Background
- Alameda Research (AR) was a cryptocurrency hedge fund started in late 2017.
- In early 2018, approximately half the employees quit, including myself and Naia Bouscal, the main person mentioned in the TIME article. At the time, I had considered AR to have failed, and I think even the people who stayed would have agreed that it had not achieved what it had wanted to.
- Later in 2018, some of the remaining AR staff started working on a cryptocurrency exchange named FTX. FTX grew to become a multibillion-dollar company.
- In late 2022, FTX collapsed. It has since been alleged that FTX defrauded their investors by misrepresenting the relationship between AR and FTX, and that this effectively led to them stealing customer deposits.
- The recent TIME article doesn’t make a very precise argument; here is my attempt at steelmanning/clarifying a major argument made in that article, which I will then respond to:
- Some EAs worked at AR before FTX started
- Even though those EAs (including myself) quit before FTX was founded and therefore could not have had any first-hand knowledge of this improper relationship between AR and FTX, they knew things (like information about Sam’s character) which would have enabled them to predict that something bad would happen
- This information was passed on to “EA leaders”, who did not take enough preventative action and are therefore (partly) responsible for FTX’s collapse
Personal Background
I worked at Alameda Research (AR) for about three months in early 2018. I was not involved in stealing FTX customer funds, and hopefully people trust me about that claim, if only because I quit before FTX was founded.
To make my COI clear: I left the company I founded to join AR; doing so was very costly to me; AR crashed and burned within a few months of me joining; I blamed this crashing and burning largely on Sam.
People who know I had a bad experience at AR are sometimes surprised that I’m not on the “obviously Sam was obviously 100% evil” bandwagon. I’ve been wanting to write something but found it hard because there weren’t specific things I could react to, it was just some vague difference in vibes.
So I appreciate the TIME article sharing some specific things that “EA Leaders” allegedly knew which the author suggests should have caused them to predict FTX’s fraud.
My Experience at AR at a High Level
I thought Sam was a bad CEO. I think he literally never prepared for a single one-on-one we had, his habit of playing video games instead of talking to you was “quirky” when he was a billionaire but aggravating when he was my manager, and my recollection is that Alameda made less money in the time I was there than if it had just simply bought and held bitcoin.
But my opinion of Sam overall was more positive than the sense I get from the statements in the TIME article. (This is not very surprising, given that the TIME article consists of statements that were probably intentionally selected to be the worst possible thing the journalist could find someone to say about Sam.)
It's hard to convey nuance in these posts, and I'm sure someone is going to interpret me as trying to defend Sam here. This is not what I’m trying to do, but I do think it’s worth trying to share my reflections to help others refine their models.
Adding my personal experience to supplement some statements from the article
But one of the people who did warn others about Bankman-Fried says that he openly wielded this power when challenged. “It was like, ‘I could destroy you,’” this person says. “Will and Holden would believe me over you. No one is going to believe you.”
I don’t want to speak for this person, but my own experience was pretty different. For example: Sam was fine with me telling prospective AR employees why I thought they shouldn’t join (and in fact I did do this), and my severance agreement didn’t have any sort of non-disparagement clause. This comment says that none of the people who left had a non-disparagement clause, which seems like an obvious thing a person would do if they wanted to use force to prevent disparagement.
Early Alameda executives also believed he had reneged on an equity arrangement that would have left Bankman-Fried with 40% control of the firm, according to a document reviewed by TIME.
I assume this is referring to an agreement between Sam and Tara, the cofounders of AR. My understanding of what happened is different, but someone told me that my understanding is incorrect. So I’m not sure what actually happened here, but I am 80%+ confident that the story is more complicated than the TIME article implies.
I can share what I do know about, which is my own equity arrangement:
- When I joined AR, Sam and I discussed an equity amount.
- I quit before any paperwork could be signed memorializing this though. (I was only at AR for about three months.)
- Obviously since no paperwork was signed, there was no clause which covered this scenario. Most startups have a one year vesting cliff, meaning that the employee loses 100% of their equity if they quit within the first year.
- I expect most startup CEOs would have said something like “hey, we didn’t actually agree to anything here, and even if we did it probably would have had a clause meaning that you don’t get any equity after quitting so soon, so I’m giving you nothing.”
- Instead, AR gave me a cash payment which was equal to the equity amount we informally agreed times the most recent company valuation (although the valuation of AR at the time was low).
- I considered this fair, maybe even more fair than what the average startup would have done.
"We didn’t know how much money we actually had. We didn’t have a clear accounting record of all the trades we’d done,” Bouscal says.
I agree that AR had bad accounting as a startup, and I agree with the implication that it was possible to predict that this would be correlated with AR/FTX having bad accounting as a mature company — I think this is a big area where I plausibly could have made a better prediction.
That being said, I still feel confused and surprised about how bad FTX’s accounting actually was. Sam’s reports make it seem like they just were not tracking asset values at all? And somehow they were doing this while having audited financials, passing due diligence from major investors, etc.? And Sam was supposedly a great fundraiser but was circulating a balance sheet with a $8B line item for “hidden poorly labeled account”? I would find it pretty helpful for someone to explain what actually happened here because this violates my models of how the world works.
(One obvious explanation is that people often cover up fraud by claiming it was simply incompetence, and maybe FTX is exaggerating its level of accounting incompetence for this reason. I don’t fully buy this story though.)
Next Steps
As mentioned, I had and still have a lot of negative feelings about Sam. But at least on a couple specific points, my experience was different from the source(s) of this article in a way that paints a less clear story of Sam’s character.
It might turn out that people were aware of stronger warning signs than those listed in the TIME article. It might also be the case that individuals could be better at predicting risk. But even if those things could have theoretically worked in the FTX case, protecting ourselves solely through better noticing "warning signs" feels fragile.
Instead, I would prefer due diligence processes which are not entirely reliant upon warning signs being triggered and evaluated until something like certainty is achieved.
In a future post, I would like to describe examples of due diligence processes that run "by default" and are less reliant upon warning signs being triggered.
Note: these are my ideas, not my employer’s. There are a bunch of people who I’ve talked about these ideas with and I am grateful to all of them, but special thanks on this post to Lizka Vaintrob, Jonas Vollmer, and my partner.
Mine too, so I went digging. All in all, one can argue (and lawyers are) that there were a lot of enablers. Certainly, people trying to actively dodge being noticed as they violate standard models, is a predictable (but not necessarily pin-pointable at the time) way our models end up failing us.
For talk about audits specifically, there's this and this. Essentially, "the firm's auditors weren't tapped to look into internal controls at FTX, and auditing the internal workings of a company isn't a [legal] requisite for private corporations." Of course plenty of people feel that doesn't hold water, and a lawsuit by FTX customers is pending.
[Edit: A suit may be reasonable because audit firms know well they are commissioned to literally prove financial safety, and the audit was used in FTX's self-promotion. That FTX was still very unsafe might prove there is negligence in the firm's business model. If I try to make this fit my model of the world, I get a thought like "corporate greed incentivizes taking on clients that want useless/partial audits that end up being no better than shams, and you look the other way as you assist them in their likely sham". I reflect more on this in the footnote which you don't have to read but>>[1]]
For talk about investors, there is this Feb 23rd piece on a major lawsuit against a few different VC banks who helped out FTX. That piece is frickin nuts just by virtue of the amount of info they fit into a mere 5 paragraphs. Here's one quote to inspire a read:
And of course there was internal assistance. I'd bet there were both (1) employees who knew what they were doing and (2) employees just following direction without realizing they were committing crimes or aiding in them.
When it comes to improving models of how the world works, Zvi's piece had some good discussion of this (and much more!). It's long, but very worth reading even months later. Here's a section on VC:
[Note: There could also be a section about lack of regulation here. As commented on here. From a "how the world works" POV, it is the mother of all permissiveness that allowed the rest, especially the useless audits. Global heuristic = Pretty nuts how much can go wrong with a regulation gap. But FTX also maybe would have found away around/already did break regulations so idk]
Anyway, just thought that all might interest you. Thank you for sharing your insights. Really useful stuff.
Interestingly, now the company has stopped offering crypto audits due to "changing market conditions". And I was going to say "good of them to notice that the bare legal minimum is not enough for one of the most volatile, least regulated assets the world has ever seen, eyeroll." But actually that auditor firm is starting up crypto audits again under a different name, sigh. It appears that they only stopped offering crypto audits because some non-crypto clients of the audit firm put pressure on them to do so. Those non-crypto clients felt that the auditor being known to audit crypto, might reduce the trust their potential clients/users end up having in their own commissioned audits. So it appears that, to make sure they can catch the most non-crypto and crypto audit contracts without one segment compromising the other, the auditors are just splitting them under two companies. I didn't see any mention of raising the crypto audit standards.
Additionally, through this process. I found mention a couple times that there are other auditing firms who do a much better job, "The big 4", and it is sort-of business wisdom to downgrade trust in audits that aren't from them. I was very surprised at this! There are auditors that business-people know to trust less? Then why do they exist? I guess because most consumers don't know enough to downgrade trust? One has to wonder if the big 4 would have put their stamp of approval on FTX or even many of this audit firm's non-FTX-clients. Probably not, right? And it makes you wonder why companies would go to these known-worse-auditors, especially if they can afford the best auditing like FTX should have been able to, if they don't have something to hide. If the goal is consumer trust, and a company doesn't have something to hide, that company should go to the best auditors, those that in-the-know-consumers trust the most, right? And surely a "worse" audit firm like this one would realize that is how the selection effect cookie crumbles. So lesser-known auditors should expect they will likely get a slew of clients who are nowhere near as reputable as those who hire the big 4 audit firms.
Sooo I think it's easy to argue that the minor audit firm(s) are negligent or intentionally turning a blind eye somewhere in their business model. But it's more a problem of incentives of corporate America and low federal standards for private corporations allowing those incentives to play out in auditing contracts, than it is a problem of a single actor. Even though the single actor/auditor might know damn well that they will end up giving a scammer cover eventually, maybe even frequently among their really wealthy clients like FTX who could have afforded better-known services. It appears to be part of the business model, chronic not acute. And as long as the private corporation and auditor are following the law in reviewing the bare minimum, oh well?
Thanks! I appreciate the link round up; the boundaries of what exactly was audited does seem helpful to know, and the claim that VCs have a preference for fraudulent founders is interesting. This is exactly the kind of comment I was hoping to get from my post.
Complying with an audit is expensive, and not just in money.
A thorough audit in progress is going to disrupt the workflow of all or most of your company in order to look at their daily operations more closely. This reduces productivity and slows down the ability to change anything, even if nothing improper is happening. It is expensive and disruptive.
A thorough audit is also going to recommend changes. Not just changes required to be technically in compliance, but ones which will make it easier to audit for compliance in the future and ones which remove something that could potentially be mistaken for bad behavior in a dim light. Making those changes is expensive and disruptive.
If you don't need extremely high levels of trust from your customers and partners, choosing to receive a thorough audit means you're paying a bunch of unnecessary costs. Much better to get a more lax audit, which is less disruptive to have ongoing and less disruptive to handle once the results are in. Better still if it also costs less money.
The correct audit is the one that provides your customers and clients - and/or your own management - with exactly as much trust and reassurance as you need them to get and no more. Anything less and you lose business that doesn't trust you; anything more and you're paying a cost for a benefit you don't actually benefit from.
Corporations have their own legal personhood; it's difficult to see how the corporation's interest could be served by such a shoddy audit that failed to detect apparently unsophisticated, and certainly massive, raids on the corporate fisc by insiders.
Also, the only known raids on the corporate assets happened post-crash and therefore long post-audit. Under the espoused worldview of the management, everything before that was plausibly 'good for the company'. In that it benefitted the company in raw EV across all possible worlds with no discount rate for higher gains or for massive losses.
That wasn't the question. The question was why any company would go to less-than-maximally-trustworthy auditors.
Maybe the big 4 are enough more expensive that it's common for people to go with other firms for reasons other than "we're doing fraudulent stuff and hope to sneak it past auditors"? And so even if you would be able to afford one of the big 4 it doesn't send a strong signal by going with someone else?
Yeah my thoughts exactly. Or, it doesn't send a big signal to non-finance people. But like, I think it should send a signal to people in finance, eg the auditors. That FTX should have been able to afford a different service and yet didn't. Or maybe, idk, should have revealed their internals for different certification (better than GAAP cert idk, I know nothing). I just think it should have raised flags for the auditor. If someone is enlisting you for purposes of increasing trust but they are clearly not doing their damnedest, according to their abilities, to ensure that trust is accurate. The US consumers can't be expected to know the difference, but the auditor should. I think.
In general, standard corporate audits aren't intended to be intelligible by consumers but instead by investors and regulators. It's shocking that FTX's regulator in the Bahamas apparently did not require a clean audit opinion addressing internal controls, and maybe no US regulator required it for FTX US either.
At present, my #2 on who to blame (after FTX insiders in the know) is the regulators. It's plausible the auditors did what they were hired to do and issued opinion letters making it clear what their scope of work was in ways that were legible to their intended audience. I can't find any plausible excuse for the regulators.
That makes sense. It is really shocking. I agree on blaming regulators [although I don't give others a pass].
[I think a section on regulations def belongs from the POV of improving world models too. Before I added my long thinking-out-loud footnote, I didn't realize just how much it all points at regulators as the original permissiveness break.]
Thanks for sharing this. I skimmed the relevant portions of the underlying lawsuit referenced in the press release, and my overall impression is "fishing expedition." (Maybe more than that against the banks . . . but those banks just went bust and I doubt will have any money to pay a judgment, so I didn't bother skimming that). Not that there aren't reasonable grounds for a class-action law firm to engage in a fishing expedition, but they won't have any real evidence until they (possibly) survive motions to dismiss and get to discovery.
Glad you liked it. Perhaps I wasn't clear in purpose though. My point was not to talk about payouts, but to explain how things like this can happen. Because it "violates model of how the world works". [Edit: I cut stuff from here and expanded on it in footnote above]
I'm just saying there are systemic reasons why the fiasco got as far as it did.
[Edit: Ah this is one of those times I might be being dramatic, but I may as well say] I'm a bit sad to hear "fishing expedition" to this. But [so many EAs didn't feel similarly] about EA leaders taking some of the blame. I didn't want to bring EA into this particular comment, but gee. The actors I've named here had like 1000x the likelihood of knowing what was going on and being negligent or otherwise at fault somehow than non-Alameda EAs did. It's a bit flippant to call it a fishing expedition to go after others, if it is worth doing, and when our community has just spent so much time talking about EA fault.
dies a bit inside on behalf of EATbh they seem like reasonable suits to me in general, and I hope disincentivize something like this from happening again :/I characterized the lawsuit is a fishing expedition because I saw no specific evidence in the complaint about what the VC firms actually knew -- only assumptions based on rather general public statements from the VCs. And the complaints allege -- and I think probably have to allege -- actual knowledge of the fraudulent scheme against the depositors. The reason is that, as a general rule, the plaintiff has to establish that the defendant owed them a duty to do or refrain from doing something before negligence liability will attach.
Of course, you have to file the lawsuit in order to potentially get to discovery and start subpoenaing documents and deposing witnesses. It's not an unreasonable fishing expedition to undertake, but I think the narrative that the VCs were sloppy, rushed, or underinvested on their due dilligence is much more likely than the complaint's theory that they knew about the depositor fraud and actively worked to conceal it until FTX did an IPO and they unloaded their shares.
(I certainly do not think anyone in EA knew about the fraudulent scheme against depositors either.)