The Fiduciary Responsibility

Lots of Talk, No Action

The failed exchange FTX had no board of directors. That was one point of failure by investors. They wanted in the deal so badly, they let the ship go through the ocean without a rudder.

No board no oversight. The LPs of the funds ought to be asking some really really hard questions.

I see a lot of chatter about fiduciary responsibility when it comes to boards. I am not sure that even if FTX had a board, the board would have acted in the best interest of shareholders.

Here is a real-world example.

A close friend of mine was one of the foremost experts on international tax. He presented tax plans to many boards, public and private. Often, the tax scheme involved a corporate inversion. That rankled many board members’ patriotic sensibilities, but they don’t have a duty to a country. Their duty is to the shareholders and to maximize shareholder return. When the math says to engage in corporate inversion, there is only one way to vote unless you can show the math differently and prove beyond a shadow of a doubt you are correct. However, it’s a long tall wall to climb.

Let’s assume FTX had a board of directors. It is still shocking to me that they didn’t. I realize this is a big assumption, but it will help illustrate the point of being a fiduciary.

Sometimes, boards will have differences of opinion with the managers of the firm. Usually, they talk it out and get on the same page. If they can’t, the board member resigns. In rare occurrences, the management team resigns and a new management team is hired.

Now, suppose you are a VC that invested several million dollars into FTX. You have seen your investment go from a few billion in valuation to $32 Billion. The biggest pressing issue in your job is to return money to your limited partners. Not only that, you have to do a minimum of 3x after fees in order to raise another fund and stay in business.

Your investment in FTX pays for your entire fund several times over and you look like a hero to your LPs.

To further set the stage so you understand the psychology of venture capital people you should know VCs have a lot of reputational costs they worry about. It’s gossipy. Potentially, you could lose out on a future deal if you are considered “tough in the boardroom”. The VC network is a clubby network where often you share deals with other funds.

Here are some hypotheticals.

1. In diligence, you discover all the problems. Do you tell anyone or keep it to yourself?

2. You go to a board meeting one day and see that FTX is not margining customers correctly, letting them utilize lots of leverage. Not only that, but instead of putting up cash, they use the FTT cryptocurrency that the company FTX created.

Do you say anything? Not only that but if FTX management doesn’t get in line do you resign quietly or let the shareholders know? What’s ironic about this part of FTX business is that Sam Bankman-Fried testified in front of Congress about totally remaking how American exchanges executed on margining.

3. You go to a board meeting and find out that FTX has an internal market-making arm called Alameda Research. In the discussion with management about what they do, you learn that they not only provide liquidity to the marketplace, but they have a trading operation that trades against customers and takes a longer-term view of the market. You don’t really understand how exchanges operate and FTX tells you other major exchanges have similar internal operations.

Do you say anything? Do you resign quietly or let shareholders know?

The other day I blogged that VCs should look at themselves for the failure of FTX. Nice to know one of the best VCs out there is in agreement with me.

Bill Gurley @bgurley

One last thing. FTX had no board of directors. Every single investor that opted into that construct earned their $0 outcome. You can’t blame Sam. Or Binance. Just yourself. You made a bad decision.

What would you do?

What Fried did was several times worse than Jon Corzine at MF only because of the size and scope. The core action and ethics around that action were the same. Eric Holder saved Corzine and kept him out of jail when he should have absolutely done the perp walk.

I’d also challenge VCs who are calling for “guardrails” and “regulation” in crypto to really think about that. Right now Gary Gensler is head of the SEC. He was pals with Sam Bankman Fried. He wasn’t as much concerned about regulating crypto as he was figuring out how to get him to funnel more money to Democratic candidates. In fact, what Gensler had been proposing was going to allow FTX to get a monopolistic hold on a lot of the crypto industry.

There are no better angels here.