When It Comes to Financial Fraud, Let Common Sense Prevail

Too Good to Be True

By Carlo Centeno

Some of the largest financial fraud schemes have taken place within the last 100 years. The truism “if it’s too good to be true, then it probably isn’t” has been pushed aside by those convinced that if they hesitate, they lose the opportunity.

Pride has a way of pushing a desire or perceived benefit into acceptance. The short version of that notion is commonly known as FOMO [fear of missing out]. White-collar criminals understand that, as investment tactics, strategies, and offerings become more complex, the easier it is to pull the wool over some eyes. For the unfortunate victims, the fear of missing out is all too real, but a greater fear comes to bear regarding their sense of self: in not wanting to appear naïve or uninformed, the ego takes over.

In the mid-1980s, Warren Buffet noted in a letter to Berkshire Hathaway shareholders about “two super-contagious diseases,” namely fear and greed. His analogy to disease — more specifically epidemics — made clear that uncertainty, time of discovery, duration, strength, along with other possible factors could compromise global economies and markets. Ultimately, this led to his aphorism, “we should be more fearful when others are greedy, and to be greedy when others are more fearful.”

According to psychologists, humans are motivated more to avoid pain than to seek pleasure. Put another way, studies have shown that, when it comes to fraud, fear is a stronger motivator than greed.

“According to psychologists, humans are motivated more to avoid pain than to seek pleasure. Put another way, studies have shown that, when it comes to fraud, fear is a stronger motivator than greed.”

Corporations and their minions take advantage of investors’ interests by feeding ‘data points,’ the kind of information most would like to hear. In a marketing sense, the perception is the reality; it’s not what investors are hearing, but what they believe they’re getting.

Investment Fraud

Investment reasoning is contrarian for most of us. We think that, when some assets are experiencing losses, we need to sell to reduce such losses, and then, when the market goes up, we should buy more of said assets. It’s been long documented that making investment decisions guided by emotions does not fare well. However well-intentioned the feeling might be, it’s usually not good in the long run.

Jim Ratley, president and CEO of the Assoc. of Certified Fraud Examiners (ACFE), notes that “there’s no such thing as small fraud, but fraud that has yet to reach their full potential.” The ACFE has reported that approximately 87% of first-time offenders have never been charged or convicted. In such cases, the idea of getting caught is real, but a sense of invincibility reinforces continuation of the tactics that keep money in the wrong hands.

Carlo Centeno

“Investment reasoning is contrarian for most of us. We think that, when some assets are experiencing losses, we need to sell to reduce such losses, and then, when the market goes up, we should buy more of said assets. It’s been long documented that making investment decisions guided by emotions does not fare well.”

According to the Federal Trade Commission (FTC), consumers reported a record $10 billion in fraud losses in 2023. The amount represents an increase of 14% over losses in 2022. The top category: investment scams. The most used method of acquiring fraudulent cash was through bank transfers.

To be clear, this writer is not aware of any cohort consumer behavioral research which quantitatively ascertains why the losses are so high, though, based on the FTC findings, the means in acquiring fraud dollars can be attributed to a combination of factors: the increased use of online selling and buying, the growing sophistication of iterative websites that mimic actual sites, proficiency in acquiring personal information, in particular from social media, and trends in lifestyle resources appearing on tablet and mobile devices, in particular with health-related products and services, dating services, and financial management.

And the losses continue to grow. Here are some fraud examples that took place not that long ago.

• Lehman Brothers: When you hide $50 billion in loans and reassign them as assets, that’s bound to backfire. It did. The bank’s internal department discovered $3 billion in losses to investors; that money was bought by Cayman Island banks to be purchased later by Lehman Brothers. The majority of the first-timers involved with the scam had no prior criminal record. Due to lack of evidence, the SEC did not prosecute.

• Enron: The Houston-based energy commodities corporation kept enormous amount of debt off the balance sheet. Clients and employees of the firm lost their retirement accounts, and shareholders lost a staggering $74 billion. Auditing firm Arthur Anderson was involved, CEO Jeff Skilling was sentenced to 24 years in jail, and CFO Andrew Fastow pleaded guilty and served jail time. Fastow forfeited $24 million and pleaded guilty to two counts of conspiracy. In a news interview, he said, “there are people who look at the rules and find ways to structure around them. The more complex the rules, the more opportunity. The question I should have asked is not what is the rule, but what the principle is.”

• Bernie Madoff: Running the largest Ponzi scheme ever, Madoff’s investment firm took $64.8 billion from investors. Any “returns” paid out came from money from other investors or even their own money. After he confessed to his sons about his fraud, the sons reported him to the SEC the following day. For all the technology available to the investment industry, the fraudulent information was stored in a 1980s-era IBM AS/400 server.

• Sam Bankman-Fried’s FTX Scam: One of the more recent scams involved cryptocurrency. The investment scam was Sam Bankman-Fried, with friends being his associates. Cryptocurrency, to this day, still poses a high level of risk (see related story on page XX). The securities platform called FTX was claimed to deliver higher rates of return in 2019. By 2022, it all came undone. Bankman-Fried was sentenced to 25 years in federal prison for the FTX fraud. At its zenith, FTX valuation reached $32 billion.

Bottom Line

Financial fraud is wrought with complexities in large part because of the size and scale of investments offered today. Adding to this depth and volume, the ongoing evolution of computers, satellite communications, storage, encryption, and verification (just to name a few factors) continues to develop ways to not only identify bad actors, but the means to identify transactions and activities that point to potential financial crimes.

Carlo Centeno is vice president and Marketing director at St. Germain Investment Management. Much of his career has been in corporate communications, primarily on the agency side, where he worked on a variety of projects with national clients. He has received both a Clio Award and a Golden Pyramid Award for strategic business-to-business communication programs. He received his bachelor’s degree in English literature from Boston University and an MBA from the Isenberg School of Management at UMass Amherst.