When investor Chamath Palihapitiya’s team at Social Capital advised Sam Bankman-Fried’s FTX to form a board of directors, an FTX representative reportedly responded by suggesting an anatomically unfeasible course of action. FTX never had a proper board of directors.
So, what can boards learn from a company that never had a board? Quite a lot, as it happens, because the story of FTX is a story of the failure to manage risk.
A lot has been written about the failure to manage crypto and accounting risk. A lot has also been written about counterparty risk. But very little has been written about personnel risk. By this, I don’t mean avoiding employing bad hats – it’s hard to know what’s in people’s souls.
What I mean is the failure to manage the risks associated with the enterprise being bundled up in a few key people.
The most obvious risk is around decision making. When you have an incestuous club removed from the outside world, as FTX’s senior managers seem to have been in their compound in the Bahamas, it’s easy for decisions to veer off course. The decision space is not explored fully as different and dissenting viewpoints may not be available. Moreover, groups can head off in weird directions.
An outsider can see group polarisation, where groups reach more extreme views, more easily than the individuals within them would. There’s also the potential for what is known as pluralistic ignorance, where everyone publicly supports an idea that they privately disagree with, because they assume that everyone else actually agrees with it, and so they go along with the flow.
The other obvious but undiscussed risk is around the incapacitation of key personnel. This could be legal incapacitation, as in the case of Sam Bankman-Fried and his executive team. Or it could be physical incapacitation, the proverbial falling under a bus. Whatever the mechanism, there is quite a lot to lose. And in this case, in an organisation with poor internal systems, there was more to lose than in most cases.
Loss leaders
So, what was lost? It seems likely that FTX is now suffering from the loss of three things. The first is company knowledge: the basic knowledge of where things are, such as deposits and trading positions. Much of this seems to have been in the heads of senior management.
The second is relationships: the linkages both within FTX and between FTX and other companies. Again, many of these relationships seem to have been between individuals, rather than formally between organisations.
The third thing that is lost is what academics refer to as transactive memory. This is, in essence, the memory of the group: the knowledge of which person knows what.
When academics talk about knowledge, they make a distinction between two different types of knowledge: tacit and explicit.
Tacit knowledge is embedded in people and not written down. For example, riding a bike is an example of tacit knowledge. Even if you read a thick textbook on how to ride a bike, it would not help you ride a bike.
Heaven only knows
Explicit knowledge is knowledge that has been codified and written down. In the case of FTX, the entire organisation seems to have run largely on tacit knowledge. This leaves those now running the organisation with a problem. As the previous management have left, so has the knowledge.
Normally companies avoid this amnesia through bureaucracy. Bureaucracy is often used in a derogatory fashion, but it’s essential to the immortality of organisations. The genius of the corporation is its ability to exist independently of the individual. The way it does this is through a series of formalised processes which are explicit and exhaustive. Hence someone can walk into the organisation and run it effectively.
Remove this bureaucracy and it leads to FTX’s new boss John Ray III, who oversaw the Enron fiasco, observing, “Never in my career have I seen such a complete failure of corporate controls.”
So, what can boards learn from this? There is one key lesson and that is: don’t depend on a single individual or small clique. There is the risk of physical, legal or mental incapacitation. They could be hit by a bus, disqualified as a director or subject to the biases that afflict individuals and small groups.
The small, incestuous, clique at the heart of FTX should have been warning enough for investors. Healthy and effective challenge is essential. It’s also important to have an effective succession plan. McDonald’s had four CEOs in two years—that’s strength in depth—but even small companies should have an idea of what to do if the principal is incapacitated.
There were many failures at FTX, but perhaps the most obvious one is the least discussed—and the one from which boards can learn the most.
Ben Hardy is clinical professor of organisational behaviour at London Business School