moneyFYI
Financial Freedom Is Merely Organized Common Sense
An Exciting Investment
Crypto Exchange FTX is in bankruptcy and surrounded by controversy. From money laundering to missing funds, to political manipulation. It should be exciting to learn more.
The new CEO, John J. Ray is in charge of restructuring the business. He is a 40-year veteran in the space and claims he has never seen anything close to the chaos within. One of the things he published is the statement, “The audited financial statements cannot be relied upon.” You don’t hear that often, almost never.
I tried to remember the last time I heard it, and I think it was with Enron. Arthur Anderson, at the time a very large, well-respected firm, was the subject. The firm did not survive as an auditor, but its consultancy division, Accenture, carried on. Like everyone with a trigger, I immediately asked Google who is the auditor of FTX? Its answer, “Prager Metis”
The five largest accounting firms in the world are, in order, Deloitte, PwC, EY, KPMG, and my old firm, BDO. It looks a little like agencies of the deep state in America. Nevertheless, I think you can rely on giant-sized accounting firms to take care of their audits. The dismemberment of Arthur Anderson is still part of their zeitgeist and possible destruction is not something people choose to ignore.
It is not to say smaller firms do weak audits, most are very good, but you should be aware of who does the work for companies you invest in.
Despite celebrity endorsements, I think one glance at the audit report would have made this business a non-starter for many portfolios. Prager Metis, in John Ray’s words, “is a firm with which I am not familiar and whose website indicates that they are “the first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland.'” Maybe they are very good, and this was an accident, but I doubt that is the way to bet.
I did some work for a medical practitioner a few years ago whose accountant and tax strategist had two other businesses. She was a professional psychic who ran a home daycare. That engagement did not last long. Sometimes you cannot get far enough away from a situation, and FTX seems to be one of those.
I went to the Prager Metis website. WOW! Impressive, but remember, we want boring investments. Exciting auditors are not part of that package. I know nothing about the firm or the nature of its audit at FTX, but I am willing to believe the firm will not survive unless they have an enormous professional liability insurance policy with an affordable deductible. Small chance of that.
I would rather have the movie rights to the FTX story than the business itself.
What auditors are for
Auditors are a bit like the adult in the room. They are the ones who condition the players to act in ways that correspond to society’s norms for communication of financial events. The norms are published as Generally Accepted Accounting Principles, GAAP.
They establish that the company’s internal control systems actually record and control things like assets, liabilities, and cash. The system should record accurately, and it should be sufficient to determine that all the transactions are present. The auditors check management’s decision limits and assess whether transaction fall within the authorities the system has created. They don’t check every transaction.
The system of control creates the story presented in the financial statements. If management draws a different picture or creates ways to avoid the system, the auditors are required to report that.
Accounting is a language, a way to communicate the meaning of what happened in a business. Management presents that story about its achievements for the year and its prospects for the future as a financial statement. Almost always, it is the right story. When it is not, the auditors should behave like an editor. Require that management amend the story until it is both clear and accurate. Should management fail to comply, they should act like a publisher and refuse to distribute the story with their name attached.
Audits are not foolproof, but egregious failures should be found every time.
The bit to take away
Look at financial statements. They tell a story. The auditor is the editor. If the auditor is not one of the large firms, you’ll want to check them out to see if they are likely to be reliable. Above all, be sure they are boring.
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software startup, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning and business matters. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Federal Business Development Bank.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
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