FTT, announced that Binance would sell its holdings. Customers rushed to withdraw from FTX, and the exchange could not meet the requests, because the assets were not there. Binance briefly signed a nonbinding agreement to acquire FTX, then withdrew after reviewing its finances. On November 11, 2022, FTX, Alameda and about 130 affiliated companies filed for Chapter 11 bankruptcy in Delaware, Bankman-Fried resigned, and Ray was appointed to run the companies (Ray, 2022).

The discovery path is itself instructive. The fraud was not found by an auditor, a regulator or an internal control. It surfaced when outside information about Alameda's balance sheet led customers to test whether their money was really available.

The speed of the collapse also tells an examiner something. An exchange that holds every customer's assets in full can survive a run, because each withdrawal is met from assets set aside for that customer. FTX could not survive one, which is itself evidence that the assets were not there. Within days of the first report, withdrawals were halted, and the gap between what customers saw in their accounts and what the exchange held became public. Ray's filings described a group of companies that could not produce a reliable list of their own bank accounts or a complete record of who held what, a state of affairs that made the eventual investigation much harder (Ray, 2022).

People Involved

Bankman-Fried was arrested in the Bahamas in December 2022 and extradited to the United States. On the same day his indictment was unsealed, the SEC and the Commodity Futures Trading Commission filed civil complaints against him (SEC, 2022). Three of his closest associates pleaded guilty and testified against him: Caroline Ellison, who ran Alameda; Gary Wang, the cofounder who wrote much of FTX's code; and Nishad Singh, the director of engineering. Wang testified that he had written the code that gave Alameda its special privileges at Bankman-Fried's direction. In November 2023, a jury convicted Bankman-Fried on all seven counts, including wire fraud on FTX's customers and lenders and conspiracy charges. Judge Lewis A. Kaplan later imposed a prison term of 25 years and a forfeiture order of about $11 billion (USAO, 2024).

Others in the companies' leadership also faced charges. Ryan Salame, an FTX executive, pleaded guilty to charges related to illegal campaign contributions and an unlicensed money transmitting business. The cooperating witnesses received lighter sentences in recognition of their cooperation. Customers and investors pursued separate civil claims, and the bankruptcy estate, under Ray, worked to recover assets for creditors. The roles of these people map onto the course's interest in technology: the fraud required not only a decision by the founder but also engineers willing to write and maintain the code that carried it out.

Outcome for Customers and Investors

The bankruptcy process recovered more than many expected, largely through the sale of investments Alameda had made and through crypto assets that rose in value after the collapse. Even so, customers waited years for repayment, investors in FTX lost their stakes, and the exchange ceased to operate. The broader crypto industry faced increased regulatory scrutiny, and the case became a reference point for discussions of how exchanges should segregate customer assets and prove they hold them.

Conclusion

FTX shows how information technology can be the instrument of a fraud rather than just its setting. The scheme depended on customers trusting an exchange to hold their assets, and on code that quietly exempted one affiliated trader from the rules that protected those assets. It was hidden by altered balance sheets, by the absence of independent oversight and by an interface that showed customers balances the company could not pay. It was discovered not by controls but by a news report and a run. Part 2 of this project will consider what a fraud examiner could have done to detect the scheme earlier and how a biblical worldview shapes the approach to such a case. The key questions for that analysis are already visible here: who could change the exchange's code, who reviewed those changes, and how customer balances could have been reconciled with the assets actually held.

References

Allison, I. (2022, November 2). Divisions in Sam Bankman-Fried's crypto empire blur on his trading titan Alameda's balance sheet. CoinDesk.

Ray, J. J., III. (2022). Declaration of John J. Ray III in support of Chapter 11 petitions and first day pleadings (In re FTX Trading Ltd., Case No. 22-11068). United States Bankruptcy Court for the District of Delaware.

Ray, J. J., III. (2023). First interim report of John J. Ray III, Chief Executive Officer and Chief Restructuring Officer, to the independent directors on control failures at the FTX exchanges (In re FTX Trading Ltd., Case No. 22-11068). United States Bankruptcy Court for the District of Delaware.

U.S. Attorney's Office for the Southern District of New York. (2024). Samuel Bankman-Fried sentenced to 25 years for his orchestration of multiple fraudulent schemes [Press release]. U.S. Department of Justice.

U.S. Securities and Exchange Commission. (2022). SEC charges Samuel Bankman-Fried with defrauding investors in crypto asset trading platform FTX [Press release].