Accounting Red Flags Are Common Among Public Crypto Companies
Weak controls and related-party transactions appear in disclosures across industry
4 min
Investors bemoan the lack of disclosure in the crypto industry. But many crypto companies disclose a lot of information, and some of it is worrisome, a review of financial statements shows.
The blowups of FTX and Celsius Network LLC exposed hidden risks that might have raised red flags for investors, including related-party transactions, commingled customer funds, sketchy record-keeping and questionable accounting. Some of these problems often appear in disclosures by public crypto companies, including weak systems used to keep numbers accurate.
A look at 19 of the publicly traded crypto miners showed that 16 disclosed significant internal-control weaknesses in the past four years, some of which were “alarming,” according to Bedrock AI, which makes software that analyses financial filings. Crypto miners build powerful networks of computers that process transactions and are rewarded in newly generated currency.
The bitcoin miner Riot Blockchain Inc. filed an annual report in March that identified four material weaknesses in internal controls. One of those weaknesses raised questions about how the company determines its revenue, one of the simplest and most important numbers in accounting.
On the day before Thanksgiving, the company filed its second amended version of the March report to say that auditors didn’t assess internal controls on a third of the company’s revenue and assets. They hadn’t analysed two of Riot’s significant acquisitions from 2021, the company said.
A spokeswoman for Riot said the filing was amended because the notice that the subsidiaries had been excluded from the assessment was inadvertently left out of the company’s disclosures.
“Crypto auditing and accounting is very much still a work in progress,” saidSean Stein Smith, an accounting professor at Lehman College, City University of New York.
Checks on internal controls are important parts of an audit because they give accountants confidence that the numbers they are looking at are valid. Weak internal controls can lead to restatements of financial reports.
Another large bitcoin miner, Marathon Digital Holdings Inc., disclosed problems with internal controls tied to revenue and its assets. It added that it hadn’t effectively designed a control to detect significant misstatements in revenue.
The company said it would work to remedy the problem by adding staff in financial and information-technology roles. The company, with a stock-market value of about $700 million, has in the past two years grown to 26 full-time employees from three, Marathon said.
Marathon has also made investments in related parties. In September, the company invested $30 million in a private company called Auradine Inc., whose business isn’t described in Marathon’s filings. Marathon’s chief executive officer, Fred Thiel, serves on Auradine’s board, and another Marathon board member is a 10% shareholder of Auradine, according to Marathon’s disclosures.
A Marathon spokesman said Auradine is an early-stage company that is a strategic investment for Marathon.
Basic accounting and operational controls can take a back seat to growth at crypto companies, as the Celsius implosion indicated. The bankrupt lender failed to ensure that customer funds in certain deposit accounts were set aside from the rest of its crypto holdings, an independent examiner appointed in the company’s chapter 11 case found.
“Due to time pressure and lack of engineering resources, Celsius chose [instead of controls] to rely on manual reconciliations and transfers of crypto assets…for the custody program,” the examiner wrote in November.
Celsius didn’t respond to a request for comment.
The lack of standardised accounting rules for cryptocurrencies can mean that even audited financial statements might fail to convey the true state of a company’s finances. Crypto doesn’t fit neatly into the definitions used to categorise assets. It lacks the government or commodity backing needed to be treated as cash, it is too volatile to be a cash equivalent, and it isn’t necessarily a financial instrument or security either, said Vivian Fang, an accounting professor at the University of Minnesota.
Regulators and accounting rule makers are working to fill the void in crypto accounting standards. The Financial Accounting Standards Board, the U.S. standards setter, aims to issue proposed rules next year.
Most companies holding cryptocurrencies have been treating them as indefinite-lived intangible assets, similar to intellectual property such as trademarks. But accounting rules allow such assets to be valued upward only when they are sold, meaning a company’s reported balance sheet might not reflect the current value of its holdings. FASB has signalled that companies should hold bitcoin and many other crypto assets at fair value.
There are also questions over whether exchanges should have to include customer deposits as assets and corresponding liabilities. The Securities and Exchange Commission in March issued accounting guidance saying they should do so.
The wild price moves of bitcoin can create odd results for miners that hold big slugs of the cryptocurrency.
Riot Blockchain said in disclosures that it has booked $126 million in revenue from bitcoin mining through September. That was more than offset by $132 million in impairment charges related to bitcoin’s declining price.
The full impact of these big price moves can sometimes only be seen in the footnotes to financial statements. In early November, Marathon said, it held approximately 11,440 bitcoin. Mr. Thiel, the CEO, citing third-party data, has described the holding as the second-largest among publicly traded companies.
In the footnotes, Marathon also said that roughly 83% of that bitcoin amount was pledged as collateral on around $100 million in loans.
On the company’s earnings call Nov. 8, Marathon’s chief financial officer said the company didn’t expect significant additional collateral requirements for the borrowing. The next day, cryptocurrencies’ volatility struck again. FTX’s collapse drove down bitcoin’s price, and Marathon was called on to post more bitcoin holdings as additional collateral, the company disclosed.
Marathon said Tuesday that it has since paid down its loan balance to around $80 million, reducing currently pledged bitcoin to roughly 65% of Marathon’s holdings.
Consumers are going to gravitate toward applications powered by the buzzy new technology, analyst Michael Wolf predicts
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Shares of retailers including Victoria’s Secret and Foot Locker are surging despite mixed holiday updates
4 min
Retailers are making modest predictions about the holiday shopping season—and their stocks are going gangbusters in response.
Victoria’s Secret, Foot Locker, Ulta Beauty and Dollar Tree are among the companies that offered somewhat mixed assessments of the state of the shopper last week. Yet each received an ovation from investors.
Traders have piled into stocks en masse since a softer-than-expected inflation reading on Nov. 14 bolstered wagers that the Federal Reserve is done raising interest rates and is poised to cool the economy without tipping it into a recession. Treasury yields have sharply declined as well, giving equities a second wind.
The S&P 500 has risen 4.1% since the report, extending its gains for the year to almost 20%.
Many depressed sectors of the market, such as retailers, have risen even faster. The SPDR S&P Retail exchange-traded fund—which includes 78 retailers, from department stores and other apparel companies, to automotive and drugstores—has jumped about 13%. Victoria’s Secret has soared 52%, Foot Locker is up 50%, Ulta has risen 21% and Dollar Tree has added 12%. (Three of the four stocks have suffered double-digit percentage declines this year.)
Americans slowed their spending in October, according to last week’s consumer-spending data from the Commerce Department. But the early readings from the holiday shopping season have been more encouraging. U.S. shoppers spent $38 billion during the five days from Thanksgiving through the following Monday, up 7.8% from the same period last year, according to Adobe Analytics.
Many investors closely watch consumer spending because it is a major driver of economic growth. If spending is too strong, the Fed could be forced to raise interest rates again. Whereas, if spending is too weak, it could be a sign that the economy is entering a recession.
In the coming days, investors will look at U.S. service-sector activity for November and Friday’s monthly jobs report as they try to assess the strength of the economy and the market’s trajectory.
“The consumer has been resilient throughout it all,” said Jay Woods, chief global strategist at Freedom Capital Markets. “The economic news is now starting to back that up, that, ‘OK, we aren’t going to be in a recession. Things are getting a little bit better.’ And these stocks that had been beaten-down are finally catching a bid.”
Victoria’s Secret posted its second consecutive quarterly loss Wednesday, with the lingerie retailer facing a continued slump in sales. But the company forecast higher sales in the current quarter, sending shares up 14% the next day, their largest one-day percentage gain in more than two years. The stock is down 20% in 2023.
Footwear retailer Foot Locker said Wednesday that Black Friday sales were strong and it forecast an upbeat holiday shopping period, while reporting lower sales and profit for the third quarter. Its shares rose 16% that day, their biggest gain in more than a year, trimming their 2023 decline to 21%.
Cosmetic retailer Ulta on Thursday posted stronger-than-expected sales in the third quarter and raised the lower end of its sales and profit outlook for the year. The shares rose 11% in the following session, their best day since May 2022. They are up 0.6% for the year.
Dollar Tree reported Wednesday that same-store sales growth was weaker than analysts expected, but investors appeared to be encouraged that the discount retailer is seeing increases in customer traffic, even if basket sizes are shrinking. Its shares rose 4.4% that day and are off 11% in 2023.
Another reason why retail stocks have rallied? Warehouses have reduced merchandise, and store shelves aren’t spilling over with discounted goods.
John Augustine, chief investment officer at Huntington Private Bank, said higher interest rates and oil prices made him bearish on retail stocks over the summer. But with an easing macro environment, he believes retailers could be poised to do well.
“It seems like traffic is gonna be there for the holidays,” Augustine said. “Now can retailers make the same profit, earnings per share, with tighter inventory?”
Short sellers are licking their wounds after the recent rally. They lost about $120 million in November betting against the SPDR S&P Retail ETF, according to financial-analytics firm S3 Partners. That compares with a loss of $2.8 million through the first 10 months of the year. Short sellers borrow shares and sell them, expecting to repurchase them at lower prices and collect the difference as profit.
Many retail stocks still generally look cheap compared with the broader market. Victoria’s Secret is trading at 11.8 times its projected earnings over the next 12 months, while Foot Locker is at 16.2. The S&P 500’s multiple is 18.8.
Despite the recent excitement in markets, many investors caution that it is too soon to count on a soft landing for the economy. Jamie Dimon, chief executive of JPMorgan Chase, recently cautioned that inflation could rise further and a recession isn’t off the table.
In the past 11 Fed rate-hiking cycles, recessions have typically started around two years after the Fed begins raising interest rates, according to Deutsche Bank. This hiking cycle started last March.
“It’s not an all-clear resurgence trade that we’re in right now,” said Brock Campbell, head of global research at Newton Investment Management. “This is gonna be a much more idiosyncratic stock picker’s group for a while.”
Consumers are going to gravitate toward applications powered by the buzzy new technology, analyst Michael Wolf predicts
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
