What lessons can members of the design and construction industry learn from the sudden and cataclysmic failure of FTX, the crypto-currency exchange? There are many, but we will focus on three of the most significant ones.

On November 11, 2022, FTX and various related entities filed for Chapter 11 bankruptcy petition in Delaware.  In support of the Petition for Bankruptcy, John J. Ray, III, the newly appointed Chief Executive Officer the FTX debtors filed a declaration with the bankruptcy court. Among the conclusions Ray reached on his first day as CEO was the following.

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.

Lesson 1: Maintain Electronic Records

With the increased use of social media and other apps, important project information is increasingly communicated informally rather than through formal procedures, such as RFIs and change orders.  Tracking and preserving those records for at least 10 years following substantial completion (the repose period in Texas) can be time consuming and costly, but without those records, it may be impossible to determine later in time who communicated with whom and about what.

After the spectacular fall of Enron, many companies paid more careful attention to the platforms used to communicate and what was communicated over them.  For instance, one of the biggest assets the federal government had when prosecuting Enron executives was the trove of emails that Enron maintained.  FTX may have learned a few lessons from Enron, but not the right ones.

FTX’s founder and former CEO, Bankman-Fried, sent communications using apps that auto-deleted messages after a short period of time, eliminating traces of impropriety that could later inculpate him criminally. In Ray’s own words,

One of the most pervasive failures of the FTX.com business in particular is the absence of lasting records of decision-making. Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same.

Lesson 2: Keep a List of Employees and Contractors and their Responsibilities

The use of independent contractors is a given in the construction industry.  Most general contractors employ numerous such contractors.  But subcontractors many times subcontract all the labor, leaving only procurement of materials and supervision of the work in-house.  At the time subcontracts are awarded, many general contractors do not know whether a given subcontractor is self-performing the work or retaining 1099 contractors to provide all the labor.  Further, most general contractors collect insurance information about the first tier subcontractors, but do not pay close attention to the second and lower tier subcontractors who may actually be performing all of the work.

FTX provides another valuable lesson in why understanding and documenting lines of responsibility and distinctions between W-2 employees and 1099 independent contractors is important.  In Jay’s own words,

The FTX Group’s approach to human resources combined employees of various entities and outside contractors, with unclear records and lines of responsibility. At this time, the Debtors have been unable to prepare a complete list of who worked for the FTX Group as of the Petition Date, or the terms of their employment. Repeated attempts to locate certain presumed employees to confirm their status have been unsuccessful to date.

Lesson 3: Track the Money

Members of the design and construction industry have contractual and statutory obligations to pay lower tier subcontractors and consultants.  Maintaining adequate reporting and controls, and retaining the proper accountants to provide oversight, are critical to designers and contractors fulfilling their responsibilities.

FTX provides yet another example of what not to do.  As explained by Jay,

The FTX Group did not maintain centralized control of its cash. Cash management procedural 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.

As for the auditing firm used by one the FTX debtors, Jay had this derisive insight:

The audit firm for the Dotcom Silo [one of the debtors] was Prager Metis…whose website indicates that they are the “first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland.”

We can expect many more lessons to be learned as the FTX bankruptcy unfolds. But at least preliminarily, there are at least 3 important lessons.  Even if those lessons are already heeded, they are worth revisiting in light of the increased informality of many business communications and transactions during the ongoing COVID-19 pandemic.

The attorneys in our Austin and Dallas office assist design and construction professionals daily in assessing, managing and documenting risk. We are available to answer any questions you may have.  Please contact us at info@gstexlaw.com.

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