This article is from:Dirty Bubble Media

Translator: Odaily Azuma

Editor’s note: On December 16, two successive accounting firms, Armanino and Mazars, announced that they would withdraw from the cryptocurrency market, which became a hot topic. This article focuses on Armanino, one of the firms that has provided services to FTX US, and combines Armanino’s support for Nexo The case of financial status certification, to a certain extent, cleared the fog of cryptocurrency audit services for us, and revealed potential risks that have not received sufficient attention from the market.

When the energy giant Enron collapsed in 2001, it was discovered that the large accounting firm Arthur Andersen, which audited Enron, had failed to detect clear fraud and malfeasance by its clients. Subsequently, Andersen was accused of participating in the largest corporate fraud case in history, and went out of business as a result. The scandal eventually led to the introduction of the Sarbanes-Oxley Act, which aimed to reform corporate accounting laws.

As it turns out, Enron wasn't the only problematic firm on Andersen's client list, as the firm ended up embroiled in at least a dozen major accounting scandals.

In theory, external auditors should provide independent assurance for the integrity and accuracy of the company's financial statements. As an impartial third party, the audit firm needs to assure investors that the audited company's financial statements are credible. Yet, time and time again, cases of accounting firms failing to meet this expectation are repeated in financial markets.

Armanino: The most active accounting firm in the crypto market

An accounting firm called Armanino LLP has been one of the most famous and active accounting services firms in the crypto world.Armanino has provided services to some of the biggest names in the industry, such as FTX US, and Armanino has issued a "certificate of health" for the company's financial situation.Of course, given that FTX US is only one of dozens of entities owned by FTX/Alameda, Armanino also claims that this is an audit limited to a single entity, so what he argues is that "it is impossible for Armanino to discover that there is a broader fraud in the entire FTX group. Fraud" seems plausible.

While this may be true, it turns out that FTX US is not Armanino’s only problematic client in the cryptocurrency market.

While Armanino offers auditing services, the firm’s most popular service in the cryptocurrency market is another — “attestation.”Compared with auditing, "certification" is a relatively incomplete inspection of the company's account books. Audits generally include independent opinions and detailed verification of the company's financial statements, but "certification" only needs to perform a limited part of the procedures, basically It is only necessary to check that the information provided by management matches its financial statements.

As an example, suppose a company claims to have a bank account with a deposit of $5,000. In the audit process, the accountant would independently request records from the bank to confirm the existence of the deposit; but in the "proof" process, the accountant would simply compare the documents provided by management with the stated figures and say, "Yes." Yes, the numbers do match!"

Doesn't seem to work, right? Especially when management can lie about the accounts.

Recently, Armanino's "proof" has begun to come under scrutiny from regulators and researchers. Let’s look at an example — Armanino’s relationship with crypto lender Nexo, and how they use a “real-time attestation” service.

Armanino and Nexo's so-called "real-time proof"

Armanino's flagship service in the cryptocurrency market is their "Real-Time Proof", which they claim is "the world's first service that provides independent accounting reports in real time". Armanino claims to generate a report on a daily basis to improve visibility into customers' financial health, providing "unrivaled transparency."

Nexo is a big customer of the service. After mainstream lenders such as Celsius Network, BlockFi, and Voyager Digital all collapsed, Nexo is one of the only remaining seedlings in the CeFi lending market. Nexo claims to manage more than $2 billion in crypto assets and is financially sound.

Armanino's website has some strong claims about Nexo's balance sheet. For example, they will put a big tick on Nexo's "proof" interface to show that the company's liabilities are backed by more than 100% collateral assets.

However, a closer look at Armanino's "proof" reveals that the process suffers from several major flaws.

• first,The "Proof" screen only provided a figure for the total liabilities to the customer, but not for the company's net worth.

• Secondly,The "proof" process doesn't actually compare what Nexo holds with what it owes.In September 2022, several states issued shutdown orders for Nexo. In those orders, the Kentucky securities regulator, which had seen Nexo’s ledger, asserted that Nexo was effectively insolvent if ownership of Nexo tokens were not included.

  ReportReportIt has been pointed out that NEXO has many of the same problems as FTT, they are very illiquid, ownership is almost completely concentrated in Nexo's own hands, and there are very suspicious trading patterns.

• third,Armanino is getting data on customer deposits and loan books from Nexo via an API.This means that Armanino has not independently verified these figures, they have only subjectively believed that the figures provided by Nexo are accurate. Armanino made no attempt to investigate the true value of Nexo's loan books, or the accuracy of the valuation methods on Nexo's balance sheet.

Why is this a serious problem? Because we don't know at all how Nexo evaluates its loan book or what loss allowances they take. Given that Nexo is in a highly volatile cryptocurrency market, the possibility of counterparty failure is actually quite high. For example, the information disclosed by Celsius Network under Chapter 11 of the bankruptcy law shows that its loan book has more than 50% loss provisions. Without knowing the quality of those loans, Armanino's so-called "certification" report simply presupposes that Nexo's valuation of the assets is reasonable.

Regulators (such as Vermont) have questioned Nexo's use of Armanino's "proof" service, and they pointed out that these so-called "proofs" provide insufficient information and have no practical reference value for regulators or investors. Despite these challenges, Nexo has insisted on confusingly referring to these "attestations" as "audits" in its public statements.

It’s worth noting that Nexo announced less than two weeks ago that it would be leaving the U.S. market due to a “lack of regulatory clarity.”…

Get out of the crypto business, why?

To sum up, one of Armanino's main services is the so-called "proofs", but since the "proofs" process does not include verification of management's statements, these "proofs" are basically worthless from an investor perspective. While this is of no use at all, it turns out that most cryptocurrency companies (including the three largest stablecoin issuers by market capitalization) are relying on so-called “proofs” of their financial health.

What's the point of a "proof" if it doesn't provide enough information to evaluate a company's financial statements? "Proof" ends up being a tool to deceive potential investors into thinking that due diligence has been done.

Of course, it's worth emphasizing that we're not alleging that Armanino has done anything illegal, and it may be unfair to compare the firm to Andersen, which behaved egregiously prior to bankruptcy. However, we doubt that it is ethical to release confusing and restricted "proofs" to the public? We also wondered, if Armanino gave a "proof" of "100% + collateral" to a client, and it turned out that the client was not actually solvent, what would they be held accountable for?

As we were making the final edits to this article, we found that Forbes Today suddenlyto reportWe were appalled by the article that said Armanino was going to exit the cryptocurrency market and that he was planning to shut down his cryptocurrency auditing business after the failure of FTX. We speculate that Armanino ceased crypto-related practice under pressure from “non-crypto market clients” who may have feared the firm’s reputational risk in doing business with cryptocurrency companies.

We wonder if there are other possible explanations, but we leave the guesswork to others.

Despite a comprehensive audit, Armanino managed to dodge one of the most fraudulent cases in cryptocurrency history. The audit goes as follows, with the incomplete "proof" service, what suspicious activity are they missing? Should the company be held accountable when they did not publicly explain to clients that the so-called "certification" was not an "audit"?

We have many questions, but few answers. But what we do know is that these answers may soon emerge.