SASc - EP239 - Battleground PPV Review with Wade Keller

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Dundeele Motors, for confident car buying and deals to feel great about from all of Ireland's trusted car dealerships. Visit dundeale.ie today. What do all of these frauds have in common? FTX, Madoff, Lehman Brothers, Enron. I could keep naming frauds all the way back to the 1500, actually. Like, whenever there's a new industry that's hard to understand and is unregulated, huge frauds occur. How can we stop this? How can you trust the system? Where do you keep your money? And what is the playbook of a fraud? So Antonio Reza, who just wrote a great Twitter thread on the Enron fraud and is also in finance for Google, comes on the podcast, and we talk about frauds. Enron, FTX, Madoff, and so on. This isn't your average business podcast, and he's not your average host. This is The James Altucher Show. Antonio Reza, thank you for coming on the podcast. Thank you for the invitation. Very glad to be here. I saw your thread on Enron, which was, if people don't know, was kind of a classic classic example of fraud. In fact, at that time, it maybe still is, the biggest fraud in corporate history. But I say classic example because we'll go through how they did fraud and and it's kinda like the ABCs of, like, how to commit a corporate fraud. And I'm also curious, you know, now this is topical because of FTX and people are comparing it to Enron, so it'd be interesting to maybe discuss that. But let again, Enron, 2,002,001, 2000, biggest corporate fraud in history. Famous corporate fraud movies have been made about it. Let's why did you write a thread about that? So I think, you know, I'm starting to build this, like, presence a little bit more on Twitter, you know, trying to find my niche and things like that, and I've I've been I've been in finance and accounting for many, many years now. And, I was like, well, you know, this this is one story that I remember so so much because I I saw the movie when I was in college. And the story just, like, hit me of how important having a CFO, a compliance culture, and all that, you know, it's very important for a company. And then I just decided to write it just for fun, and then, coincidentally, this whole FTX happened. And then I read this article from the secretary of treasury before, and he was, like, saying, no. No. This is more like Enron. And I was like, yeah. I agree. So then I shared it, and then it just kinda, like, resonated with people. And but it was honestly just for fun. Yeah. The more I see and this is why your thread on Enron is so interesting because it's it's as if and you could even go all the way back to, you know, the the South Sea Bubble and what was going on there. Like, all of a sudden, I realized, yeah, FTX and Enron are similar. We'll get to the similarities in a second. And it is almost like a playbook. Like these guys, whether they know it or not, they're almost doing the same techniques. And not just how they're moving money around, but how they're squashing internal communications in the company and and so on. And, you know, maybe it's just they have to do that that way to commit fraud or I wonder if they're just learning like, well, this is how Enron did it so I'm gonna do it. But but let let's let's break down Enron for a second. And and, you know, how would you how would you describe it? How do you describe Enron? Yeah. I mean, I think for the people that don't know, I guess, the younger ones, so it was basically one of the biggest fortune 500 companies, you know, back in the late eighties, nineties, and they dominated the market in natural gas. This company who started to become very innovative in terms of not just selling the natural gas, but actually bundling it up as a security and then trading it, you know, with many, many businesses, and they started to create this, like, market leadership. And they became huge in in terms of you know, back then, it was, like, 60,000,000,000 valuation, which was huge back then. But then it was a house of cards. It just started to Well, let me ask you a question. Let me Yeah. And and just break that down a little bit. They didn't, like, drill for natural gas or anything. They didn't produce the natural gas. No. No. But they helped energy companies that did. Like, your standard utility company that might have natural gas, but they needed to hedge their risk. Like, oh, what we just bought all this natural gas, a contract for the next 5 years, but what if natural gas goes down and we just spend all this money? Companies would then use Enron to take the other side of their risk. Like, Enron would say, don't worry. It's almost like an insurance company. Like, don't worry. We'll if if natural gas goes down, we'll compensate you this way, and then Enron would trade natural gas futures to kinda hedge their risk. Yeah. So they they were basically like an intermediary of the natural gas producers and their final customers. And like you said, they just mitigated the risk. And the thing with this or the complexity was that these contracts were really long, like, sometimes 10 to 20 years. And it just it was ripe to have some sort of accounting manipulation to make the earnings a lot better than they were. Yeah. Because how did any company like, if I'm a youth let's say I'm Duke Energy or Con Edison. How can I trust that, oh, okay? It's nice that they're gonna hedge a 10 year the risk of a 10 year contract. What if natural gas goes to 0 and I just bought all this natural gas, I'm screwed if I have a 10 year contract. So it's nice that Enron said to everybody, oh, don't worry about it. We'll take care of it. But how can if you're if you're Duke or Con Edison or any big utility company, how could you really trust that they they know enough to hedge that risk? Yeah. I mean, I don't know. I I think, like you said, I don't think you could even guess or estimate the the price of natural gas beyond 12 months even if you looked at, you know, market indexes or whatever. So, no, I think nobody could trust them, but I think it was just a lot of hype around the company and how smart they were and how they were just booking earnings, in the current quarter. And they just keep growing. The stock kept growing, and they just became like that market. I think it was a lot of hype and customers just trusted them. And not just the customers, but also their independent consultants, their auditors, like, everybody even the SEC actually trusted them on how they were valuing these contracts and then how they're booking them. And I think all of that together just created this sort of, trust in the system, and people were just making business with them. I mean, step 1 is and this is for true for Enron. It's true for WorldCom. It's true for Bernie Madoff. It's true for FTX. All of these frauds have this thing in common, which is they have high up government, you know, connections, trust, support. You know, in in the FTX example, I don't know all the details, but his parents are involved heavily with the administration, with Enron. Ken Lay was, like, best friends or good friends with George w Bush. And I'm not I'm not saying the politicians, any of these people are guilty. They didn't know. It's just that Ken Lay, who was the CEO of Enron, was able to kind of wear this as a badge of honor just as Sam Meggemann Fried was able to wear the other side as a badge of honor. Madoff had been instrumental in creating the Nasdaq, so everybody thought, oh my god. This is the smartest guy in the world. He's a genius. WorldCom was in charge of the Department of Defense's telecom system, so everybody thought it was beyond reproach. But then, you know, the other thing is is that they're all dealing with kind of mathematically in they're not just trading stocks. They're dealing with something that's a little bit too hard to understand, natural gas derivatives. Yeah. How the whole all the I should have mentioned Lehman Brothers in there too. You know, housing derivatives. Derivatives of derivatives of derivatives. Like, it was, you know, Sam Bankman freed. Nobody knows what the heck he was doing Yeah. With all the crypto stuff and derivatives on cryptos, and FTX was, like, the biggest crypto derivatives exchange. So so it's all so step 2 is deal with something that's so complicated, you don't even really need to explain it. Yeah. In fact, I think they it was a point of pride for them to to not explain that. I remember in one of the analyst calls, somebody asked them, how come we never get a statement of cash flows when you report earnings or you give guidance? And the guys were like, well, you know, it's just it's the way it is. And then we cannot explain, and we take pride in that that we cannot explain our business because it's very complex, and only smart people understand that. So it it was the culture. Same with Madoff. Yeah. It was yeah. It was called the Madoff had, like, some name for his option strategy and and and so on. And so so yeah. So and the other thing that is is kind of part of the downfall, it's not part of the playbook of committing from, but part of the downfall, is eventually the the entire market turns, and you can't like like here's a typical thing. So let's take Enron. As they have as they have fake gains, but they really have losses, it's no problem for them when they're small because they say, hey, we have gains. The stock grows. They could sell stock to raise money, and that covers up the losses. There's various ways you could use you have cash in the banks so you can cover up your losses. And but eventually at some point, as they say the tide comes out, and this is what happened in every single case, Enron, Lehman Brothers, Madoff, FTX, is that there's no source of cash anymore, and they're too big now. So the losses are not 5,000,000, it's 10,000,000,000. Yep. And so so, like, so, like, what was Enron doing to to commit fraud? So there were 2 things that stood out. So the first one was Jeff Skilling, who was at some point the the CEO. Right? He he came from a consulting background, and one of the his ideas was to use this method called mark to mark accounting. Basically, what that means is that you're able to book the earnings of a 10, 20 year contract in the current period rather than spread it out throughout the life of the contract. Let let me explain that, like, in simple terms. Just as if, let's say, on the last day of the year, you get a contract for a $100,000,000. Mhmm. That that's for the next 10 years. So, oh, I'm gonna I'm a chair company. I'm gonna sell lawn chairs to somebody over the next 10 years, and they're gonna be ultimately $100,000,000. It's as if they're booking that $100,000,000 that day rather than spread out over the 10 years. Exactly. And then the problem with that is that so your earnings look great, which pumps the stock, but then the cash will only come in quarter after quarter, right, as as the payments come through. So there's this huge huge mismatch between earnings and cash, and that's what basically created a liquidity crunch, and that's what may what made the end run, you know, basically fall. That was one thing. And then the other thing which you could say was even more obscure, which is the one that I find even more fascinating from a finance standpoint is that the CFO was using all these, like, special purpose entities to basically move any project that would be bad or would have a bad margin, and then they would move it off balance sheet. So that project would never show up in the financial statements that went to The Street. So, therefore, everybody would be thinking nothing's wrong. It's great. And so this is always the curious thing because this kind of became a gray area legally in all their trials because technically, you can move something to another business. And then the question is, how do you value that new business? Well, they were just valuing it be because that new business might be have a a corporate veil around it, you don't really know then once it once an asset is in the new company. So, okay. Let's say I'm committing fraud. I have something that lost a lot of money, but I don't wanna tell people about it. I haven't invested lost people a lot of money, but it's illiquid anyway. I don't wanna tell people about it. I'm creating another company, move that asset in it. Maybe I invest, you know, I'm investing in that new company with the asset I put into it, but I'm just now what's that new company worth? That's what is on the balance sheet. Well, I could say it's worth anything I wanna say it's worth. Yeah. Yeah. And, I mean, these guys have, like, probably 100 of of those, special purpose entities, and it was like a maze. Like, no. I think until today, nobody can explain how they moved all of those balances. And when you, I mean, when when you read the book, they actually explain how, Andy Fastow, who was the CFO, actually made deals or cut deals with the banks to, you know, move the money for him into these, like, kind of vessels of that that were containing the bad project and the bad margins. Okay. But let me ask you a question. Like, so let's say you're the CFO, and you have some asset you want you don't want anybody to see. Mhmm. So you create a new company. Let's call it a special purpose vehicle, but it's really just a new company. Yep. And now this new company buys this asset from you for, you know, let's say let's say the asset you wanted to tell people it's worth a $100. The new company will buy it for a $100. You'll have an agreement. Won't necessarily send the money to you, but they'll have an agreement to buy it for a $100. And now you can say, oh, it's gone. I sold it for a $100. We'll get that $100 later, but don't worry about it. Yeah. I mean, honestly, I wouldn't be able to tell you exactly how that works, but I know, for example, there's tactics where I think I don't know which company they did this with, but they they faked the sale. And it was kinda like a loan. Like, we're loaning you this asset, so it's no longer in my balance sheet. Then you're gonna buy it from me. Right? And then I'm gonna declare the revenue, book the earnings with that. But then in the in the next quarter, then I'm gonna do, like, a refund. And then the asset comes back to me. It's again in my balance sheet, but I already reported the earnings and the revenue the prior period, and the stock has already pumped. So I think it's something like that. Yeah. Your point is the stock's already so high that now if it's a loss, it doesn't matter. Yeah. And they keep and they just keep doing that, like, on a rolling basis. I think that's one of the things that that was legal back then and and you could do. And there were, for example, a lot of the issues in in accounting with revenue recognition is that at the end of the year, a lot of them try to do that. Like, they they would try to pump. For example, there was, stories where people would actually, you know, sell warehouses of inventory, but it was more like the leaseback where you would actually just transfer the asset, but then you would get it back the next year. So then the inventory would come back. But on the reported year that ended, your sales went went through the roof. So the valuation of the stock went up. The market cap capitalization was was up. And then it's just a new year. You operate the same way, and you just keep rolling and doing the same thing. The problem is what happens is and and by the way, a lot of hedge funds used to do this and maybe still do. So Mhmm. Have you have you ever heard of, like, pipe funds? So they they would invest in a stock at, like let's say a stock was trading for $5. They would invest directly into the company and buy stock for $3. And so but the stock was restricted. And so Oh. The question is how do you value, like like they would buy the stock for $3, but they could hypothetically market at $5 that day. And a lot of hedge funds would do this, and they would say, oh, we're up 60% this month, and then they would raise a ton of money. And so then they would Oh, wow. Then they would take the loss the next quarter or the next month even, and but it doesn't matter because the loss was be much tinier for them now because they raised the new money then the the gain was huge, but the loss was small even though it was the same dollar amount, percentage wise. Wow. No. Never heard of that one. So so Yeah. I mean, it's like financial engineering. Enron is kinda was kinda doing the same thing, but don't they start to think, hey. If our stock stops going up, we're in trouble? Yeah. Yeah. I mean, I think that's when when, like, the there was a whistleblower, basically. They just kinda looked at I think they removed the layer, and then she started reporting straight to the CFO. And she started asking questions like, hey. This doesn't add up. Like, how come we have, you know, earnings that we have not realized booked in the period? Where's the cash? Like, I think this this might be fraud. And I think that the the CEO, Kenneth Lay back then said, like, no. No. No. It's it's fine. And she he kinda brushed her off. And they just kept telling the story. The stock was great. The stock was great, but then everything started to fall apart once the because they were all depending on on deregulation, on the the regulation of of natural gas. That for them was the blessing. But when, you know, especially the state of California and and I think overall the United States started to close that door and and everything started to get more regulated, it was a house of cards. Like, all the shanks in the arm and started to show, and they had to start, you know, basically disclosing, and then the SEC got involved. There were investigations. So, you know, it's funny how one thing that they were betting on and they were super, let's say, they were spending so much money on the regulation and lobbying, but when it stopped, they just the the whole company crashed. So in the fraud, they were doing this mark to market where they were recognizing revenues they should not have recognized because it was over, like, a 10 year period. They were recognizing it right away. And they also took anything that was a loss, moved it over to a new a new company, and now they couldn't see the loss. It was only still a gain until they were big enough that they could recognize the loss, and it wasn't a big deal. Was there a third component of the of the fraud? This one wasn't necessarily, let's say, the an accounting fraud, but one of the business practices that was pretty, let's say, aggressive or super aggressive was that the traders would actually there was this whole drama where they actually were shutting down power plants to start creating demand. And then that would pump the price up of the of the trades. They would make money. But then people, for example, in in their in their homes, they would actually not have energy. And then whenever the bill came, the the prices were extremely huge. And these guys, there's recordings of the traders where they're actually making fun of people. Like, hey. Just shut it down, and it's fine if California burns and whatever is then they would there's some calls with the plan managers like, hey. There's, not a lot of demand at this plant. Can you just shut it down? And then the price will be he's like, yeah. Yeah. I can shut it down for the next 3, 4 hours, and then I can, you know, start it start it back up. So that was, like, more non engineering accounting malpractice, but just in terms of the business practice, that was very, very aggressive, and it just messed with people's lives and and and in the end, they got sued for that as well. And conspiracy charges. And and again, like, that actually is really insidious. That that's Yep. But all of this stuff like, let's even take the mark to market stuff. You know? Here's here's an example where there's always a debate. I have this asset. Is it worth more than I paid for it or is it worth less than I paid for it? Well, if there's no market for it, you don't really know. And if the market is very there's not a lot of people in the market, you might know it's it's a question of how you value something. Let's say I wanna value my house, but the how and then let's say my house is exactly the same as the house next door. Now the guy in the house, Texas w***e, is getting a divorce, and so he has to sell his house quickly to pay for the divorce, and so he sells it for 50% discount to what, you know, most people was worth. Now is my house so if I'm marking to market, technically my house is now worth 50% less because this duplicate house is would just sold for 50% down. So then it's not quite fair to mark to market. And this was the problem the banks had in the financial crisis is that, you know, these things would be happening. Like, the housing market was falling apart, but in some areas, it was falling apart too much. So if you mark to market, the banks suddenly were out of business all of a sudden because it's the so they became like a a a phrase mark to imagination. Like, banks were allowed to use their best fair estimate, which, of course, you know, that's like giving the the criminal the keys to the the jail. I think he wanted to do that at the beginning, kinda replicate the bank model where you basically, like, use mark to market when you kinda like like you said. Right? You you basically adjust the value of your portfolio based on what's happening in the market. But I think that where they got it wrong was that they were booking everything in the quarter. Like, that that was the big mistake. Because even I remember in my days when I was in GE and I was in this, like, business, basically, it was called the power services. And we had long term agreements as well, like, 30 years. But, basically, the the value of that contract, you would carry it in the balance sheet at, basically at cost, and you would adjust the value based on kinda like mark to market. Let's say it wasn't called that, the methodology, but it wasn't a quarterly basis, and you would adjust it, you know, very mildly. Like, it wasn't that aggressive. Like, you would try to match as much as possible the revenue with the cash, and the mark the market value of, you know, whatever any big swing in the economy that that would affect that value. But it was something more methodical where this is was extremely aggressive, and then it just creates, like, this vicious cycle. Because once you recognize the all the earnings in 1 quarter, then the next one you need to catch up. Right? So that you need to book another one, the same size, and then another one so that you start showing growth. So it became addictive to these guys to just start booking contracts and then mark the price up and then book everything in the quarter and just keep making deals and deals on these and and volume. Right. Like like, the most conservative thing you could do is until something is bringing cash in, you you mark an asset at cost or lower. So, like, it's lower and and you have a like you were saying, it has to be a methodical algorithm so that you can't change it mid quarter. And that's the most conservative thing you do. This way you can never, take a profit on it unless there actually is cash coming in the door. But GE though was I'm sure it was methodical, but GE was known for GE Capital in particular was known for smoothing out earnings. Like, it's very consistent with their earnings because they were, like you say, buy these assets. The assets were, you know, at discounts, let's say, to the their their actual value, but they might have other, you know, legal restrictions or whatever. And so they had an an algorithm for figuring out. They wouldn't take the full value, but they would partial value, and that's how they would smooth earnings. Yeah. Yeah. And I think, you know, every company back then used to do that. Right? That whenever again, it was GE. You can think about Halliburton. All these companies that were in big industrials. Whenever the end of the year would come, there was some sort of, let's say, accounting maneuvering to try to make their earnings estimate. But the fundamental reality was that there was enough cash coming in next quarter. Like, your cash flow was not at risk. That was that was the key. That's why, you know, they disclosed the cash flow statement, and if you could see how the whole three statements are kinda flowing together, whereas Enron did not disclose cash flow. And they were just, you know, reckless on how how the accounting was treated. So I think that's the big mismatch between manipulating or smoothing earnings if you want from mild accounting, like, you know, within the framework of legality. And, and these guys, they were just, like, you know, basically committing fraud. Yeah. Because, ultimately, the only way they could get cash was by their stock getting bigger and then raising cash by selling stock as opposed to getting actual cash flows. And Yep. And the way they were getting their stock higher was by reporting these gains that were not accurate. And, you know, so the question the question is though, like you said, one person was a whistleblower. She noticed there was no cash coming in, and she noticed there were all these, you know, all these investments that maybe they had made the quarter before were disappearing off the book. Where were they? Oh, we sold it to, you know, xyz3inc in Connecticut. And then and then we're just valuing it on our books at the same amount or or maybe even a little higher because x y z paid paid up for it in this contract. Here's the contract. And, you wonder, why didn't people dig in further? I mean, it's funny because their motto was their slogan was ask why. And, just people did not ask. Like, if you, if you look at the documentary, a lot of them were, like, the thing is that we were just fed up with this culture of the strongest survive, and there's career opportunity here for you. And then everybody was getting big paychecks. Right? And bonuses, and people were, you know, cashing in stocks. So I think that there was this culture of, you know, nothing will happen to you if you make money. And and that was that was known throughout the company. Because even I think the the first fraud story, was with these people that were basically taking funds from the company and then just making bets, kinda like a hedge fund a little bit. And then they were making 1,000,000. And then they said, hey. You cannot do that. And then Kenneth Lay said, no. No. No. Just keep making those millions because that's the only division that makes money. And then that just trickled down, and that was the culture of the company to the point that some of the execs, apparently, they had disagreements with the CEO and the COO. They quit. They went to another company. They couldn't cut it there because the culture was not the same, and then they came back to Enron because they knew that the only place where they could thrive was was in a company like that, where you had, you know, basically, like, to do whatever you want. And, you know, I wonder how many like, if if the markets had moved in the direction that they wanted, I wonder if they would've, in the long term, gotten away with it, or if eventually they would've just got again, gotten so big that just a small move in the markets, they would've come tumbling down. And then I wonder how many companies did get away with it because they made some bet that was illegal. I mean, they they hit it in some illegal way, and then the markets did kinda go in their way, and they survived. And they said, okay. Phew. Never gonna do that again. Yeah. I mean, I'm pretty sure there's examples like that, especially even you could say more mid cap companies. Right? Right. Because that was small enough to get away with it. Yeah. Exactly. Right? Like, especially in anything that is, I think, retail where they were, like before that governance started to kick in where, hey. You cannot basically, like, you know, the 4 criteria to recognize revenue. Right? Like, the most important one, you need to, it says, like, you have to deliver the product or sir or render the services. But in reality, what that means is that you need to transfer the risk of ownership completely to the customer or to that other person. And in these cases where, hey. You leave it on the on the warehouse, or I transfer risk of ownership when the thing is on the on the truck. It's you could play with that. You could manipulate that a little bit, but now it's so restrictive to, like, not until the customer signs off the order and says it's mine now, and it's transfer physical transfer of risk and on paper. Now it's a lot harder to get away with it. But back then, I mean, anything that was retail or, you know, maybe some small manufacturing, I'm pretty sure that some people got away with it. You know, the essence of all this kind of, like, finance law, it it seems to me and I'm not a lawyer, so I don't know. But it just seems to me being in this world for a long time. There's 2 things. 1 is disclosure. Just disclose everything you have. If it's a loss, it's a loss. If it's a gain, it's a gain. If you're doing something illegal, just disclose it, and chances are because you disclosed it, it'll be fine. Like, oh, you're using special purpose vehicles? Disclose all those special purpose vehicles and what's inside them and how you're valuing these assets, and then the market decide if you're doing it fairly or not. But if you disclose it, you can at least say, hey, you weren't lying. The other thing is risk. Every transaction has to have risk. Else, why are you doing the transaction? Because a lot of times, oh, I could run a hedge fund, and if something's down, I could run another hedge fund which buys the asset risklessly from me. There's ways to pretend like you're taking risk, but actually not taking any risk. Yeah. And, you know, it's funny that you say that because now it's actually required to disclose, for example, on the income statement that you have all these, couple lines where, like, discontinued operations. Right? Where it's basically a line where you say, okay. Stuff that didn't work out and it's a bad margin or whatever, you just put it in that bucket. And then there's footnotes in the financial statements where you kind of know what are those and and then the price of the stock. Right? Just considers that in, and then that's that's the reality. And, I think there's more checks and balances now, again, in what's already regulated because when you start talking into more deregulated space, just like Enron and now probably on this, crypto space, it it's a lot harder to know what's going on, what's within a corporate structure. Right. Because there's 2 things about it being unregulated. First off, if it's not regulated, there aren't laws. So Mhmm. For instance, trading in energy derivatives at the level Enron was, it's unclear what the law this is why this was their entire argument. This is why some of those executives actually took the risk of going to court. They could've had a plea deal and gotten like 1 or 2 years in jail. I remember there was one executive, he was working for the CFO and Mhmm. He decided to go to court because he didn't think what they did was technically illegal, and he got 20 years in jail. And because so so there's that part that if it's unregulated, the laws are very unclear. We see this with Lehman Brothers and the whole financial crisis. It's unclear what happens if you mark credit default swaps on, you know, collateralized, you know, futures of collateralized mortgage obligations. It's like derivatives on derivatives on derivatives. There were no laws for these things. No one knew how to value these things. They were just saying we didn't know. It's you value them how you value them. And then in even like, you know, FTX, it's not that they were unregulated. They're outside the US. So Yep. It's Bahamas law. Like, it's un you know, it it's gonna be an interesting court trial when that does come to trial because what are the laws? They broke. There's not any laws yet. We know that he committed fraud, but it's unclear, I think, exactly which law we're gonna use to to get him. Yeah. Yeah. Yeah. And I think in that space, it's probably more again, I'm not no expert, but just from, you know, the little literature that I've read, the regulation in crypto is a lot less prescriptive of, you know, what should you consider as a security, what should be considered as a commodity, who can, for example, mint these types of of coins, of tokens, and can you use them as collateral, which is what he did. Right? And that's why he why he got in trouble. So this one is a very deregulated space. And then to add to the fact that they can operate from outside the US, then that's that's a tough one. I mean, we know they use just like Enron, they use separate entities to Mhmm. Kind of cloak their losses. So if something was a loss in FTX, they Alameda could could buy it from them. Or if Yeah. Or or vice versa. If something was a loss in Alameda, which was their hedge fund, then, you know, FTX could put customer this is where FTX certainly could have broke some loss somewhere, is that FTX would take customer money and patch up the losses in Alameda Yep. Which works when you're small again, but doesn't work when you're too big to to hide it, like and and and all the whole crypto market's coming down. And then I guess the third thing, if you could mint your own coin, your own money, and then put that in the hedge fund, it's another oh, FTT, the currency, is trading for so many dollars, like, a token. Yep. Let's just mint some more, and we'll put it in Alameda. And let me let me ask you about this. Like, so Alameda would invest in a private company or even a public company like Robinhood. Mhmm. The company would be required to put their those dollars that were just invested by Alameda into the exchange FTX, and then FTX then would use that money, that exact same money that just left Alameda. They would put it back into Alameda to hide losses. Yeah. That's gotta be illegal somewhere. I can't even get my head around it. Yeah. I mean, this one I mean, think about it. The back to the regulated space. Right? You cannot say, hey. I just created this fiat currency that I'm gonna use as collateral for that loan or investing in that company if it tanks. Right? But here, that's what they did. They they basically use their token, which has some sort of speculative value, and people believed in it because, you know, all these people were invested in it. Is it okay? Yeah. That market price will hold, so I'm just gonna put it here, and that's the collateral for whatever bets I you know, if I lose the bet on on this hedge fund risk or whatever, that was it. Like, they were create they were minting their own money, which is something that you cannot do in the regulated space. So that's, again, not sure if that's illegal, but again because there's no framework there's no legal framework to protect that, but, yeah. That's that's crazy. That's the thing. Like, again, all these things this is why the the Enron executives themselves were confused as to the legality of whether they they were willing to take the risk of going to court and going to jail for 20 years when they had a plea bargain right in front of them. They took that risk because they didn't think they they probably knew it was wrong, but they didn't think it was illegal. And Yeah. And and you know what? It's funny because back then, the the main thing they were pushing, it was this, like, the securitization of things. The back then was kinda like a trend. Back then, it started that movement of, oh, I can make anything as security, you know, and and sell it to the market and get more money and use that money to make more bets. That was not regulated that well back then. It was it was kinda like a new financial, let's say, I would, like, move or or or or or hack to come up with money and profits. And now, for example, if you do that parallel with what FTX is doing, for example, minting your own coin, giving certain discounts or or advantages to people that hold that coin, therefore, that again, not regulated. There's not a framework. You they they probably could still argue what we did. It was okay because it was you know, people believed in it. It's just like the money. Right? It's not it's backed by the difference it's backed by the central banks, but, like, there's a value. There's a there's a there's a value in that token. Right. There's a liquid market there's a liquid market for FTT. It was trading for, like Yeah. $32 a token. And so they had it on their balance sheet. They were marking it to market. And, oh, yeah. We have this token that's valued at at x. And, but of course it was like you said, a house of cards. Like once the tide came in I mean, all these things have a triggering event. Like in FTX, there was the fact that Binance was gonna sell all their tokens that suddenly scared everyone. There was literally a run-in the bank. Everybody wanted their money out of FTX, and and FTX had no money left because they had given it all to Alameda, the hedge fund. And and it was insane. Like, it was not a small I was reading today that it was I think they had total of 16,000,000,000 of of assets, and they loaned 10 Yeah. To Alameda. Of customer funds. Yeah. But it was, like, it was not okay one. It was, like, more than half. Okay. But let me ask you a question. Like, if I'm a bank and you give me you put money in your savings account, I am, as a bank, allowed to use that money to for instance, I will lend it out to homeowners, and then this is your mortgage. So, I mean, it's heavily regulated, and there's a certain, you know, percentage you're not allowed to to loan out and you have to keep track very accurately. Yep. But, again, that's a there's a spectrum of regulated to unregulated. Some of these things are wrong but gray area legally because a bank's allowed to use your Yep. Your your they could they could loan the money to a hedge fund for instance. Yeah. So here actually, that's an that's an interesting point. Here, what happened from what I understand is that FTX, because they're an exchange, they're required to have reserves of 1 to 1. So if if a customer has 1 Bitcoin, they're required to have 1 Bitcoin. And then there has to be the legal framework there is that you have to be if you think about the New York Stock Exchange or Nasdaq, they have to have a very clear segregation of what's customer funds and what is their, let's say, pool of funds that they can play with. So that's fine that they have this headphone and whatnot, and and and even if FDX with their own money wanted to loan that out, that was fine, but they played with the reserves. So that's why they couldn't fulfill the promise when there was a money, sorry, the the the bankrupt. Well, they they claimed to have a $1,000,000,000 in reserves, but, you know, he or I I don't know if I don't know if Sam Bankman Fried lied or not. But at when when it was about when the fraud was about to break, he said we have a $1,000,000,000 liquid. And but there was more than a $1,000,000,000 of run on FTX, and so they Mhmm. Couldn't meet it. Now people didn't know that a lot of the assets on their balance sheet was in the form of loans to out their own company Alameda, but still he claimed to have some reserves, but the run was too big for them. Yeah. Yeah. Because, again, they basically loaned out the reserves. So even the the even the percentage that they were required to keep, you're saying they it was gone? Yeah. Yeah. So basic and that was the crime. Right? If and if if you read the articles, basically, what it says is that that they didn't segregate what was money to play with and reserves that if, you know, if the operations apparently went went bust, that money cannot be funded used to fund the operating expenses of the business. Like, if the if the business goes, goes to the ground, they have to have that pool so that people get their money back. It's kinda like pensions. So what happened here is that they took, let's say, the equivalent of these pensions, and then they they gambled with them. So that's why they didn't have the liquidity to fulfill the promises whenever people were asking for their money back. So and and it was a twofold thing. And now pensions, they can again take the money in the pension and buy stocks and so on with it, but I guess they can't use leverage. They can't risk the reserves. Mhmm. Exactly. They can't use so much leverage that if there's if the whole market goes against them, you know, unreasonably, they can't it won't risk dipping into the reserves. Yep. And I guess that's true for banks too, but when things were crazy with all the house I with all the housing derivatives, they nobody knew how to value these things. And, essentially, you know, a 1% move in derivatives caused a 100% of Lehman Brothers to get wiped out because they didn't model their their risk correctly. Yeah. Yeah. Yeah. Yeah. And, you know, I I I heard this, interview with, I didn't interview an article. But it was the CEO of Coinbase, and he was saying the difference between them and FTX is that these guys in Coinbase, they're actually so first of all, they're they're actually incorporated in the states, and they're regulated as a trust. Whereas these guys basically are out of the Bahamas. There's no regulatory framework or exchanges over there. So he was in we have to have that kinda, like, reserve ratio of 1 to 1. Otherwise, we get in trouble. Right? That's something that gets audited quarterly bay with the 10Q that they have to submit to TheStreet. Because FTX was private and it was just, you know, bunch of you know, I think it was, like, $32,000,000,000 valuation based on all the investment from SoftBank, etcetera. They but they didn't they didn't have that regulation. They didn't have that. Alright. You need to have this one to 1. There was nobody telling them that that was what they should do. It was more something of I think it was anecdotal that they had to do that, and I think that's why they they said, let's go for it. Nothing's gonna happen. The the FTT is gonna hold up. So yeah. And this is, like, part 3 of the of the playbook of fraud, which is who's doing your accounting? Like, you know, it with FTX, basically, nobody was doing their accounting. With Enron, as you point out in your thread, Arthur Andersen, which was the biggest accounting firm in the world at that time, was doing their accounting. Although, Arthur Andersen was also a consultant advising Enron on how to do all these frauds, which is, you know, a top of interest. With Madoff, his accountant who did his annual audits, was some guy who had, like, an office in a strip mall in Long Island who was just getting paid a lot of money. And, you know, Lehman Brothers, the accounts just didn't simply they simply just didn't understand the derivatives. Like, in every case, you kinda have to compromise your accountant. Yeah. I mean, so first of all, I think that they didn't even have a CFO, in FTX or a board or anything like that. Naza, look, I was an auditor when I was in GE. I was an internal auditor. And I think one of the reasons with that company again, what happened kind of recently, it's different, and I was no longer there. But, when I was there, so the internal audit team was pretty strong, and our job was to kinda, like, find all the bad stuff before and fix it before a KPMG, came and kind of, like, actually audited the stuff. So we and then we have to work very closely with them, which is something that obviously here didn't happen. There was no compliance function. Actually, I think there was a head of compliance from what I understand, but it was, not not good. Yeah. There was no CFO. There was no oversight from, you know, accounting rules, nothing like that. So no auditing. So that's why these things happen. Not saying that a CFO is like the savior, but it is important to have one. Here's the problem going forward. 2 problems. 1 is, obviously, Enron blowing up didn't destroy the energy industry. WorldCom blowing up didn't destroy the telecom industry. Even Madoff blowing up didn't destroy the hedge fund industry. The hedge funds hedge funds are bigger than ever. I mean, Madoff's hedge fund would almost be a medium sized hedge fund now compared to some of the large hedge funds out there. And FTX, while it's casting a shadow over crypto right now, is not gonna long term effect. There's 16,000,000,000 crypto markets like a multi $1,000,000,000,000 industry. But, a, how do you trust where your money is, whether it's at a bank like Lehman Brothers was or at a trading firm like an Enron or, an exchange like an FTX. How do you trust where do you put your money? And then the other problem is financial innovation is a good thing overall. Like Mhmm. You know, these derivatives that are created are used by serious people to to serious companies to hedge risk and allow firms to take bigger, even technological risks and innovative risks because they know they can hedge their risk in various ways. So when used properly, financial innovation is is awake. Capitalism Yep. Grows, and it fuels innovation so that capitalism could grow further. So so this is gonna happen. Every time it happens, there is some fraud. Yeah. Yeah. I mean, I I I wonder if it's just a, you know, a price to pay to push the industry forward. Right? Because what's happening now, I think, is gonna create a lot of pressure around building some regulatory framework for crypto. The only thing that I, curious if it's if it's going to be a very negative, like, perception of what happened, and everybody's just gonna come try to hunt, down the the players. Whereas I feel like there's many things to unpack here. Right? Because there's, like, potential of blockchain, potential of decentralized finance. Like, there's so many things to unpack, but it was just one bad actor that hopefully doesn't, you know, messes it up for for for everybody, for all the good things that can come out of, you know, you know, like, tokens and coins and and things like that, exchanges that are more innovative. I agree. Like, imagine, for instance, you're at Google. Imagine Google has a sort of data token. So I'm a customer or I'm someone who uses Google every day, like many people are, millions of people do. And what if Google has to pay every time my data is sort of stored in the database, like, oh, here's, you know, this generic person's search data, I get it's like a mining Google's data coin, and advertisers, if they wanna make use of personalized data for for their own targeting, they have to pay into like, I I'm Yep. I get, I get A card. Yeah. Or whatever. Yeah. So so there's some value there because advertisers there's gonna be supply and demand. Like, there's some advertisers who are gonna wanna buy data, and there's some and Google's gonna wanna or I'm gonna wanna sell data, and so on. So there's some value that that is created by a real world use case. That's that's very an innovative use of crypto that hasn't happened yet, but you could see this in almost every industry. There are use cases that can't be done without crypto, and and that will actually make the industry advance forward. And so there are I get I agree with you. There are I hope this doesn't, you know, just everyone starts dancing on the graves of of crypto. But here's the problem, like, the person who was introducing the law in the senate for regulation, I think I think was Elizabeth Warren. And I think Sam Bank of Reed's parents, or one of them works with her, or or did, or or still does. I don't know. So there's gonna be lots of backlash here. Yeah. I mean, the guy, I think I was I think he donated $40,000,000 or something like that to the president Biden's campaign Yeah. And, like, his bunch of others. And then in the midterm elections too. And, again, I'm not I'm not criticizing him for his we don't know his political opinion. He was right to, you know, hey. If you're gonna lobby, spend money. So that's happens in every industry. Yeah. I just that you wonder if that's more like, this is something I was thinking about this morning. Did he know that this was a house of cards and he was building political capital with all these donations? You know what I'm saying? Because it's similar to what Enron did a bit. So Enron, for example, gave, this, like, Enron award to Alan Greenspan for service and excellence and whatnot. So they had all these venues where they appeared to be altruistic and do that because at the end of the day, they they they they called on those favors, right, when they were on trial and and things like that, trying to get the appeals, etcetera. So I wonder if, you know, I don't know, like, from from when you see, like, some YouTube videos from him when he talks about altruistic, you know, deeds, he looks pretty genuine. But I wonder, was he did he know? And that's why, kinda, he he was planning. Alright. I need to build some political capital here before if the house, you know, burns burns down. Yeah. I don't know. Because a part of me wants to think he sort of just fell into this. But the more I read about it, the more insidious it looks. And and and by the way, everybody's kind of a a culprit here. Like, Binance clearly knew or, like, CZ, the the CEO of Binance Yep. Clearly knew what he was doing when he said, oh, I'm suspicious of FTX. He knew there was gonna be a run on the bank there and that FTX will collapse. I don't think he anticipated that all of crypto would be affected. I think he thought he was just targeting an enemy, and this is how he was gonna take him down. But if you look at, like, Enron, one thing that happened after Enron collapsed is that every single energy company, the stock went down, you know, 70, 80. But these are utility companies. Like like Con Edison is not a trading firm. It provides electricity for everybody in the New York City area, and the stock would be down so much that their dividends were were 15% a year. It's like crazy. And, it it brought down for, like, a whole year, the whole the entire industry. Yeah. I mean, that's what they were saying. I think the the term some of the journalists were using is, like, contagion risk where one bad actor or one bad event just kinda, like, spreads out like a fire in every company. And and, yeah, I think, for example, what happened with Enron, like, just the trust was lost in the system and the checks and balances that, you know, hey. Accountants are supposed to say no. Lawyers are supposed to say no. There's, like, all these backstops that didn't work, to stop them. So I think that probably the market priced in those assumptions that are like, okay. If it's happening with the best in class company right now, I'm pretty sure it's happening with everybody else. So let's wait until regulation steps in, etcetera. So and when all that regulation starts to started to kick in, like the Sarbanes Oxley Act and and all these, legal requirements to sign off on documents, and now the CEO and CFO are basically responsible and liable if they're lying in any case, that's when I think the market started to move up again. And I wonder if it's gonna be the same here. Like, probably a lot of crypto confidence is gonna erode. And then at some point, hopefully, it goes back up. Yeah. And and, look, I think there'll be there will be faster movement towards regulation, which will be ultimately ultimately in the long run a good thing. Like, crypto, it's not like the Internet. In in in the nineties Yeah. Everyone was saying, what if the US bans the Internet? Well, they can't. It was just it was moving too fast. It was too big. There were so many use cases. So ultimately, they just had to regulate and not ban. And it's the same thing here. It's, this is a moving train and the best they should do is regulate it so it doesn't screw people over. But here's here's another interesting thing though is that people were putting their money in FTX like it was a bank account, not realizing that it wasn't a bank and it wasn't in the US, so it had no law US laws applied to it. Like, I could put money in Wells Fargo, and I can say to myself, okay, there's a 120 year history here or or bigger, a 150 year history, and there's huge laws in the US. I'm pretty confident, like 99.5% confident, there's still some risk, that I'll I'll get my money back if I put it in Wells Fargo in in a worst case scenario. But if I put my money in a hedge fund, I don't get the same degree of confidence. And if I put my money in an offshore hedge fund that has no laws, I get 0 of that confidence. And I think people thought, oh, well, FTX is just like my corner bank. It's this guy's well known. He's got trust. Yeah. You know, he's got the all the the the they they make money. I see his face on the cover of Forbes. And Yeah. You know, after the recession, I thought maybe the only safe place to put my money is something like a Fidelity where they have to they're sort of like a bank, but they're really they had to be 1 to 1. They had to have they had to just keep my dollars. They didn't Fidelity doesn't lend out your money in in mortgages. So there was there was there was basically no risk. And I wonder what people will do here. Where do you I don't know. Like a bank? No. I mean yeah. I mean, for now, it's like a little bit of a split between savings just in case of for a rainy day, some cash for, you know, and then some stocks and things like that. But mostly index funds. Like, I'm pretty safe in terms of how I invest my money, but I think part of that problem, I think that people need a little bit better financial literacy, like education on because even if you invest in your 401 k. Right? People say, like, oh, your 401 k is super, safe. But Enron's was not. Right? People I think one of the testimonials was that a guy had, you know, $350,000 in in his 401 k for 20 year career, And he ended up cashing out, like, $1200. Oh my god. So people need to understand that, yes, it's a it's a even stocks, even index funds, all that stuff, there's there's some risk embedded in that. Right? Like, there's the the company can tag. It can be disrupted. Like, people that invested in Nokia, for example, and, again, Nokia was on the Forbes Magazine, and they missed the train, and then also that some of the pensions tanked. Like, there's that that's more of a financial literacy problem, I think, that people need to understand. Okay. In fact, I was there was a tweet I posted today that there should be an exam, you know, before you invest in crypto, there should be an exam that tells kinda like a driver's license. That's a good point, actually. You know? Yeah. Because, you know, for example, like, you have this concept of, like, the accredited investors, where you cannot go into a hedge fund unless you are an accredited investor and you meet certain requirements, you have certain wealth, etcetera. I think for investing in risky assets like like crypto and things like that, people just go for the fad and then, like, all NFTs and there are all these hype, you know, built by influencers. But reality is like, alright. Do you actually understand, you know, what a portfolio is made of? Like, do you understand your risk tolerance? How much can you put up without starving your kids? Like, all these things that I feel like it's a little bit of a test that you know, are you not smart enough, but are you informed enough to put your money where it's gonna be yield the best return for you? And that's something that, for example, I learned late. And I think, you know, you should teach that to your kids, probably. Yeah. No. Look. I learned it really late as well, unfortunately, many times over. And people need to understand like, if you're gonna invest in something, you have to know why you're investing. Are you investing because this company makes a lot of cash? Are you investing because there's a lot of hype? So, like, for instance, Tesla, maybe doesn't make a profit yet, but a lot of people trust Elon Musk, and they know that that's the risk. Is that Elon Musk, you know, do we trust this this personal brand or not? But I invest in, let's say, Walmart because I know how much cash they make. It's very easy to understand their cash. There's no weird financial accounting. It's the one of the biggest companies in the world, and and it better be accurate, their accounting, or else the whole financial system is worthless. So then you understand, like, how they make their cash. Will they sell things to people? But with Enron, we didn't really you know, they claimed to have a lot of profits, and it claimed to be this, but but they couldn't but they didn't have cash flows. So if they're claiming profits, but there's no cash flows, you have to under that's not impossible, but you have to understand why that exists. And they weren't able explain that. And Madoff wasn't able to explain it. Maybe FTX wasn't able to. I don't I don't know yet. Lehman Brothers wasn't able to explain it. It was it was too complicated. So you have to really understand what you're investing in. People don't do hype. Yeah. No. I mean, I remember in college, there was just one personal finance class, and it's also about the way you teach it. Because I remember I I mean, I was asleep in that cla*s. So I was wondering, you know, if you gamify investing for kids, you know, that would be a cool idea probably to start teaching them early because, yeah, you you need to understand, not necessarily, like, you you don't need to be an accountant, but it's a good idea to understand how the financial statement the statements work, like a business model of a stock if you wanna be a a stock picker. Right? Because otherwise, you just go, hey. This is my money. I'm gonna give you 20% of my paycheck every month and, just index fund safe, you know, risk tolerance kinda medium. Right? Then that's fine. But if you wanna be a stock picker, for sure, for example, you know, investing in companies that now are, like, tech companies that everybody thinks, oh, they're great or whatever. But, you know, how do you how do you start interpreting something like the metaverse, for example? Like, how do you value that? How do you, like do you understand that business model? How would the economics look like? That's crazy. Like, if if, for example, if if if Meta were to split up and have Facebook stand alone and and and Meta, like, Metaverse stand alone, how would why would we invest in Meta for them? Something that I don't even know yet. So Yeah. I mean, you either have to, a, there's 2 strategies there. You either have to say, well, look. Everyone else is into this, so I'm gonna ride this train until it's over. Or you could say, look. I think based on my own research, you know, and this is not me speaking, but hypothetical me. Yeah. I think the metaverse is worth x 1,000,000,000 of dollars 10 years from now, and you just, you know, you discount that back. Like, what does it mean that it's worth now? And, you know, personally, I don't I think they took too big of a risk, Meta, because they didn't have no idea how to value what they were building because it might not people might not be interested in it, and that's their big problem right now. But Yeah. You you're right. I think I think, you know, you almost have to gamify. Like, maybe you almost have to do, like, like, a just like there's books of crossword puzzles, what about a book of kind of simple financial problems? Like, what is the risk in a company that's building, you know, a metaverse but also has a 1000000000 users on Facebook and Instagram and WhatsApp? And what are list the risks. And, you know, or what is the risk on, you know, something like FTX that run that runs its own, hedge fund on the side. So, that's interesting. Could be food for for thought. But, but look, Antonio Antonio Reza, what what's your Twitter account name? At the Antonio Reza. Yeah. You can find me on Twitter, and, I write about finance topics and money and, self growth and just try to make people, you know, understand how can they make their business grow and their careers grow. Your threads are riveting. I definitely highly recommend. It's it's at theantonio Reza. And thank you so much for for coming on the show and and explaining all this stuff to us, and look forward to having you on the show again at some point. Thank you so much for the invitation, and just wanna say, very, very, very delighted to be here, and, thank you for the opportunity. Thanks.