Temasek, Sequoia Capital missed huge risks in FTX

Due diligence on crypto businesses must be tougher in future

By: Toh Han Shih

The implosion of FTX and the November 18 firing of Caroline Ellison as chief executive officer of the crypto trading firm Alameda Research, co-founded by Samuel Bankman-Fried, the former FTX CEO, has inflicted losses on Singapore’s premier sovereign wealth fund Temasek, despite what Temasek calls “extensive due diligence.”

There seem to have been multiple warning signs. In now-deleted posts on social media, Ellison said she was attracted to men “controlling most major world governments” and that she has indulged in polyamory, or simultaneous romantic or sexual relationships with multiple partners, reported the Daily Mail. Alameda, while Ellison was its CEO, extended a US$1 billion loan to Bankman-Fried, her ex-boyfriend, according to a declaration to the US Bankruptcy Court for Delaware filed on November 17.

How could Temasek and Sequoia Capital, one of the most respected venture capital firms, have invested in a company like FTX which involved people like Bankman-Fried and Ellison? In a statement on November 17, the Singapore sovereign wealth fund said it would write off its entire US$275 million investment in FTX, once the world’s third largest crypto exchange which filed for bankruptcy protection in the US on November 11. Sequoia Capital said it was also writing off its US$150 million investment in FTX.

“Similar to all investments, we conducted an extensive due diligence process on FTX, which took approximately eight months from February to October 2021,” said Temasek in its defense. “During this time, we reviewed FTX’s audited financial statement, which showed it to be profitable. In addition, our due diligence efforts focused on the associated regulatory risk with crypto financial market service providers, particularly licensing and regulatory compliance (i.e. financial regulations, licensing, anti-money laundering (AML)/ Know Your Customer (KYC), sanctions) and cybersecurity. Advice from external legal and cybersecurity specialists in key jurisdictions was sought, with legal and regulatory review done for the investments.”

“A thorough and proper due diligence? Or yes but with the wrong focus, or oversight, considering what were missed but now emerged: missing funds through “back doors,” imprecise accounting of the value of FTX’s crypto assets, unacceptable management practices, using corporate funds to buy homes in the personal name of employees, etc,” said Vanson Soo, a Singaporean who runs the due diligence firm Vanuscript Consulting in Hong Kong, in his blog article on November 18.

Some of the balance sheets of companies related to FTX were not audited and did not include some liabilities, while they were under the control of Bankman-Fried, the declaration disclosed. An emergency motion filed in the US Bankruptcy Court for Delaware on November 17 cited “the almost complete lack of dependable corporate records” at FTX and its related companies.

The FTX Group did not maintain centralized control of its cash and its cash management failures included the absence of an accurate list of bank accounts and account signatories, as well as insufficient attention to the creditworthiness of banking partners around the world, said the declaration.

“In the Bahamas, I understand that corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors. I understand that there does not appear to be documentation for certain of these transactions as loans, and that certain real estate was recorded in the personal name of these employees and advisors on the records of the Bahamas,” said John Ray, who took over as FTX CEO and chief restructuring officer, in the declaration.

The Bahamas is where FTX is domiciled and where Bankman-Fried currently is located.

According to media reports, during a hearing in the US Bankruptcy Court for Delaware on November 22, FTX lawyer James Bromley said of FTX, “What we have here is a worldwide, international organization, but which was run as a personal fiefdom of Sam Bankman-Fried.”

FTX, Bromley said, “was in the control of inexperienced and unsophisticated individuals, and some or all of them were compromised individuals.”

Temasek said, “We also gathered qualitative feedback on the company and management team based on interviews with people familiar with the company, including employees, industry participants, and other investors.”

Did Sequoia Capital and Temasek know of loans used by employees and advisors of FTX to buy homes in the Bahamas and did Temasek learn that FTX was controlled by “inexperienced and unsophisticated individuals”? Did the venture capital firm and sovereign wealth fund discover Ellison’s proclivity for men bent on “controlling governments” and Bankman-Frieda’s practice of running FTX as his personal kingdom?

In a complaint filed on August 11, 2019 at the US District Court for Northern California in Oakland, a Puerto Rican company, Bitcoin Manipulation Abatement LLC, sued several defendants including Alameda Research, Bankman-Fried and Ellison, alleging that from November 20, 2017 until August 2019, the defendants violated US law by operating an unlicensed money transmitting business, laundering money, wire fraud and manipulating the prices of certain cryptocurrency derivatives, alleged the complaint.

These allegations have not been proven conclusively as true, as the defendants have not been convicted of such offenses. Nonetheless, the complaint was filed on August 11, 2019, before Temasek started its due diligence in February 2021. Was Temasek aware of this complaint? If it was, Temasek’s due diligence team should have looked into the serious allegations of this complaint, even if they turn out to be false, if they didn’t do so. 

Others smelt trouble at FTX

There is no reason to doubt Temasek’s statement that it conducted extensive due diligence on FTX, but the fact remains that the sovereign wealth fund missed some enormous risks in FTX. Other potential investors smelt trouble at FTX and shied away from the company.

In a forum on Twitter on November 12, Elon Musk said of Bankman-Fried, “But then I got a ton of people telling me [that] he’s got, you know, huge amounts of money that he wants to invest in the Twitter deal. And I talked to him for about half an hour. And I know my bulls**t meter was redlining. It was like, this dude is bulls**t – that was my impression.”

“Then I was like, man, everyone including major investment banks – everyone was talking about him like he’s walking on water and has a zillion dollars. And that (was) not my impression…that dude is just – there’s something wrong, and he does not have capital, and he will not come through,” said Musk, who bought Twitter for US$44 billion in October.

Another potential investor, Alex Pack, was concerned about the seeming lack of barriers between Alameda and FTX, reported the Wall Street Journal. In December 2018, Pack, then a managing partner of Dragonfly Capital, a crypto-focused venture firm, met Bankman-Fried in the Upper House, a swanky hotel in Hong Kong. The talks fell apart when Bankman-Fried revealed that Alameda was working on the crypto exchange that would become FTX, but only wanted Dragonfly’s money for Alameda, not FTX.

“Alameda and FTX were tied at the hip. Proposing to use our money, if we were to invest, to finance his new business to the detriment of the business we were investing in—that left a pretty sour taste in our mouths,” Pack told the Wall Street Journal.

At the Saudi Future Investment Initiative in October, Bankman-Fried met officials from the Public Investment Fund of Saudi Arabia, one of the world’s largest sovereign wealth funds, and pitched FTX to them, then flew to Abu Dhabi to seek investment from the emirate’s wealth funds, said the Wall Street Journal. He came home empty-handed, the Journal added.

If Musk, Pack, and Middle Eastern sovereign wealth funds decided not to invest in FTX, why did Temasek and Sequoia Capital?

“We recognize that while our due diligence processes may mitigate certain risks, it is not practicable to eliminate all risks,” Temasek said.

In a call, Sequoia Capital apologized to its investors for losing US$150 million on FTX, reported the Wall Street Journal. The US firm’s partners said Sequoia Capital would improve its due diligence process in future investments.

Likewise, Temasek will have to conduct more rigorous due diligence checks in future potential investments in crypto-businesses.

Toh Han Shih is chief analyst of Headland Intelligence, a Hong Kong risk consulting firm.