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FTX Auditors Doubled as Crypto Industry Cheerleaders

When FTX faced a liquidity crisis, the auditor of its US unit seized the moment to promote its services to other crypto companies that were under the spotlight.

It’s a “nice time to remember” Armanino LLP’s specialized crypto insurance, the firm tweeted last week, refers to a product that verifies client assets held by crypto firms.

When FTX’s former CEO Sam Bankman-Fried testified before a congressional committee in December, the firm, which is in the Top 20 by revenue, cheered him on. “Let’s go buddy!” the firm tweeted.

There is a race among crypto brokers, lenders and exchanges to calm their anxious clients by getting the blessing of an auditor. But the type of audits they are getting and the collapse of an audited firm like FTX shows how far that sector is from a traditional regulated, scrutinized industry.

Cryptocurrency exchange FTX was seen as a survivor in a struggling industry, but over the course of six days, the exchange collapsed due to a sudden liquidity crisis. WSJ explains the factors that drove FTX’s growth and what led to its demise. Illustration: Alexandra Larkin

An Armanino spokesperson said the firm “has been and will continue to be an advocate for improved trust, transparency and regulation in the digital asset industry.”

FTX US, which Armanino audited last year, is one of several FTX companies that filed for the largest crypto-related bankruptcy ever last week.

Binance, the largest crypto exchange, said it is working on a so-called “proof of reserves” report, a type of third-party verification that falls short of a full audit of the company’s books.

Binance is facing delays because the auditor it wanted to use was busy doing proof of reserves for others, Changpeng Zhao, the exchange’s founder, said on Tuesday. Another issue: The auditor is one of two that have audited FTX companies. He declined to name the firm. “There’s some scrutiny there,” he said, adding the exchange is working on an alternative.

The type of audit Binance has said it is getting won’t necessarily protect investors. Proof of reserves checks are designed to tell customers that their money is still in their accounts and have not been borrowed elsewhere, but may not reveal much more.

“Proof of reserves is not sufficient … to prevent another disaster from happening,” said Mriganka Pattnaik, CEO of Merkle Science, a risk and compliance firm. “It’s a good start, but it’s not an audit.”

FTX was a relatively rare example of a crypto company that did have a full GAAP audit. Mr. Bankman-Fried, who founded FTX and stepped down as CEO last week, considered it a milestone. Private companies are not required to audit or publish their financial statements.

The audit reassured several FTX marquee investors, according to people familiar with the matter. But John J. Ray, the company’s new chief executive, said Thursday he had “material concerns about the information presented in these audited financial statements,” particularly regarding FTX Trading Ltd. The statements should not be relied upon as a reliable indication of the financial circumstances of the companies, Mr. Ray said in a bankruptcy court filing.

FTX Trading, the crypto exchange’s main international operations, has been audited by mid-sized firm Prager Metis CPAs LLC. It is the first accounting firm to open an office in the metaverse, according to its website, which includes that virtual world in Prager Metis’ 24 global locations. The firm’s Hackensack, NJ, office gave FTX Trading a clean audit opinion for last year, the financial statements show. Armanino’s audit opinion for last year for FTX US, a smaller company focused on US clients, was also clean.

One weakness of the audits is that they did not cover the effectiveness of the FTX companies’ internal controls. Checks on these controls are mandatory for audits of most large public companies, under a law passed after the Enron Corp. accounting scandal. But no such requirement exists for private firms, such as FTX.

Weak internal financial controls at FTX may have contributed to its failure. The company borrowed billions of dollars in client assets to finance risky bets through its affiliated trading firm, Alameda Research. FTX had a “complete failure of corporate controls and … a complete absence of reliable financial information,” Mr. Ray’s court filing said.

“If there had been a rigorous internal control audit done to the standards of what is typically done by the Big Four [accounting firms], it would have revealed significant deficiencies in FTX’s internal controls,” said Daniel Taylor, director of the Wharton Forensic Analytics Lab at the University of Pennsylvania. “And it is likely that the [financial problems] would have been revealed earlier.”

Prager Metis said it stands by its audit opinion. “According to media reports, the issues at FTX that led to its demise … long ago the last period we audited,” it said. Armanino is “confident that it complied with all applicable professional standards in the performance of its audit work,” a spokesman said. The firm has not done any work for FTX US since issuing its audit opinion, the spokesperson added.

FTX and Mr. Bankman-Fried did not respond to requests for comment.

Armanino’s tweet from his crypto Twitter account that Mr. Bankman-Fried supported, was unusual because auditors are required by regulators to maintain a “professional skepticism,” including an alertness to significant errors and fraud, when assessing a company’s finances.

The audit firm also applauded Hester Peirce, a Republican commissioner at the Securities and Exchange Commission, when she criticized the regulator’s plans to tighten crypto enforcement in May. “She’s the bomb,” Armanino tweeted.

When the CEO of his client, crypto exchange Kraken, made a tongue-in-cheek job offer to SEC staffers saying that crypto pays better, Armanino retweeted it saying “truth.”

Earlier this year, Armanino offered, “Congratulations to the Kraken team!” says its proof-of-reserves audit showed the crypto exchange had $19 billion in cryptocurrencies bitcoin and ether.

Prager Metis, the other FTX auditor, said on its website in June that it was “proud to support FTX US.” The now-deleted post was illustrated by a photo of Prager Metis auditors at a Yankee game with FTX.

—Peter Rudegeair contributed to this article.

Write to Jean Eaglesham at Jean.Eaglesham@wsj.com and Patricia Kowsmann at patricia.kowsmann@wsj.com

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