The FTX Scandal: What Actually Happened?

Welcome back to We're Talking Money. I'm Roger Fuller, portfolio manager, along with Phil Clark, wealth adviser and founder of OmniStar Financial Group. Phil, want to thank you for taking some time this evening to go over this complicated yet controversial subject.

Yeah, man. Thank you, Roger, for hosting. I'm looking forward to it. I know we're about to dig into something that is probably on everyone's mind, so I'm looking forward to it. Let's dig in.

Absolutely. So, FTX has been in the news like crazy lately. A lot of stuff going on there. Matter of fact, this past Super Bowl, Larry David did a commercial on FTX and in fact may have done one of some of the best fortune telling ever. Like I was saying, it's FTX. It's a safe and easy way to get into crypto. I don't think so. And I'm never wrong about this stuff. Never. So, exactly. Tell us what is FTX.

Yeah. Well, first, Larry David, you're right. That was a brilliant commercial. I don't think at the time anyone knew how right he was. Obviously, in that commercial, he gets everything wrong. That was a $21 million commercial, by the way.

And what is FTX? FTX was a crypto exchange. We'll call it a crypto exchange today. It's still there. It's in bankruptcy. And if you want a little more definition, Roger, that just simply means that it's a place where people come together and they can put their money, their fiat currency into this exchange and they can purchase or they can gamble or use derivatives to bet on of various cryptocurrencies. So, think Bitcoin, BTC, or think Ethereum or Dogecoin. So, all of those were on that exchange and anyone could trade those via FTX.

Well, can you give us just a brief definition or description on not only what is cryptocurrency, but why does cryptocurrency have a value? There's lots of controversy around this whole Bitcoin thing. Some people believe it's completely farcical. There's no value. Other people believe it has tremendous value.

Crypto is what is it? First, it's something that's built on what's referred to as blockchain technology. And but it starts with this incredibly difficult to replicate blockchain technology. And that blockchain has to be completed in order for coins to be produced. They have to be mined. And so every time a transaction or a bitcoin is produced, more blockchain is formed. And there's a finite amount, say for example, Bitcoin, there's a finite number of coins that will be produced by the Bitcoin blockchain. When it reaches the end, that can have tremendous value.

It's based on the simplest idea of supply and demand. That's it. It doesn't have value other than that, Roger. If it wasn't in high demand, it wouldn't have value. But it takes fiat currency to buy it or you have to be sharp enough with the technology, the computers to mine it. Most experts will tell you it cost about $35,000 to mine a coin because of the power that's required, the intellectual component that goes into that and the technology itself, the computers that you need to do it.

So, if I have crypto, other than exchanging it for cash, how else am I spending crypto?

That's a really good question. You're probably not. There's a few people that, or a few businesses that take crypto as a normal currency, if you will. So Starbucks would be one of those and Tesla at one point was dealing in crypto. So there's plenty of ways to use it. But I would tell people to think of it more as a method of moving money, not walking in the store and spending it. Certainly not like fiat currency, like you pull a dollar bill out of your pocket or get out your debit card.

Crypto is not there and so you're not going to see it used like that anytime soon, but they'd love for it to go in that direction and I think maybe one day it could. But right now think of crypto as a store of value, not a currency per se. It's more like gold versus currency.

Okay, so Sam Bankman-Fried, 30-some years old, the starter and founder of FTX, built this empire, now it's gone. What decisions did he make? More importantly, maybe what did he not do? What caused the collapse of FTX?

Yeah, Roger, that's on everybody's mind right now. We saw charges brought against him in the recent days and even today there was testimony on Capitol Hill. Who knows where all of that goes? But what did Sam Bankman-Fried do or not do?

Well, I think number one, you're exactly right. He created this thing. He first created Alameda Research. That was the beginning. And then he came up with FTX. He did all of this in 2019 for the most part, at least with FTX. And this was his brainchild. And the goal was to create an exchange that was easier to use, that was competitive as it relates to commissions or charges for trading on his platform.

He sold a lot of people on this idea. He graduated MIT, so one would imagine he's pretty smart guy, but I'm not really sure how smart he really is because let's be honest, where he sits right now is potentially facing a life sentence in jail. What we also know is that all of this wealth that he thought he had evaporated overnight.

Sam Bankman-Fried, I don't know that he started all of this with the intention of defrauding people, but I certainly think he went into it in a very naive way. He had this group around him, Roger, of eight or 10 schoolmates or classmates, if you will, people that he worked with. These people had no experience in business. They had no experience in markets. None. They're barely in their mid to late 20s. So, they certainly didn't have a lot of experience.

And one in particular who was his girlfriend, she became the, I believe she became the top dog at Alameda. Well, she had absolutely no experience in that. And when you speak to her or listen to her in interviews, if she gives you confidence, then you might need to be examined.

So, what are some of the charges against Sam Bankman-Fried? What are some of the accusations that he did wrong at FTX? Again, that kind of caused the crumble, if you will.

At the end of the day, this is classic Ponzi scheme. This isn't about did he knowingly or unknowingly make all these decisions. This is a person that sits at the top of the third largest crypto exchange in the world. This guy is supposed to know what he's doing. He's supposed to be in the vanguard of protecting the people that are investing with him.

He moved monies into places they shouldn't have been moved. He gave bonuses of millions of dollars to people inside the organization that were friends, loans that were to people within his core team. And he had other people in HR that would fire folks that didn't agree with him. There were so many things that should have signaled problems.

Instead, we had people like Cramer on CNBC applauding this guy, calling him the next JP Morgan. You had Kevin O'Leary, Mr. Wonderful, who was supposed to be this extremely successful guy, and he is. But here he is, saying that Sam Bankman-Fried, you got to put your money with him. He's great. And Tom Brady doing the same thing. And Shaquille O'Neal and the list goes on. Knowingly or unknowingly, they're getting people just like you or me to say, "Wow, this looks like a great deal."

Not to mention, he put his, well, I say he put other people's money to work and sponsorships, between namings of stadiums and sports sponsorships. He did a lot with other people's money, if you will. But he did everything he could to get that name out there, I guess, to solidify the name of FTX.

People without experience. These are the kind of things that they would do, number one. And number two, someone who is just full of this new found wealth, to him, he probably thinks the more that I'm doing all of this, I must look like a very successful person. And I think he did.

But when you're spending millions to sponsor an arena, for example, and I believe they were in Miami, they had the Pro Bowl arena there and then he had, he's part of the Mercedes racing team sponsorship and the list goes on. But they were spending millions and millions and millions of dollars in sponsorships.

Sam Bankman lived in a $32 million estate in the Bahamas. Yet on the surface, people would see him as someone that's this very humble, easygoing sort of nerd like guy. And everybody saw him as this, just surely he couldn't be harmful. He must be this innocent, just benign kind of guy that is generous. In fact, a lot of people on YouTube, a lot of people in social media refer to him as the most generous guy they've ever met. When you're spending somebody else's money, it's always easy to be generous.

And that's before we even get into the political donations, which topped tens of millions of dollars both to Democratic and supposedly to the Republican party as well.

Yes. I don't think Bankman was doing or giving money on the Republican side. I think one of his insiders was doing that part. SBF was giving a lot to Democrats. Without a doubt, the political campaigns that he was supporting makes you wonder what is it that he wanted in return? What was a guy like this looking for?

Why would you do all of that if you've got this great company and everything's being done by the book and you have nothing to hide? Why would you have to support all those people with this fledgling company? Just didn't seem like a great way to spend money. Certainly didn't seem like what a quality CEO would be doing. But again, other people's money, it turns out, might have made it a little bit easier.

So, very successful company. Misappropriating other people's funds or clients' funds. Falsifying, if you will, returns and what's being done with the money sounds an awful lot like Bernie Madoff and the Ponzi scheme that really rocked the financial world and is still having effects on the financial world.

I think Bernie Madoff probably always will be considered the arch fiend of the financial world. This guy, he masterminded probably what will always be remembered as maybe the, certainly one of the greatest of all time Ponzi schemes. They're not too dissimilar. I think SBF, Sam Bankman-Fried, I think this is absolutely a Ponzi scheme.

The classic definition of a Ponzi scheme is when you're bringing money in from investors and you're using it for something other than benefiting them, when he's spending that money and he needs to bring in more and more and more to continue this charade or whatever it is, that's Ponzi. Well, I think Bernie Madoff did the same thing. So Madoff would pay returns using the money that was coming in from other investors.

I think this one is worse, Roger, than Madoff. Not necessarily because of the dollar amount, because it sounds like Madoff might still be a larger scheme than SBF or FTX. But what I mean by that is I think that the lack of investor due diligence, I think FOMO, so fear of missing out, I think herd following, all of those things played a role here.

Now they did it with Madoff, but Madoff's, you got to remember his clientele was organically built, correct? That was all word of mouth, not a lot of advertising, not celebrity driven.

Not at all. Not at all. He was the celebrity, but very low-key really. SBF and FTX on the other hand, we talked about Brady. We talked about Shaquille O'Neal. Help me out if there's more that you can think of.

Kevin O'Leary, Kevin Larry, Larry David. Steph Curry, I think, was a part of—

Steph Curry. I'm sure there was more that we're not, probably that we don't know about. Mercedes was in there, stadiums, you name it. So, all these places, all of these brands, if you are, or the branding in the places that they chose, those things are huge influencers.

And then you take a Cramer on CNBC every night yelling at investors on the television, and people love him, right? He's got a great following. People follow this guy daily. They live by what he says. Well, he called SBF or Sam Bankman-Fried the next JP Morgan. Are you kidding me right now?

So Cramer usually is not a guy out there that is celebrating criminals. And so for him to say that, I say, "Wow, shame on Cramer for not doing your due diligence and recognizing what's really going on here."

But then you take all these celebrities that influences people.

Absolutely. And as your friends start doing it, you get the FOMO and man, you want to do it and all of a sudden people just totally forget that something bad could be going on. But I think in this case, everybody, including the celebrities, they were on this bandwagon with this young, turns out thief, liar, fraudster. They're on board with this guy because he seems so nice. He seems so generous. Well, again, somebody else's money is easy to be those things. So, everybody just jumped on board with him.

So, Bernie Madoff ran this humongous Ponzi scheme. We learned from it. We thought we'd never see anything like it again because of what there was. The due diligence came out.

Yet, here we are again showing that history repeats itself. The only thing that we learn from history is we learn nothing from history. So, it happened again. So again, innocent clients were hurt. Innocent clients lost money, lost fortunes, lost life savings. What should clients be talking to their advisers about? What should they be doing to make sure they are not victims to something like this?

History repeats itself. I get that. But I also think that history, or rather time, tends to heal the damage and so we forget, and not that anyone forgot Bernie Madoff, but everyone thinks, well, but we have protections in place now and we don't have to be circumspect. We can just go through life, do whatever, and somebody's got our back until they don't have your back. And the fact of the matter is when you've got so many people in something like this being duped and everyone's jumping on board thinking this is the next JP Morgan, it's easy to all of a sudden become credulous and you get sucked in with everybody else.

So what can people do? Yeah. Give me three things, three, four, or five things that a client should ask either their adviser or wealth management firm to give them some confidence that they're dealing with a legitimate firm.

Boy, there's a lot of things that you could ask. First, who selects your securities? That'd be one easy one to say, who's doing the selecting here? Is this internal? Is it third party? What kind of securities will I hold? Are they held with a custodian or do you hold them? And those are simple things. That'd be one that they could ask. Who handles my trading? Is that done internally like at FTX? FTX handled all of their... they handled all of the selection, if you will, of what was available on their platform and then they moved people's money onto that platform and then they traded. Now, crypto is different versus typical equity trading, but nevertheless, you want to know who's doing the trading, who's selecting the securities, and who's holding the funds. Is it held at the firm? Are held at a third party custodian.

For example, here at OmniStar, just to answer a couple of those questions, who selects the securities? Our investment committee meets and follows a strict set of rules to decide what securities and public traded securities that go into a portfolio. The trades are done through a platform at Fidelity, which is a third party. The equities, cash, money market is held at Fidelity, a third party custodian. And Fidelity along with a third party generates the statements to show what is in those accounts and the performance of those accounts.

Going back to Bernie Madoff for example, I know he created his own statements. Everything was done in-house and everything was fabricated and was 100% not true. He created every statement and they were worth nothing more than the paper on which they were created.

In our case at OmniStar, OmniStar is the adviser, Fidelity is the custodian. We work with Morningstar institutional to give us performance reporting. Fidelity does performance reporting as well, but we choose a third party to give us the ability to see Fidelity against the third party and we want to be sure that those are congruent, that they tie. If they don't, if something's out of... is off-kilter there, then it's easy to detect that. When one place like Sam Bankman-Fried is doing everything and nobody has oversight, it's easy for those things to go off the rails.

I would also add though, Roger, to our listeners that with the crypto market, it's a little different because it's so unregulated. It's not transparent. It's anything but open book and very private, if you will. And so that in itself, in my opinion, breeds some of the very things that we're talking about here. And by the way, this isn't the first, this not the first failure in the crypto space. There's lots of failures that occurred prior to this one.

Absolutely. There'll be more to come.

Yes. In fact, Sam Bankman-Fried was going to be the golden boy that rescued everybody. He was trying to buy a few. They failed. And so of course, Binance was going to buy FTX and save them, except Binance then backed away because they knew something was wrong. And they're the ones really that let the cat out of the bag, right? And started this spiral effect that turned into ultimately the bankruptcy and the destruction of a lot of other companies and people.

But the other thing that you asked, or rather what you were asking in terms of what an investor can do, Roger, they can also use other resources. They can check with the SEC. They can check with their state. I would give you one simple thought as it relates to that. In 2021, when FTX became a household name and everybody was using it, they had a million users, Roger, and they were trading $10 billion a day of crypto. I'm here to tell you that if a firm in 2021 is two years old, you really ought to ask yourself, how in the world did they become worth $30 billion in two years? That's unusual by a long shot.

I don't think enough questions were asked. A lot of people jumped around this guy and painted him as the boy wonder. I think a lot of people got duped. And unfortunately a lot of people are going to be paying for this one for a long time. Hopefully some regulation that's needed will be put into place here. But right now we got a long way to go in a trial. We're going to see how this thing turns out. I think a lot more shoes will drop here, Roger.

And I think you're right. We'll see. This can be ugly. But we'll eventually get to the bottom of it. We'll know exactly what happened, but a lot of people lost here. It's gonna be a very interesting road to follow.

Yeah, no doubt about it. So, we want to thank everybody for tuning in. Again, if you are investing with a financial advisor or wealth management firm, do your due diligence. If you're looking to invest in something like crypto, really do your diligence and know going into something like that, it is a speculative investment. Be prepared to handle the volatility and only put in their money that you can afford not to have access to for the next 10 years or maybe ever. Thank you guys. Tune in next time on our next episode of We're Talking Money.