Crypto Investors Face Probe For Sloppy Due Diligence

The US Securities and Exchange Commission (SEC) is reportedly looking into FTX’s investor due diligence approach.

This, as the high-profile investors who gave the crypto exchange equity capital bankrupt are increasingly learning that their investments may prove worthless.

As PYMNTS was one of the first to stand out last November, a host of highly respected investors lined up to give money to the so-called “cool kid” of the moment, Sam Bankman-Fried, at mind-blowing valuations.

In the wake of FTX’s high-profile and rapid demise, the SEC has alleged that the crypto exchange raised more than $1.8 billion from different equity investors, including 90 US-based investors, since May 2019.

These backers include Patriots owner Robert Kraft’s Kraft Group, entertainment giant Endeavour, the family investment office of an Alibaba co-founder, as well as billionaire hedge funder Daniel Och, founder of Och-Ziff and member Endeavor’s board.

But Bankman-Fried got its biggest checks from some of the best-known firms in the venture capital industry, including Tiger Global Management, SoftBank and Sequoia Capital, which handed over their money to FTX with few questions asked.

The SEC, along with the US Department of Justice (DOJ), claim that Bankman-Fried was actually orchestrating a “massive, years-long” fraud.

A representative for the SEC has not responded to a request for comment from PYMNTS.

no one did their homework

According to a Reuters report citing unnamed sources, the SEC is investigating the extent of due diligence policies and procedures that top-tier financial firms and other investors had before giving capital to the cryptocurrency exchange.

As previously reported by PYMNTS, the FTX crash provided a master class in crypto industry risk management and accounting failures. FTX had grossly deficient internal controls, including an independent CFO or board, and fundamentally “poor” risk management procedures that allowed assets and liabilities “in all forms to be generally treated as interchangeable.”

As his financial empire collapsed, Bankman-Fried tweeted: “…poor internal tagging of bank related accounts meant I was substantially out of my users sense of margin.”

5) The full story here is one I’m still fleshing out every detail of, but as a very high level I screwed up twice.

The first time around, poor internal tagging of bank-related accounts meant I was substantially out of my users sense of edge. I thought it was much lower.

—SBF (@SBF_FTX) November 10, 2022

He even acknowledged in a televised interview after his company’s shock implosion: “I wasn’t even trying, like, I wasn’t spending time or effort trying to manage risk at FTX.”

Bankman-Fried added: “What happened, happened, and if I had spent an hour a day thinking about risk management at FTX, I don’t think that would have happened.”

The SEC’s investigations do not indicate wrongdoing on the part of investors, but at the heart of the agency’s investigation is the question of whether venture capital and investment funds fulfilled their fiduciary duties to their own limited partners and investors.

The outcome of the SEC investigation could see those funds and investment vehicles face regulatory scrutiny, according to the report, even if they are simultaneously considered victims and creditors of Bankman-Fried’s alleged fraudulent orchestrations.

The fact that FTX has been able to extract nearly $2 billion in funds from some of the sharpest financial minds in the business could become an asterisk in its praise.

For now, as lowly investors downplay the scale of their financial stake and the losses in FTX, they are simultaneously pointing to other successful investments they have made. While more details will surely emerge as the October trial date approaches, questions remain about the long-term effect this ordeal will have on risk appetite within the venture industry.