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Lessons from FTX — Investment Frauds and How to Avoid Them

by | Nov 24, 2022 | Business Litigation, Investment Disputes

Most of us have been reading about the recent FTX crypto currency investment scandal.  It appears that what was going on is that FTX was taking investor funds (from ordinary people like us but mostly from sophisticated “pro” investors like Sequoia Capital, Softbank, and others) and simply lending these funds to the FTX owners (who were buying fancy homes in the Bahamas, yachts, and the like) such that now these investors have lost billions.  With a “b”.  The same man who handled the clean-up of the Enron scandal is now informing us that FTX looks like a bigger mess than Enron.  We never, ever, learn.

Frankly, this scam should have been easy to spot.  After all, I steered clear of it and I am no investment pro.  FTX had two hallmarks that in our experience here at Buffington Law Firm almost always red flags an investment fraud.  Firstly, FTX “guaranteed” an 8% “risk free” return on funds.   Remember, we are living in a time when the Federal Reserve, even after recent modest interest rate hikes, has kept interest rates on the US T-bill at extremely low rates literally for a generation.  The T-bill is universally understood to constitute the benchmark for a zero risk investment.  Eight percent returns are hard to come by, and if legitimate they invariably involve taking risks in order to get them.  This is great for borrowers, but has murdered a generation of would-be risk-averse investors.  Secondly, there was no articulation by anyone as to how FTX was able to achieve such stellar results.  FTX’s founder mouthed platitudes about building an exchange where you could buy anything, even a banana, whatever that means.  Apparently this blather meant something to greedy “professional” money managers, but applying a little common sense should have tripped anyone’s “BS Detector.”  Let alone the critical facilities of professional money managers.  Greed can be rocket fuel for stupidity.

Buffington Law Firm’s business litigation attorneys have handled many cases involving investment fraud that were very little different in their essentials from the present titanic FTX scandal which is dominating the financial news.  Every single one of these scams involved two factors: a too good to be true ‘guaranteed’ return, and a vague or implausible explanation as to how the investment was supposedly achieving these results.  Generally, when we initially meet with the investor victims we can determine that they were victimized by investment fraud after a short consultation because these two factors are always present and are unvaryingly accurate in detecting fraud.

Even if you are assisted by a professional investment advisor who tells you that a certain investment is “safe”, if it has the two above red flags, proceed with caution or better yet, do not proceed!  Remember that the investors who got suckered and scammed by FTX were almost all professional investment advisors.  They acted more recklessly (read: stupidly) than any layperson with common sense, and who reads this article, should have behaved.  Frankly, there is little evidence that many professional money managers are any smarter or better informed than any of us.  Just look at Jim Cramer of CNBC fame.  He has been a serial screwup in terms of investment advice for a generation and yet he is still on the air drawing a multi-million dollar salary.  Go figure.

Incidentally, with FTX there were many, many other red flags besides the two mentioned above.   For example, FTX had no accounting department and no internal controls.  Now, ordinary investors generally do not themselves do “due diligence” on investments in order to evaluate a proposed investment’s internal financial controls.  They rely on “pros” and the investment’s auditing CPA firm to do this.  Instead, these “pros” based their investments on mindless blather from FTX’s owner and did no due diligence worth mentioning.  FTX did have auditors, two separate firms, in fact.  (This is always a red flag — it may mean that the firm being audited does not want each auditor to have the full picture).  How FTX’s auditors failed to note the lack of financial controls and the literal shambles of the FTX corporate formalities defies the imagination.  So much for the “wisdom” of the “professionals.”

If you believe that you are the victim of investment fraud, Buffington Law Firm’s litigation team invites you to contact us for a Free Legal Consultation.  All consultations are protected by the attorney-client privilege and are with an experienced business and fraud litigation attorney.