Is the FTX Story the Stuff of a 'Bernie Madoff, 2.0"?

On Wall Street, history tends to repeat itself. Is the sudden collapse of crypto exchange FTX, and “SBF” - the rare crypto guy with a perceived pro-regulation and altruistic reputation - in fact Madoff 2.0?

 I have some insight into similarities and differences between Madoff’s and Samuel Bankman-Fried’s respective demises. I spent years corresponding with Bernie Madoff in lengthy communications covering over 400 pages; offering the deepest behind the scenes look at a man whose name is synonymous with financial crimes.

Like Madoff, SBF cultivated a reputation of trust – Madoff with regulators and his largely Jewish network of clients. SBF with politicians; regulators and within the crypto community.  Madoff was so trusted amongst his investors; he was known as the “Jewish T-bill” seemingly as safe as U.S. Treasuries. 

Madoff used word of mouth in what was essentially an affinity crime, where 85% of the victims were Jewish. SBF used celebrities and politicians to buy credibility. In both cases no one knew what was really going on. Both Madoff and SBF appear to lack genuine remorse or accepting of responsibility. SBF’s “the dog ate my homework” story carries less credibility with every revelation.

Was, FTX, in fact, similar in nature to a Ponzi scheme – where there is no real investment activity going on. Returns are derived from investors’ money being used to pay other investors’ returns. While FTX had real investment activity going on, there is some alleged semblance of similarity in the FTT tokens that FTX used essentially as its “currency” underlying its risky trading schemes; whose value may have been artificially maintained to manipulate the market. Maintaining a stable value was essential for the conflicted trading affiliate, Alameda Research, also 90% owned by SBF, to sustain the collateral value of customer assets. Which morphed into massive self-dealing and a fundamental securities industry fraud – commingling of customer assets with firm assets. Customer assets were diverted for personal benefit, according to the SEC, including: $73 million in political donations; $1.3 billion in loans to SBF using customer money as collateral; $300 million in real estate purchases; $200 million in investments, such as in the electronic trading Robinhood; and $400 million into two hedge funds. It was one smart dog who ate the homework, if the government allegations are proven; as the customer money SBF used as his personal collateral, was segregated by Alameda programming to avoid charging him any interest on “borrowing” his customers’ money for collateral.

The rapid demise of FTX when the collateral value collapsed is reminiscent of Lehman’s sudden demise from a liquidity crunch when the commercial paper market was shut down to them, when its illiquid real estate investments collapsed in value.

Like Madoff, there were massive red flags that were missed with FTX. Madoff had no accounting ledger system for the Ponzi scheme and his auditor was a one-man firm in a strip mall. FTX apparently had no risk management or financial controls and had a small CPA firm looking at its essentially non-existent books.

With both Madoff and SBF, there were massive failures of due diligence. Madoff had sophisticated Wall Street “feeder” hedge funds funneling assets to Madoff. Madoff would not allow them to conduct due diligence on his fund, despite that being their very function. In FTX’s case, savvy institutional investors, including Sequoia, Citadel, BlackRock and Soft Bank – fiduciaries of their investors’ assets, apparently conducted minimal due diligence.

Madoff was able to steal customer money because he allowed no independent custodians to hold the money separately from Madoff’s firm. Neither FTX or Alameda had independent custodians of customer assets, nor was there any regulation requiring it in the unregulated Wild West that is the crypto world. 

Madoff was stealing customer money all along and transferred $800 million of customer money through the “backdoor” to prop up his one-time legitimate market making business. FTX transferred $8 billion of customer money through the backdoor at SBF’s proprietary trading arm, Alameda, as collateral for risky, illiquid trading. Madoff vaporized a total of $65 billion of what his 16,000 customers in the U.S. and 720,000 internationally thought they had. As of now, FTX owes $3.1 billion to over a million creditors and investors; and vaporized $32 billion of market value.

Madoff ran one of the more ethical Wall Street firms alongside the biggest criminal fraud in Wall Street history in one corporate shell. SBF had a web of over 100 companies, more akin to the Byzantine financial structure that Enron created which masked significant conflicts of interest and self-dealing, while hiding excessive levels of debt.

The SEC missed uncovering the Madoff Ponzi scheme in five separate investigations in a systemic regulatory failure. Crypto not only continues to operate within no real regulatory framework but technically falls under the jurisdiction of the CFTC, not the SEC, fragmenting the regulatory structure. Cleaning up messes after fraudulent behavior is a bit late for victims.

Ultimately, Madoff knew he was committing a Ponzi scheme fraud. With SBF, intent is a key issue – was this gross incompetence with a total lack of financial controls, or intentional fraud based on conflicts of interests and self-dealing? At best, it was one smart dog that ate the homework. At worst, there will be another similarity with Madoff – a long jail sentence.

It’s clear FTX has similarities with Madoff and several other financial scandals. The more things change, the more they stay the same.

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