The Tide is Out...

Published on 22 Sep 2010 under category: article

As published by inCompliance, Autumn 2010, p28

Dan Hyde gives a countdown of the top frauds to beware of in a recession

It is a widely accepted and statistical fact that instances of fraud increase during a
recession. Fraud, it seems, is ever-present, driven by greed, ambition and the “need”
to fund a “lifestyle”, gambling, drink or drug habit. Those drivers are often heightened by
a recession which may bring a reduction of income into the household and a perception
that money is essential to ensure survival through austerity.
In the corporate world a recession will not always result in diminished targets for
executives, who may then rationalise that cheating is not really cheating as they are
merely striving to meet otherwise unattainable targets, and to protect their job,
income and the interests of shareholders and the company. Fraud thus becomes pathological
– first there is the perceived need or motive, second the window of opportunity, and finally
the self-justification. In examining the top frauds I think it more
useful to refer to those that will have the potential to cause maximum damage and
consequences than those that may be most prevalent. That is not to say my top frauds
are not prevalent but they additionally cause immense damage.

Maximum damage

To understand the future one should look to history. Enron stands out as a warning. Enron
effectively hid debt and failed deals through creative accounting and “partnerships” with
shell companies which were effectively used to bury Enron’s failures and liabilities and kept
many millions of debt out of sight. Essentially Enron was able to exaggerate its profitability.
It falsified its financial information such that when its true position emerged the losses
were chasmic. WorldCom, Tyco and more recently Satyam
Computer Services, which apparently falsified its financial position to the tune of $1bn, are
other cases in point. This, in my view, is the top fraud. It can be committed and hidden in
a number of ways and can result in massive loss and financial suffering. There can be
fictitious or failed transactions geared to avoid detection or to make the corporation appear
more profitable; for example a transaction that never completed but was signed off and
included in the books to bolster profits. There can be deliberately false accounting entries or
those that are so complex and convoluted as to intentionally mask the true position.
The truth is what matters. Records can, even on audit, be accurate and apparently
correct but do not reflect the true state of the company. If they distract from that truth then
in all likelihood they are part of a fraud. Sam Antar, a highly successful “career” fraudster
once said, “it’s like David Copperfield – it’s an illusion”. Mr Antar realised that sitting a highly attractive female next to a male auditor helped the distraction strategy and that delaying the auditor so that 80% of the work had to be completed in the last week ensured the audit was rushed.
Impossible to prevent?

My second nomination for this list is insider dealing. It has recently been headlining as the
FSA has sought to blaze a trail and warn those in the City that this is a crime and it that it will
be prosecuted. Insider dealing can similarly be difficult to uncover and more difficult to prosecute. It is, however, thought to be widespread and endemic, driven by economic ambition, the simplicity of its execution, and the rationalisation, in the mind of the inside trader, that it is victimless. It is hard to see how a corporation can completely prevent this crime. Corporations rely on individuals treating confidential, market-sensitive information as exactly that – confidential. Some will always see the
opportunity of trading on the value of such information and perhaps the answer lies in rigorously screening and analysing potential recruits, and ensuring that, in addition to internal controls, there is a company culture that mitigates against such criminal opportunism.
As with falsification of accounts there can be vast sums involved in insider dealing – it is a crime which warps the market and whose existence propagates the “greed is good” culture that can permeate and corrupt.

Bribery loves a recession

Third has to be bribery. The advent of the Bribery Act (see pp20-21) is likely to throw this particular form of corruption under the spotlight yet, like insider dealing, it has always existed. And bribery loves recession. Companies or individuals in search of lucrative deals may be all too tempted to push the brown envelope across the table if their “gift” is returned many fold in increased orders for goods or services. The Bribery Act will hit not only individuals but the company unless (this is strict liability) it an demonstrate it had appropriate measures in place (and they were properly implemented) to revent bribery. It is no surprise that there are courses up and down the land offering advice on identifying possible bribery and spotting “red flag transactions” that should cause concern. The rationalisation for bribery is that without it the company will lose out to a competitor who will offer a bribe. I predict that bribery will become headline news as prosecuted companies scream that they cannot compete in overseas markets where the bribe or facilitation payment is an integral part of the culture and that our legislation hampers business. Unfortunately such arguments will not provide a defence (to company or individual) under the Act.

Boiler rooms

Fourth and finally I must mention the boiler room scam. This flourishes in boom and recession alike relying on a potential investors hope for a high return. Boiler rooms generally purchase shares that are non-existent, non-tradable or so over-priced as to be worthless. The fraudster distances himself (overseas) and employs high pressure sales tactics to suck in the investment.
The City of London Police has recently uncovered a “master list” and has contacted a thousand potential victims to warn them that their names and personal details are on the list. The boiler room scam not only strips people of their hard earned savings but dents confidence in the genuine investment market.
My phone forever rings with enquiries from those who have been the victims of a boiler room scam and are desperate to recover their loss. Recovery can be possible but is made difficult by the complex laundering of proceeds if, by that stage, any proceeds remain. So is there any moral or guidance to all of this? Perhaps. Don’t be distracted. By any means.

Dan Hyde, white collar crime lawyer at
Cubism Law.