The Breakdown - Guy Who Oversaw Enron Says FTX Is Worse

Episode Date: November 18, 2022

This episode is sponsored by Nexo.io, Circle and Kraken.   Today NLW covers two major updates in the FTX saga. The first is first-day declarations by FTX’s new CEO John J. Ray III that argue that, in short, FTX is worse run than Enron. The second are messages between Sam and a Vox reporter in which Sam  lets the veneer of ethics down and reveals his true beliefs about power.    - Nexo Pro allows you to trade on the spot and futures markets with a 50% discount on fees. You always get the best possible prices from all the available liquidity sources and can earn interest or borrow funds as you wait for your next trade. Get started today on pro.nexo.io. - Circle, the sole issuer of the trusted and reliable stablecoin USDC, is our sponsor for today’s show. USDC is a fast, cost-effective solution for global payments at internet speeds. Learn how businesses are taking advantage of these opportunities at Circle’s USDC Hub for Businesses. - Kraken, the secure, trusted digital asset exchange, is our sponsor for today’s show. Kraken makes it easy to instantly buy 185+ cryptocurrencies with fast, flexible funding options. You’re covered by industry-leading security and award-winning Client Engagement, available 24/7. Sign up and trade today at kraken.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is "Back To The End" by Strength To Last. Image credit: Greg Smith/Corbis via Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

These are not the thoughtful, considered beliefs of a man who has seen the world in all its confounding agony and inconsistency. It's freshman seminar nihilism from a boy who found it easier to justify his wanton ambition by pretending that everyone else was just pretending to. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, circle, and. Cracken and produced and distributed by CoinDess. What's going on, guys? It is Thursday, November 17th, and today we're talking about how the guy who oversaw the demise and breakup and bankruptcy of Enron says that FTX is worse.

Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us in the breakers discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Well, folks, the hits just keep on coming. Two big pieces of news in the FTX saga. And unfortunately, that is where we will be focused for today. I will promise you again that starting on Monday, we are in grateful for Bitcoin Week. And to the extent that there are any mentions of this, it will only be in passing it in the context of lessons learned. All right. So as I said, two big pieces of news in the saga and the first has to do with revelations from the bankruptcy process. As you well know at this point,

on Friday, FTCS filed for Chapter 11. This has not been a straightforward process. In fact, there is a jurisdictional battle around where the bankruptcy happens. On Wednesday, the Wall Street Journal wrote that the Securities Commission of the Bahamas said that John J. Ray III, the new CEO designated by FTX to oversee the bankruptcy, did not have the authority to initiate a U.S.-based Chapter 11 proceeding. On Tuesday, FTX Digital Markets, the company's Bahamas subsidiary, filed for Chapter 15 in New York in order to seek recognition of Bahamian liquidation proceedings.

If that is successful, some of the proceedings could move from the U.S. bankruptcy courts to the local Bahamas courts. There's an initial hearing on December 13th. Now, the details of all this don't so much matter other than as a demonstration of just how messy this is going to get. However, in the U.S. Chapter 11 proceeding, Ray has filed his first day pleadings, which is effectively a 30-page overview of where the case is so far. It is in a single word shocking. Here are some of the highlights. Maybe the most quoted part comes from the very, very beginning.

Ray writes, I have over 40 years of legal and restructuring experience. I have been the chief restructuring officer or chief executive officer in several of the largest corporate failures in history. I have supervised situations involving allegations of criminal activity and malfeasance, Enron. I have supervised situations involving novel financial structures, Enron and residential capital,

and cross-border asset recovery and maximization, Nortel and overseas shipholding. Nearly every situation in which I have been involved has been characterized by defects of some kind in internal controls, regulatory compliance, human resources, and systems integrity. 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. 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. Now, obviously, this is where the title of this show comes from, and that never in my career quote is making it all the way around the internet.

Now, going back to the jurisdictional issues, it sounds from this document that Sam is trying to meddle to try to get the jurisdiction out of the U.S. Ray writes, Mr. Bankman-Fried, the co-owner and controlling owner of all of the debt, debtors and of F.TXDM, appears to be supporting efforts by the JPLs to expand the scope of the FTXDM proceedings in the Bahamas, to undermine these Chapter 11 cases, and to move assets from the debtors to accounts of the Bahamas under the control of the Bahamian government. In verified messages posted through Twitter, Mr. Bankman-Free just yesterday expressed profane

disdain for regulators, his regrets that these Chapter 11 cases having been filed, and disclosed his goal that, quote, we win a jurisdictional battle versus Delaware to have any proceedings occur in the Bahamas. Now, I'll leave it to you, dear listener, to determine why you think Sam might be so eager to have the jurisdiction out of the U.S. and into the Bahamian government that he was very close with. However, that's not where this ends, and it gets even messier. Going back to the document from Ray, in connection with investigating a hack on Sunday November 13th, Mr. Bankman-Fried and Mr. Wang stated in recorded and verified text that Bahamas regulators instructed that certain post-petition transfers of debtor assets be made by Mr. Wang and Mr. Bankman-Fried, who the debtors understand

were both effectively in the custody of Bahamas authorities, and that such assets were custodied on fireblocks under the control of the Bahamian government. The debtors thus have credible evidence that the Bahamian government is responsible for directing unauthorized access to the debtor's system for the purpose of obtaining digital assets of the debtors that took place after the commencement of these cases. The appointment of the JPLs and recognition of the Chapter 15 case are thus in serious question. It appears that the automatic stay has been flaunted by a government actor, no less. This is no time to be arguing over venue. Basically, Ray is accusing the Bahamian government of colluding with Sam and Gary Wang to move funds to them

even after the Chapter 11 bankruptcy had been filed. Still, when it comes to what the Crypto space is talking about most, there are a couple distinct things. One very notable part of the filings seems to give an answer to where did all this money go. Effectively, these documents show that, among other smaller loans, FTX loaned Sam, a total of $3.3 billion, and his co-founder, Nasad, $543 million. Some people are honestly relieved, because at least it shows where some of this money went. Still, I think the thing that might have the community most livid comes from this section, Section F, digital asset custody. It's short, so I'm going to just read it here. The FTCS group did not keep appropriate books and records, or security controls with respect to

its digital assets. Mr. Bankman-Fried and Mr. Wang controlled access to digital assets of the main business in the FTX group, with the exception of Ledger X regulated by the CFTC and certain other regulated and or licensed subsidiaries. Unacceptable management practices included the use of an unsecured group email account as the root user to access confidential private keys and critically sensitive data for the FTX group companies around the world. The absence of daily reconciliation of positions on the blockchain. The use of software to conceal the misuse of customer funds. The secret exemption of Alameda from certain aspects of FTX.com's auto-liquidation protocol

and the absence of independent governance as between Alameda, owned 90% by Mr. Bankman-Fried and 10% by Mr. Wang, and the dot-com silo in which third parties had invested. Now, obviously, the new thing that we learned here, because we had known about the software to conceal the misuse of customer funds after Reuters reporting last week. The new thing here was the secret exemption of Alameda from certain aspects of FTC's auto-liquidation protocol. So when everyone else was getting liquidated for making bad trades, Alameda was not. The conclusion ended as strongly as Ray began. Finally, and critically, he writes,

The debtors have made clear to employees and the public that Mr. Bankman-Fried is not employed by the debtors and does not speak for them. Mr. Bankman-Fried, currently, in the Bahamas continues to make erratic and misleading public statements. Mr. Bankman-Fried, whose connections and financial holdings in the Bahamas remain unclear to me, recently stated to a reporter on Twitter, f*** regulators. They make everything worse and suggested the next step for him was to win a jurisdictional battle versus Delaware. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on Nexo Pro. The new spot and futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources.

Utilizing the complete Nexo suite allows you to earn interest and borrow funds as you wait for the next trade setup. Visit pro.nexo.io. That's p.ro.n.xo.i. and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money. around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted

stable coin. As one of the largest, longest-lasting, and most secure exchanges, Krakken continues to set the industry example for transparency and trust. Twice yearly proof of reserves audits verify your assets are backed by real assets. Industry leading security keeps your funds and information safe. And award-winning client engagement teams are available for support 24-7. Buy crypto instantly with fast, flexible funding options on Cracken. Download the Cracken app on Google Play or the Apple App Store, or visit crackin.com to join. So what is Ray referring to? Well, what he's referring to is a bombshell piece in Vox.

SBF was messaging with a reporter who he thought was a friend and who he would later claim quote-unquote leaked their chat. I'm going to go through the messages in the order that Vox put them in because I think they did a pretty good job of organizing the key points. The reporter's name was Kelsey, and I'm going to refer to her as Kelsey from now on so I don't just say the reporter. Kelsey writes, you said a lot of stuff about how you wanted to make regulations, just good ones. Was that pretty much just PR too? Sam responds, There's no one really out there making sure good things happen and bad things don't. Usually there's only one toggle, do more or do less.

Yeah, just PR. F***c regulators. They make everything worse. They don't protect customers at all. They can't actually distinguish between good and bad, just do more business or do less business, and put up more modes or put up fewer modes. No one will.

But you want to know the truth? No one's doing it in the rest of finance either, or for that matter other areas that are regulated. The FDA isn't helping the giant crackdown on Big Ten. has no point or goal or philosophy behind it. OFAC is slowly undermining U.S. interests globally and is the single biggest threat to the U.S. being a superpower. ESG has been perverted beyond recognition.

Kelsey chimes in, I'm sort of putting together a picture where you don't believe anyone is doing anything for good reasons. You don't believe the good guys are good, so why not make it big and then be the ones who get to decide what good is? And if you have to do sketchy stuff along the way, everyone else is doing it too, and plenty of them are worse, and people still like them as long as they win. Is that fair?

Sam responds, And there's some truth to it, but it's also true that I didn't want to do sketchy stuff. There are huge negative effects from it. And I didn't mean to. Each individual decisions seemed fine, and I didn't realize how big there some was until the end. This brings us to Section 2 on being willing to behave unethically. This is really some of my favorites. Kelsey writes,

I was just relistening to that conversation we had this summer about whether you should do unethical shit for the greater good. Sam asks, what did I say? Kelsey says, you were like, nah, don't do unethical shit. Like if you're running Philip Morris, no one's going to want to work with you on philanthropy. There's a risk of doing more harm than good, but even if you subtract that out, pretty not worth it. I was trying to figure out like if that was the kind of PR off-the-cuff answer. Sam says, man, all the dumb shit I said, it's not true, really. Everyone goes around pretending that perception reflects reality.

It doesn't. Some of his decades' greatest heroes will never be known, and some of its most beloved people are basically shams. Among the ghost, CZ was a walking example of don't do unethical shit or your money is worthless. Now he's a hero. Is it because he's virtuous or because he had the bigger balance sheet, and so he won. Kelsey goes on. So the ethics stuff, mostly affront? People will like you if you win and hate you if you lose and that's how it all really works.

Sam says, yeah. I mean, that's not all of it, but it's a lot. The worst quadrant is sketchy and lose. The best is win plus question mark, question mark, question mark. Clean plus lose is bad but not terrible. Back to Kelsey, you were really good at talking about ethics for someone who kind of saw it all as a game with winners and losers. Yeah, he-he. I had to be. It's what reputations are made of to some extent. I feel bad for those who get

by it. By this dumb game we woke Westerners play where we say all the right shibboleth so everyone likes us. And here I think it's clear that the mask is coming down. And it's important to note here that we're not just dealing with the substance of what he's arguing, although I think there's a lot to dig into on that too, as we'll talk about in a moment. But it's also about who's making these arguments and how baldly he's completely contravening every part of the image that he's tried to make for himself over the last few years, which gets us, as opposed, to the next section, on bending the truth. Kelsey says, you tweeted out some stuff like, we never invest your deposits. That was BS, right? Sam says, it was factually accurate. Kelsey says, huh? But like, their deposits

were totally not there. Or do you just mean, technically, it was Alameda? SBF says FTX, correct. Which, by the way, everyone knew as soon as we learned what was actually going on, and we went back and looked at Sam's thread where he said, we never invest your money. We knew he was going to pull some stupid bull crap like this, pretending that it wasn't exactly the same as if he was investing it as FTX. Anyway, back to Kelsey. So FTX technically wasn't gambling with their money. FTX had just loaned their money to Alameda, who had gambled with their money and lost it? And you didn't realize how big a deal it was because you don't realize how much money it was? Sam says, and also thought Alameda had enough collateral to reasonably cover it. Kelsey says, I get how you could have gotten away with

it, but I guess that seems sketchy even if you get away with it. Sam says it was never the intention. Sometimes life creeps up on you. Now, one of the common threads you see in here is Sam setting up Alameda to be the fall person for this. But Kelsey got some real information out of him that wasn't there yet about how this all went down. When she pushes him on lending out customer funds, he writes, it's complicated. A, wasn't quite lending them out. It was messier and more organic than that. Each step was in isolation, rational, and reasonable. And then when I finally added it up all last week, it wasn't. B, most exchanges did some variant of what we did, just not as big and without the run of the bank, at least recently, and more intentionally. See, everyone wants to be clever,

and the clever thing to do is some sort of complicated 3D chess involving customer orders or data, or something like that, which makes no actual sense. Kelsey goes on, so there's no point of like, let's lend out customer deposits, just various financial instruments that ended up to that, and you didn't even see they'd added up to that? Sam says, yeah, like, oh, FTCS doesn't have a bank account. I guess people can wire to Alameda to get money on FtX. Dott-da, three years later, dot-da-dot. Oh, it looks like people wired $8 billion to Alameda, and oh, God, we basically forgot about the stub account that corresponded to that, and so it was never delivered to FTX. Jesse Powell from Cracken had a load of fun with this one, writing, read, quote,

FTC couldn't legitimately obtain a bank account, so we had Alameda laundered money to circumvent the normal controls. Three years after failing to do basic accounting and reconciliation, we found out that we'd done goof to the tune of $8 billion of client funds. Oops, common mistake. Now, these keep going on, and it finally comes to what he regrets, which more or less amounts to losing, and what comes next, which is Sam still saying that he's going to raise $8 billion in the next two weeks. Alex Kruger summed this all up. The insane SBF chat logs can be condensed into, A, his public persona was an act, B, the means justifies the ends, best to be dishonest, but win.

C, doing sketchy things is okay. D, he had been using customer funds for a long time. E, it wasn't quite lending them out. Eric Wall agreed, saying, so the takeaway from the Vox messages is that FDX basically never had any intention of maintaining separation between the exchange in Alameda. Customer deposits rolled in and it was just viewed as their liquidity. They never even tracked how much of their customer funds they had lost. Cutting to what I think is a little bit more of the quick, Travis Kling said if we keep granting sociopath's positions of significant power, we're not going to make it. They will inflict damage

to a degree that we can't come back from. Crypto will fail if we keep doing this. lawyer Haley Lennon wrote, the most chilling aspect of this convo to me is that Sam believes everyone thinks and operates the same as he does. Like everyone just lies and tells people what they want to hear to be liked. Now, I don't know if that's exactly what I read in this, although I think her point about this being chilling is dead on. What stands out to me is that this is some version of a self-imposed cynicism where this person has convinced themselves fully

that there's no such thing as right and wrong, there's just power and who wields it. Sam probably believes himself very wise to understand this, to have pierced through the normal veil of human social convention and to understand that it's all artifice. It probably makes him feel very smug that so few others seem to get it, never realizing, of course, that perhaps the reason that others don't get it is that it's wrong. To me, nothing about any of this reads as wise. It doesn't read as sage. It certainly doesn't read as someone who has put themselves close to the true human condition and come away embittered,

and with this is the only possible conclusion. Instead, it reads like a petulant teenager, scrawling society with a big X on it and bemoaning the fact that no one gets it but him. These are not the thoughtful, considered beliefs of a man who has seen the world in all its confounding agony and inconsistency. It's freshman seminar nihilism from a boy who found it easier to justify his wanted ambition by pretending that everyone else was just pretending to. And maybe he's still just pretending. It's become clear that the woman who wrote the article was someone who Sam was friendly with. They swam in the same EA circles and this has led to some speculation about what if this was a plant? What might Sam's objectives be? He went out of his way to walk

it back in a thread saying that she had leaked these texts and that regulators really had a tough job and blah, blah, blah. For me, right now, my money is on this was real and that he actually finally let the mask drop for the first time and maybe a long time. However, I don't blame anyone for always assuming at this point that Sam has a nefarious motivation. Autism Capital wrote a couple days ago, this FTX fiasco is really doing its best to confirm every single conspiracy theory everyone has ever had about anything. And it's hard not to agree. For now, I want to say thanks again to my sponsors, nexus.io, circle and crackin. And thanks to you guys for listening.

Until tomorrow, be safe and take care of each other. Peace.