Your Guide to Criminal Capitalism: How to Spot The Next FTX

U.S. stock and bond markets are closed Friday, March 29, in observance of Good Friday. It’ll be business as usual on Monday. In the meantime, now’s an opportune time to step back for a “big picture” analysis.

Sam Bankman-Fried on March 28 was sentenced to 25 years in prison by Judge Lewis Kaplan, a year and a half after Bankman-Fried’s crypto startup, FTX, suddenly exploded and crashed to the ground in spectacular fashion.

FTX, at one time the world’s second-largest cryptocurrency exchange, filed for Chapter 11 bankruptcy protection in November 2022 after panicked customers withdrew billions from the exchange in only a few days, triggering a halt to withdrawals.

FTX’s tousle-haired founder, Sam Bankman-Fried (aka SBF), had been glamorized in the financial media as a tech whizkid. Now he’s the poster boy for crypto fraud. A prison sentence was virtually assured after a jury found Bankman-Fried guilty of seven federal counts of fraud and conspiracy in November 2023.

SBF used customer funds to prop up his trading business, Alameda Research. FTX’s implosion caused the cancellation of a planned acquisition by rival cryptocurrency exchange Binance.

The FTX collapse was a global contagion that wiped out scores of individual investors. The company’s bankruptcy petition lists more than 130 affiliates in countries, with more than 100,000 creditors and liabilities in the range of $10 billion to $50 billion.

Read This Story: Crypto’s Re-Accumulation Phase; Plus, “SBF” Faces The Music

Judge Kaplan ordered Bankman-Fried to forfeit $11 billion, including properties and other assets acquired with stolen customer funds. The ruined remains of FTX are now in the hands of corporate restructuring expert John J. Ray III, who handled the liquidation of Enron in the early 2000s.

From Bankman-Fried to Bernie Madoff…

The financial world is rife with fraud. The next Bankman-Fried, or Bernie Madoff, or Charles Ponzi, or “Kenny Boy” Lay is just around the corner.

Remember the late Bernie Madoff? He seemed like a guy you could trust…a mensch. An experienced stockbroker, he once served as chairman of NASDAQ. His wealth management company, Bernard L. Madoff Investment Securities LLC, boasted of consistent, market-beating gains, enticing an enviable roster of rich and famous clients. He seemed to take pleasure in helping clients, employees and charities.

But the mensch was a monster. As the world now knows, Bernard L. Madoff Investment Securities was all a Ponzi scheme on a mind-boggling scale. “Uncle Bernie,” as people called him, stole an estimated $50 billion, making it the largest financial fraud in U.S. history.

How many times have you heard someone on CNBC say: “This stock is a screaming buy!” But just because a smug television performer with perfect hair is saying it, doesn’t make it true. Beneath the enthusiasm could be hidden risks.

Maybe you’re considering investing in the MAGA meme stock Trump Media & Technology Group (NSDQ: DJT), which operates Donald Trump’s personal megaphone, the money-losing Truth Social social media platform.

Trump Media & Technology Group went public this week and initially soared in value. However, according to many financial analysts (including me), the company is a brazen pump-and-dump scheme. The new venture has as much chance of success as Trump University, Trump Airlines, Trump Vodka, Trump Magazine, Trump Steaks, and Trump’s bankrupted Atlantic City casinos.

If you think Trump Media & Technology Group is a good investment, there’s a bridge in Brooklyn that I’d like to sell you.

Read This Story: Lessons From The Worst Stock Crashes Ever

I distinctly remember television analysts telling viewers in 2008 to buy Bear Stearns with both hands, even after the storied investment bank had struck an iceberg and was taking on water. When Bear Stearns finally slipped under the waves as part of the global financial crisis, there weren’t enough lifeboats.

Fancy textbook terms such as “disruptive technology” and “creative destruction” are all fine and good, until you take a beating on a stock because a fundamentally weak company has gone down the drain.

As always, it’s not enough to pinpoint a promising industry. The key is to do your homework and find the right stocks.

Before investing in a company, you need to look under the hood, to see what you’re really buying. Here are 10 signs of a company that’s in deep trouble. Beware of any single sign, or combination thereof.

1) Dividend cut

Companies that reduce, or eliminate, their dividend payments aren’t necessarily on the road to bankruptcy. But a dividend cut is often the dead canary in a coal mine.

If a company you own has slashed its payout, watch for falling or volatile profitability, an excessively high dividend yield compared to peers, and negative free cash flow.

2) Turmoil in the auditing process

All public companies are required to get their books audited by an outside accounting firm. It’s not unusual for a company to switch accounting firms, but the sudden dismissal of an auditor or accounting firm for no discernible reason should make you suspicious. It typically indicates internal dissension over how to handle problematic numbers.

Also, examine the auditor’s letter. As part of the proxy statement, auditors must write a letter confirming that the financial data was presented fairly and accurately, to the best of their knowledge. If in the letter an auditor raises doubts as to the company’s sustainability, you should get very worried.

3) Unmanageable interest payments

Study a company’s balance sheet, to determine whether it has sufficient cash to satisfy creditors. If a company is imploding, its cash cushion will incrementally wane until it can’t pay its bills.

A handy indicator is the “cash ratio,” which helps you calculate a company’s ability to pay short-term debt obligations. The ratio is determined by dividing current assets by current liabilities. A ratio higher than one indicates that a company will have a solid chance of being able to pay off its debt; below one is a red flag that a company can’t handle its debt.

Some indebted companies manage to beat the odds and clean up their balance sheets, but more often than not, poor debt metrics spell doom.

4) A stampede of top executives for the exits

High executive turnover usually means that the company is suffering internal turmoil that’s born of growing corporate vulnerability.

When top executives quit their cushy, well-paying jobs on their own volition, it usually means one thing: the firm is in trouble.

5) Excessively high valuation

Investors often get excited about an over-hyped stock that seems too compelling to avoid, even if the market is favoring it with irrational exuberance.

This truism bears repeating: If a stock is considerably more expensive that its industry or direct peers, or its estimated growth is greatly out of whack with its valuation, stay away.

6) Suspiciously low tax rate

If a company is playing fast-and-loose with the tax code, it usually faces a day of reckoning in the form of expensive and time-consuming audits that distract management. Not to mention the potential fines, penalties and bad publicity.

7) Lack of financial transparency

The world’s second-largest economy epitomizes the dangers of opaque accounting. Consider the massive debt woes and defaults of China-based property developer Evergrande Group (OTC: EGRNF).

China’s endemic lack of transparency makes it hard to gauge how badly the Evergrande debacle could affect China’s financial stability, and by extension the world’s.

China has a large, informal network of lenders such as off-balance sheet operations tied to local banks, insurance companies and a host of others. Many borrowers turn to non-traditional lenders for financing, because borrowing from official lenders is often difficult for small- and medium-sized business, thanks to the tendency of the Chinese banking system to favor state-owned enterprises.

The policy-making mandarins in China’s centralized mercantile economy racked up debt during the coronavirus pandemic (and during previous economic downturns), by trying to stimulate the economy through infrastructure projects, many of them poorly conceived and wasteful. State banks are now plagued by nonperforming loans. Whether it’s in China or any other country, beware of smoke-and-mirrors accounting.

8) A rising short interest ratio

Short interest is the total number of shares that have been sold short by investors but have not yet been covered or closed out. When expressed as a percentage, short interest is the number of shorted shares divided by the number of shares outstanding.

For example, a stock with 1.5 million shares sold short and 10 million shares outstanding sports a short interest of 15%. Most stock exchanges track the short interest in each stock and issue reports at the end of the month. If short interest is spiking, it’s a clear signal that investors are souring on the stock and it bears closer scrutiny.

9) Increased insider selling

If corporate insiders are suddenly dumping a stock, they know something that the rest of us don’t. It’s often a tip-off that the people running the company realize that the stock is about to underperform the market. But there’s a caveat: sometimes insiders sell for personal financial reasons that aren’t related to the health of the company.

If only one corporate insider is selling, or if the stock has run-up quite a bit, it may simply indicate an individual’s desire to pocket profits. But if several corporate insiders are all selling within a short period of time…watch out.

10) Selling the “family jewels”

If a company is dumping flagship products or property at fire sale prices just to keep the lights on, you know that the end is near.

Look at it in personal terms. If you’re a baseball fan and you owned, say, a baseball signed by New York Yankee legend Derek Jeter, you wouldn’t sell it unless you were going broke, right? Same principle applies to companies.

Have you ever invested in a company that failed? Your cautionary tale could help other readers. Drop me a line:

Editor’s Note: Did you know that cryptocurrencies are surging this year? Indeed, we’re in the midst of a roaring bull market in crypto. The FTX scandal is actually an encouraging reminder that crypto isn’t a lawless “wild west.” Bad players in the crypto realm are eventually brought to justice.

The FTX scandal also underscores the need for crypto investors to seek expert guidance, to separate the solid investments from the scams.

Every portfolio should have exposure to crypto. But you need to be informed, to make the right choices. The good news is, the experts at Investing Daily have done the homework for you.

Want to tap crypto’s massive money-making opportunities, but with mitigated risk? Start receiving our FREE e-letter, Crypto Investing Daily. Click here now!

John Persinos is the editorial director of Investing Daily.

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