Category Archives: Audit

SOMETIMES YOU’RE SORRY YOU READ THE NEWSPAPER

 

(A “Heads Up” to Boards and Trustees?)

(By Joe Koletar) Is there anything more good and pure than a charity?

There are over one hundred thousand of them in the United States alone. We have all seen their ads or received their solicitations. Each cause seems both important and noble: sick children, abused animals, wounded veterans, battered women, the arts, education, feeding the poor, etc.

These charities (called Not-For-Profits) may be national in scope or regional. They may have an ethnic or religious base. They may raise thousands or even millions to advance their worthy cause.

Unfortunately, they are filled with people, those most elusive of all creatures. Most are good. Some are not.

This is hardly an issue peculiar to NFP’s – Presidents have gone bad; Members of Congress; religious leaders; members of the medical, education, accounting and legal professions; Agents of the CIA and FBI. The list could go on. Are we to throw up our hands and trust no one? Of course not; but some thoughtful analysis may be in order.

NFP misdeeds fall roughly into two categories:

• Shady people pretending to represent an established charity;
• Others who solicit funds for a fictitious charity.

Let us focus on the performance of the legitimate charities.

The 2/23/15 edition of Crain’s New York Business carried the following article:

Nonprofits In Search of Accountability,” by Reynold Levy, page 9. Mr. Levy has been an executive in several NYC charities and has a forth-coming book: “They Told Me Not To Take That Job: Tumult, Betrayal, Heroics, and the Transformation of Lincoln Center.”

His article recounts problems encountered by several NYC-area charities:

• The New York City Opera.
• The Federation Employment and Guidance Service.
• Yeshiva University, and its Einstein School of Medicine and its Cardozo Law School.
• The Metropolitan Council on Jewish Poverty

One suspects Mr. Levy could cite more examples and perhaps he will in his book, but his message seems consistent – where were the watchdogs? He asks that simple question of the trustees, the State Attorney General, the staff of such charities, and the audit firms that examined the financials.

He could add at least one more group to that list – the donors. Are we to assume that doing our homework ends when we graduate from school? The message seems simple:

• Continue to support the charities of your choice, but ask questions;

• There are groups that monitor charities and report on their financial performance. Look at “administrative expenses,” which can be a significant portion of funds donated. Ask what these expenses are. Why they are necessary?

• Ask for information as to salaries paid to top executives – some are well into the six-figure range.

In short, be an informed donor and ask the watchdogs to pay closer attention.

Copyright 2015

Joseph W. Koletar

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

WHISTLEBLOWERS – FACT AND FICTION

(By Joe Koletar) Whistleblowers have, to many, achieved an aura of James Bondesque mystic. The lone wolf, privy to sensitive information, who shrugs off risk. The lone voice in the wilderness, borne on the wings of truth and justice, who navigates the reefs and shoals put up by the opposition, to arrive at the shores of recognition and reward. (OK, no lethal gadgets or beautiful assassins now in thrall of the fearless hero, but the basic idea is the same.)

Were that always true. Numerous studies have shown over the years the typical fate of most whistleblowers is termination, joblessness, social isolation, alcohol and drug use, divorce, and sometimes suicide. A recent column in The CPA Journal, June 2015, page 5 may help illustrate this point.

Tony Menendez was a CPA employed by Haliburton, a major oil field services company. In the course of his duties Menendez discovered that revenue recognition practices were contrary to accepted accounting practices. He spent months trying to bring this to the attention of his superiors. Eventually, even senior executives accepted his position, but the accounting practices which enhanced the company’s balance sheet, continued. This was in 2005, often referred to as the “Enron” era. Frustrated by corporate inaction, Menendez filed a confidential report with the SEC that same year.

The company immediately struck back (it appears it learned of the SEC contact,) and identified him to many of his co-workers. Per the CPA Journal article, this was in conflict with not only the provisions of the Sarbanes-Oxley Act of 2002, but also contrary to Haliburton’s own policies.

Let us return to Mr. Bond. Did Menendez receive praise, perhaps a note from the Queen, and the pleasure of the beautiful assassins for years to come?

Not quite. After nearly a decade of legal battles, Menendez was awarded $30,000 by the courts. That works out to roughly $3,300 a year, or about $.1.65 an hour, based on a 2000-hour work year.

Should this be seen as a warning to keep your mouth shut? Hopefully, no. Consistent statistics compiled by the Association of Fraud Examiners indicate that tips, usually anonymous, are the single most effective means of discovering organizational fraud.

Is there a moral to the story? Yes, do it because it the right thing to do, especially if you have a professional obligation to do so. If you want to go for the money, that is fine, but prepared to wait.

Copyright 2015
Joseph W. Koletar

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

 

WHO GUARDS THE [PRISON] GUARDS?

(By Joe Koletar) It is a question the Romans asked of themselves two thousand years ago, but still seems pertinent today. The subtitle of the news article cited below reads: “Corrections Workers Convicted of Using Inmates’ Social Security Numbers to Get Refunds.” With the recent breakout in an Upstate New York prison and the charging of a prison staff member of assisting, the question arises again.

To recycle an old line –“Who can you trust?” Apparently, at least some watchdogs are still awake and performing their duties, but even they seem to come into play only after the damage has been done.

The article, based on a 2014 report from the Treasury Inspector General for Tax Administration, found that false returns using prisoners’ Social Security numbers had “surged” to 137,000 in 2012, up from only 37,000 five years earlier. If 137,000 alarms you as a taxpayer, does only 37,000 make you feel warm and cozy? What is going on? Is anybody in charge of this boat? Have we gotten to the point where our most effective response is to let the watchdogs tell us years later the number of dead and wounded?

Were the issue only limited to false tax returns. The article also reports phony credit card accounts, and unpaid medical, energy, and insurance bills. The IRS reports that attempted false claims alone amounted to $1B. Luckily, only about $70M was lost, but this is just the IRS, and not other forms of identity theft fraud. But all this begs the issue. Why must we only try to “block?” Are we not treating the symptom, and not the disease? The “disease” in this instance is corrupt corrections personnel. The article notes that a shift clerk at one facility claimed $750,000 in false tax returns, and received $176,000 in refunds. The clerk had access to 25,000 files on current and former inmates.

In the “you are not to believe this” category, one corrections official is reported to have declined to respond to requests for more information on this issue, citing “security concerns.”

Is this dark comedy, or a remake of “Alice In Wonderland?” Either way, the question is what can or will you do about it.

The ball is in your court. If you believe “that’s just the way things are,” you have every right to do so. To a point. You are not only wasting your money, but mine also; and millions of others.

If you do not like the way things seem to be going, use every legal means to change it through reform advocacy. If you choose not to, you have made a career change. You have moved from being a “victim” to being a passive accomplice.

Your choice.

(Observations based on “Tax Fraud Cases Target Prison Staff,” by Joe Palazzolo, The Wall Street Journal, 3/13/15, page A-5.)

Copyright 2015

Joseph W. Koletar

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

The Dark Side of “It’s not my problem” and the Power of Inter-dependence

As long as I meet my goal of keeping engine pressure at a certain level, the fact that the ship hit an iceberg is someone else’s problem.”
Building from Joe Koletar’s blog entry on Drucker and MBO (managing by objectives), we turn our attention to the problem of the dangers of single-minded goal fixation and the ties to fraud. Our colleague, Sridhar Ramamoorti, (also the senior editor of The A.B.C.s of Behavioral Forensics) discovered the above quote at a Titanic exhibition. He noted the statement was so outrageous he laughed out loud.

In a sense it is laughable that someone would be so out of touch with something that threatens his own life and not know it. Unfortunately, those of us who are impacted by the global marketplace (basically anyone reading this), were given a demonstration of the degree of risk with the recent financial crisis. And we continue to be.

Here, we will explore the ties of single-mindedly driving to a goal and the risk of fraud.

The Pyrrhic Victory
Imagine this scene: you are at a family reunion, men of all ages have congregated together and are teasing each other and sharing tall tales. Then, one of the younger men, typically a newlywed, boasts about how he told his new wife off. He’s proud of getting the last word in and winning an important battle. As he tells his tale, he punctuates the story with why it was important to set the right tone in the marriage: how he is not going to be one of those guys who is all about being sensitive nor about listening. He plans to be “the man” and not be run over or put in his place like weaker men he knows. He wants to declare his independence and the primacy of his goals and needs. As he concludes, you note he declares victory in his tale because the conversation stopped, there was a dark cloud that came over his wife’s face, and she “stormed out”.

Can you picture this scene?

Now imagine the others’ response to this boasting. The unmarried gaze with adoration at their hero. But, for those men who hear the story and have experience being married, there is now another cloud that falls over the scene. Like doctors hearing someone dismissing a fever while noting the symptoms of Ebola, or an arrogant CEO describing her business while the board of directors hear the signs of a failing business, everyone but the person telling the tale knows something is wrong. Horribly wrong. They, as well as the men at the family reunion, have all been witness to a Pyrrhic Victory.

Pyrrhus has the unfortunate honor of being one of the few generals who was able to defeat the Romans. Battling the best army in the world with skillful tactics, he defeated them not once but twice. In the end however, the costs to his army were too great. The Roman army was too large and could afford to take the losses they sustained. Relative to Pyrrhus, the Roman resources were infinite.

If we are victorious in one more battle with the Romans, we shall be utterly ruined.
Life of Pyrrhus
– Plutarch

Human Interdependency
Our imaginary young newlywed senses he won and has vanquished the opposition, but the wise uncles and cousins know he has not. His wife does not want to have her goals and plans dismissed. She will re-engage in the battle and our young man will learn his victory was a Pyrrhic one.

Yet he has an out.

Unlike the Romans, if he can begin to see the need to not try and fight over goals but to see goals as a give and take, he will find a balance with his new wife and avoid victories that leave him utterly ruined. To do so, he will need to allow some of her goals to be primary and his secondary. This allows for inter-dependence: a shared interconnectedness in the work as a couple. If they do it well, this will be an important principle for their marriage.

In our imaginary setting, there will be those who will see the dynamic playing out poorly for him and will want to help their kin. Battle-scarred men will come to his aid to share a better path.
This has echoes in the financial crisis:
· Why bother thinking about soft skills if they get in the way of profits?
· Why question the trend – do you want to kill the golden goose?
· What role do regulators play other than to hold back the free market’s beauty?
· Why should good people pay for losers’ mortgages?
These simple-minded frameworks miss the power of working to see that an ethical, humane, and interdependent market place has value in the long run.

We welcome your comments.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

 

ALL GOAL LINES AREN’T ON FOOTBALL FIELDS

(By Joe Koletar) In 1954 the management theorist Peter Drucker brought light unto the land, and the people saw the light, and the people thought the light was good, and thus they pursued the light.

Drucker’s revelation was actually very simple – the leader sets the big goal. Lower and lower levels of management set subordinate goals to help achieve the “big goal.” If everyone does their job the “big goal” is achieved and joy and happiness reign throughout the land. Silos are full, cattle are fat and cups runneth over. Drucker used the acronym SMART – goals should be “…specific, measurable, actionable, realistic, and time-sensitive…”

Were it that simple. The article cited below advised there have been over 1,000 studies of goal-setting systems, and over 90% have achieved positive results. But, in fairness, the article also offers some critical analysis of such systems. It comes from Professor Gary Latham at the University of Toronto, whose research produced the 90% success figure, and Max Bazerman of the Harvard Business School whose work on goal-setting resulted in a 2009 book, “Goals Gone Wild.” There have been other voices regarding the “magic” of informed and insightful goal -setting. All, apparently, is not perfect in the “promised land.”

First, to state the simple, the theory assumes the leader has set an appropriate and productive goal. (To see how that expectation can go awry, read Vic Hartman’s blog about the Atlanta Schools scandal.) Then the theory assumes that each level of subordinate executive or manager will set goals to achieve the primary goal. Latham, Bazerman, and others have come to have doubts about the mechanically precise nature of such processes. It is reported that Drucker himself, over time, came to realize that there were issues. To briefly summarize but some of the issues:

• It is too bureaucratic. The subordinate goals have to be monitored.
• The focus of the system is “outcome goals,” say 20% increase in sales, when the future is rarely that certain a thing.
• Periodic goal-adjustment seems to work better than an annual process.
• Managers under goals pressure may tend to abuse their subordinates.
• Important matters outside the goal-range target may not be addressed.
• Goal pressure may promote risky or even fraudulent behavior (Again, the Atlanta Schools scandal underscores this point).

In management theory this is called “sub-optimization.” As long as I meet my goal of keeping engine pressure at a certain level, the fact that the ship hit an iceberg is someone else’s problem.

Those messy things called “humans” seem to have a habit of getting in the way of precise theories. Thus, the A.B.C.’s of Behavioral Forensics major point: The “human” element is in pretty much anything.

We welcome comments.

For quotes and general information see, “Management By Objectives Is Making A Comeback, Its Flaws Supposedly Fixed,” The Economist magazine, 3/7/15, page 70.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

How To Explain the Mortgage Fraud Crisis: A Nash Equilibrium or a Nash Conspiracy?

(By Vic Hartman) The recent passing of Princeton University Nobel Laureate in Economics, Professor John Forbes Nash, Jr., more popularly known as the paranoid-schizophrenic genius featured in the 2001 movie A Beautiful Mind (inspired by Sylvia Nasar’s biography and starring Russell Crowe), is an appropriate time to admire Nash’s work and consider its applicability to the field of Behavioral Forensics.

Behavioral Forensics is a body of work that can assist anyone from governance leaders to fraud investigators in understanding why people commit fraud. You can read more on this approach to understanding the fraud phenomenon in the book, A.B.C.’s of Behavioral Forensics (Ramamoorti, Morrison, Koletar & Pope, 2013, Wiley). Let’s see if the late Professor Nash’s work can add insight into Behavioral Forensics.

Professor Nash’s greatest contribution to economic game theory—that studies strategic behavior of interacting opponents—has come to be called the Nash Equilibrium. The Nash Equilibrium is a concept of game theory where the optimal outcome of a game is one where no player has an incentive to deviate from his or her chosen strategy after considering an opponent’s choice. In other words, an individual can receive no incremental benefit from changing actions, assuming other players remain constant in their strategies. (According to Nash, “an equilibrium point is an n-tuple such that each player’s mixed strategy maximizes his payoff if the strategies of the others are held fixed. Thus each player’s strategy is optimal against those of the others.”) This equilibrium typically holds true for a non-cooperative game involving two or more players. Each player is assumed to have knowledge of the strategies of all of the other players and each player acts rationally. The outcome of the game will be determined by the set of strategies of each player and their corresponding payoffs. The Nash Equilibrium is attained when no player has anything to gain by changing his or her own strategy. Let’s apply the Nash Equilibrium to the U.S. mortgage crisis described in previous blogs.

By way of summarizing the mortgage fraud crisis, an entire market of mortgages was originated all too often with “bad paper.” Congressional policy to create affordable homeownership, under the Community Reinvestment Act, may be considered the first step in this process. With the acquiescence of Fannie Mae and Freddie Mac, the race to provide homeownership to everyone was on. Mortgage brokers sold mortgages to buyers of homes with the inability to repay the mortgages due to predatory lending, ignorance, and oftentimes, fraud. After origination, the mortgages were usually resold in the secondary market to participants undoubtedly having knowledge of the quality of the paper. These mortgages were then rated by the big, but rather conflicted credit ratings agencies and resold on Wall Street as exotic financial instruments with names like residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs, even synthetic CDOs). Ultimately, the only non-participant in all this wheeling-and-dealing, the U.S. taxpayer, bailed out the entire market.

An essential key to this mortgage lending crisis is the market’s belief that Fannie Mae and Freddie Mac guaranteed these mortgages even if they, as guarantors, became insolvent – – which as it turns out was a valid strategy. At this point, let’s juxtapose the economic concept of a moral hazard into each participant’s strategy. In essence, a moral hazard occurs when one takes more risks because someone else bears the burden of those risks, if the strategy fails, and losses are incurred. In the mortgage fraud crisis, each player is passing the bad paper simply because it’s profitable whenever the risk-taking pays off. Each participant is working under the assumption that someone else bears the risk of loss should a mortgage, portfolio, or tranche become impaired.

Can Nash’s insights into game theory shed some light on U.S. mortgage fraud crisis? After all, each market participant stood in Nash Equilibrium. The game was non-cooperative and involved numerous market participants. Each understood the other’s strategies and acted in their own self-interest.

The Nash Equilibrium also provides insight into another question that has frustrated the U.S. taxpayer. Why haven’t more bankers gone to jail? Part of the answer lies in the requirement for the prosecutor to prove mens rea or criminal intent beyond a reasonable doubt. In the case of the mortgage fraud crisis, those standing in the Nash Equilibrium are, by definition, non-cooperative. Proving a well-orchestrated criminal conspiracy by individual defendants is challenging because the market participants are not communicating game-playing strategies with each other. Further, each participant plays a single, isolated role (e.g., consider the separation of mortgage initiation, mortgage servicing functions, and selling RMBS and CDOs on Wall Street). The market participants are also presumed to have knowledge of the criminal and regulatory rules enforced by DOJ, SEC and banking regulators, and thus, constrain their behavior to provide the perception they are within legally permissible boundaries. However, proving that any one individual or defendant violated these rules by knowingly transferring impaired mortgages onto the next participant has proven challenging for prosecutors. As recently as this week and after remaining silent ever since the 2008 collapse of Lehman Brothers, ex-Lehman Brothers CEO Dick Fuld attempted to make the brazen argument that while there were multiple external factors for the demise of Lehman, the decision makers inside of Lehman played by the rules, and were blindsided by the “perfect storm” of external factors. (For a Lehmann insider’s viewpoint, and an alternative account, see the 2010 book by McDonald & Robinson, titled, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers).

In an attempt to hold sophisticated market participants criminally liable for their individual roles, can a prosecutor charge a “Nash Conspiracy?” Each defendant would be charged with a Nash Conspiracy imputing knowledge of the non-cooperative game strategy on each defendant. The object of the conspiracy being a “moral hazard” whereby all defendants are taking unreasonable risks creating “systemic risk” to the entire U.S. economy, but knowing full well the U.S. taxpayer could ultimately bear the burden of loss (in the so-called “too big to fail bailouts”). For this purpose, we now have a new “systemic risk regulator” under the Dodd-Frank Act of 2010, the Financial Stability Oversight Council (FSOC), that has the power to identify and designate certain financial institutions as being “systemically important.” Presently, the concept of a “systemically important financial institution” (SIFI) in the U.S. extends well beyond traditional banks and is often included under the term non-banking financial company. It includes large hedge funds and traders, large insurance companies, and various and sundry systemically important financial market utilities. In future financial crises, the SIFI-designated entities would primarily be on the hook, because their individual activities would be perceived as creating systemic risks to the entire U.S. economy.

Although not as vindicatory as seeing an executive in handcuffs, the SEC and DOJ have had much success extracting large settlements from financial institutions as opposed to individual defendants. In these civil lawsuits, the government has a lesser burden of proof in establishing the corporate entity acted with the requisite level of intentional wrongdoing, known as scienter. Although regulators were probably not thinking in Nashian terms, the essence of these civil suits is to hold institutions accountable for their market participation in the mortgage fraud crisis.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

MAKE UP

(By Joe Koletar) We usually find it both normal and charming for a young child to make up an imaginary friend they may play with and even talk to. There comes a time, however, when little boys discard their “super-hero” costumes, and little girls discard their tin-foil “princess” tiaras.

Such behavior can frequently carry over into adulthood, especially among women, who use chemicals to alter the natural color of their hair or contours and complexion of their face. (In fairness to women, men seem to be catching up, especially in the realm of elective cosmetic surgery.) Women actually call such products “make up,” and many are quite skilled at using these techniques.

All of this is, within reason, well and good, but its character changes when we enter the realm of fraud. Those inclined toward unethical behavior seem to have a habit of “making up” an alternate persona – usually that of the kind, honest, giving, and trustworthy person. Consideration of such behavior brings us to an interesting point of analysis.

Is the new “persona” merely an artificial lure to draw in more victims, or is it deeper in terms of the individual psychology of the perpetrator? It is merely useful, or is it necessary? (The two options may actually be quite closely related.)

The fraudulent person often is generous in supporting good and worthy causes, but they rarely do so in private. (No anonymous donors here.) They get public recognition, media attention and, down the line, “character” references when they come up for sentencing. (Now, the fact that they did these good deeds with stolen money seems to be frequently overlooked, but that is another story.) Charity fraud and affinity fraud are pretty common, because the victims are emotionally vulnerable and therefore gullible. It’s been written that “A funny thing happens when a person with money meets a person with experience: The person with the experience ends up with all the money and the person with the money ends up with all the experience.”

But, what psychology drives such behavior? Is it purely utilitarian (“bait,”) or is there another element at play? One might wish to consider the worth of Leon Festinger regarding what he termed “cognitive dissonance” theory. The concept is somewhat simple. People who do bad things often have a psychological need to try to “balance” such actions with good actions, so they feel better about themselves. (Think of Robin Hood, and you may be getting close.) Colleague Daven Morrison points out that narcissism (a maladaptive need to make oneself the center of attention) may be involved. Or the “As-If” personality, where it’s hard to find the real person because of the illusions created by airs and affectations. Both types of issues can be found in damaged people who are insecure in themselves.

For those with an interest in fraudulent behavior, it is a challenging, and often murky, road to explore. Recognize the road surface, but take time to examine the murky psychological road-bed beneath it. That road-bed can be explored in A.B.C.s of Behavioral Forensics (Wiley, 2013).

Copyright – 2015
Joseph W. Koletar

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

Banks say “Bring it On!” … US Justice Department does

Banks say “Bring it on”, and US Justice does

Two international banks’ role in the financial crisis formally enters the US Judicial System

(Daven Morrison) One of the most memorable events of the financial crisis was Rick Santelli’s passionate plea on the floor of the Chicago Mercantile Exchange. Early on in the crisis what came to be known as “Rick Santelli’s rant” was galvanizing to many.  Live on CNBC, Santelli placed the blame for the financial meltdown on the backs of “losers”. Observers note this began the rise of the tea party and at this point Santelli became the “father” of the movement. Santelli saw his moment as the best five minutes of his life and he summarily defined the problem as being “losers” who can’t afford to pay their mortgage.

With the problem simplified as “people buying their way into prosperity”, Santelli served as judge and jury for the crisis and asked those around him on the trading floor: “How many of you want to pay for your neighbor’s mortgage?”

Santelli tapped into a primitive aspect of human nature: scapegoating. Scapegoating presents many problems. First, scapegoating feels good so it is seldom questioned. Second, scapegoating appeals to raw emotion and energizes people. It is especially effective when a group feels victimized or powerless. And as the market was working it’s way through a crisis, there was a lot of pain. Lastly, and most importantly, scapegoating undermines understanding; it takes a distressed group of people who need to change and allows them an out.  Instead of seeing their role in the problem – and the financial markets played a central role, they could point the finger instead of the thumb and feel good that they were not to blame.  Effectively side-stepping any learning (which they needed to do) Santelli’s rant and those that followed his line of thinking assured those in the financial market place avoided doing any soul-searching.

Fortunately Rick Santelli is not a judge.

Denise L. Cote is a judge. And after a careful consideration of the facts, she has determined two banks: Nomura Holdings and The Royal Bank of Scotland (RBS), guilty of causing the financial crisis.  Why just a Scottish and a Japanese bank (where are the other banks)? The well-known banks took their lumps in the form of financial penalties ($18B) but they never had the audacity, i.e. the Santelli arrogance, to take their case to court and claim innocence. But these two banks did. RBS and Nomura took on the US Justice system effectively arguing: “It’s not us, your honor, it’s the losers who don’t pay their mortgage. And if you want to sue us, then bring it on!” 

The verdict changes the narrative. Now, the “losers” are the banks, and not the mortgage holders.  As I heard the story when it first began to unfold it struck me that the crisis was like a fire (the hot CDO market) that needed any form of fuel to keep burning – so any paper that could be created could be a mortgage. It didn’t matter whether or not it was legitimate, the essential factor was to feed the CDO burning engine.

As a psychiatrist I am not familiar with all the forces pushing and pulling a market. However I am very familiar with the power of a drug that causes physiological dependency. When a drug causes physiologic dependence the body’s healthy homeostasis gets thrown off. In other words, our bodies’ natural ability to keep things together gets out of whack. Normal signs to take care of fundamental needs such as eating, sleeping and of course using something in moderation, are ignored and the drug looms larger and larger in the dependent person’s mind. When this becomes addiction, the system is set off course by geometric orders of magnitude. For example, different from caffeine or sugar something addictive like cocaine, heroine or crystal meth, causes a person to do whatever it takes to get it.

Sadly, there is a tie to the traders of the Chicago CME. Here in Chicago today, in the wealthy conservative western suburb of Chicago where some of the traders live there is a terrible heroine epidemic. High school kids experimenting with pain-killers get hooked at pill parties. They then become easy prey for the dealers who want to get them addicted to the most pure forms of heroine. The dealers use a powerful dose of pure heroine. This transition is often lethal. Even if they survive the mega dose, the drug burns them still – permanently altering their quality of life.

An addicted Crazy Farmers’ Market:

Per Judge Cote’s decision, per the New York Times: Wall Street Banks were purchasing high-risk mortgages to bundle into bonds to be sold around the world. As these machines chugged along the quality dropped. It was the demand for mortgages that caused the failure, not “losers who didn’t pay their mortgages”.

Several of my clients had ties to the housing markets in the run up to the crisis. Many noted that the mortgages being written were unfair, scams, tricks on people who wanted to dream big and really didn’t understand how the process worked. These mortgages were the equivalent of the pain pills feeding the CDO insanity.

The CDO markets’ success unfortunately altered the mortgage process; with the addiction to a need for mortgages, the financial services industry (banking especially) became addicted to the product. As it unfolded the poor were scapegoated. But now, with Judge Cote’s actions, there is a new sheriff stepping into the Crazy Farmers’ Market. She has had the courage to enforce justice. Eight years later it also looks less like an engine bring through fuel and more like a drug abuser on a binge.

But the story isn’t over, the sheriff has more to do; despite this, no one senior executive has gone to jail.

How is that justice?

“It’s impossible for you to have been more wrong, Rick. Your call for inflation, the destruction of the dollar, the failure of the U.S. economy to rebound… The higher interest rates never came, the inability of the U.S. to sell bonds never happened, the dollar never crashed Rick, there isn’t a single one that’s worked for you.

“Every single bit of advice you gave would’ve lost people money.”

                  CNBC Reporter Steve Liesman to Rick Santelli Summer 2015

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

OPULENT EXCESS: WHEN DOES IT STOP BEING FUNNY?

(By Joe Koletar) Crain’s New York Business of February 2-8, 2015 carries the following article:

“The house that Ira built: Trial begins for mining maven Ira Rennert, Accused of Looting his Company to Build the Nation’s Largest Private Mansion,” by Aaron Elstein, page 1.

The article cites information from estimates and other sources indicating that Mr. Rennert, who later would be convicted of wrong-doing, seems to have gone a bit far in the view of some. His mansion is described as having: 29 bedrooms, 39 bathrooms, 3 dining rooms, 3 swimming pools, a 164-seat theater, gymnasium, basketball court, and bowling alley. Its assessed tax value is reported to be $248 million; its property taxes last year were $756 thousand, and its estimated size is 62 thousand square feet.

Ordered by a federal jury to return $118.2 million plus interest to his defunct company, Mr. Rennert’s current legal situation is actually not the issue. For this posting, the issue is our society’s concept of “More.” If one slice of rich pie is good, are four slices that much better? Some wealthy and famous people – like Bill Gates and Warren Buffet – are reported to have arranged to give most of their accumulated wealth away to charities.

The game is over. You and your team have won. Now what do you do with all the trophies? An old Texas oil baron is reported to have once said, “Hell, son, it ain’t the money. It’s just how we keep score.”

Which brings us to an observation once made by the noted novelist, William Styron, who once referred to “The American bitch-goddess. Success.”

Indeed, how much “success” is enough? Is “more” always better than “enough?” We address such issues in The A.B.C.’s of Behavioral Forensics. What seems to prompt excessive behavior?
Ego? Love of self (Narcissism)? Clinical or sub-clinical psychosis? The fact, in the long run, seems to be it is all a game of some sort, and the kid with the most marbles can decide what
they want to do with them once they have “won” the “game.”

This would be an amusing commentary on human nature were it not, in more than a few instances, so closely connected to human suffering: jobs lost, savings depleted, bankruptcies and mortgage foreclosures, etc. Is the game so important that what the military calls “collateral damage” is seen as just an unfortunate circumstance of little concern?

More than a few entertainers have used the concept of “excess” to be funny: Dolly Parton and her bust size; Dean Martin in acting drunk; Woody Allen with his neuroses; Rodney Dangerfield and being a loser; Jerry Lewis with ineptness. These excesses make us laugh and we enjoy the entertainment, but the raise a somewhat simple question:

When does it stop being funny?

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.

IT’S JUST A NUMBER………RIGHT?

(By Joe Koletar) Others dress this up a bit, and refer to it as “The sin of quantification.”

We like numbers, because they seem to be “hard,” and “scientific.” A number is an inert, immovable, thing. It never lies. It just sits there, looking at you. Perhaps saying, “Here I am. What are you going to do about it?”

The challenge moves from the number to mere human beings, those soft, mushy things afflicted by emotions, bad backs, and distractions.

Recent reporting reveals apparently popular and increasing efforts to better measure human behavior in pursuit of organizational success.

These ideas are not new. Witness:

o “The Balanced Scorecard – Measures That Drive Performance,” by Robert S. Kaplan and David P. Norton (Harvard Business Review, January-February 1992, page 71.)

o “The fact that ultimate goals often do not lend themselves to quantification usually leads to an attempt to work down the hierarchy of subordinate goals until one or more are found to which numbers can be assigned.” (Dr. Terry L. Cooper, Journal of Systems Management, September 1979, page 10.)

Are numbers important? Of course they are – $2 is more than $1; 20 years is longer than 10 years.

But do we perhaps ride the horse too fast and too far?

To mangle an old saying about a king in a time of distress:

“A number! A number! My kingdom for a number!”

But reliance on a number or numbers primarily because they are available is called, in management theory, “sub-optimization.” The hope is that the pristine number will somehow reflect a larger reality. It usually does not work.

Should numbers be thrown away, like clothes no longer in style? Of course not. But, is a notion of balance perhaps worthy of consideration? We’re talking about a zero-sum game here: Balance would divert at least some focus from numbers to the no-less-important factors— affect, culture, tone from the top, the ethics behind the numbers, and the longer-term mission of the enterprise. These non-number factors ultimately influence the numbers themselves. Positively and negatively.

(By Daven Morrison) It’s well known that smart phone use while driving often causes accidents. We can apply that lesson to the use of numbers. As Joe writes, attending to the numbers is very important, but that focus can distract us from organizational factors that stimulate or discourage fraud in the first place—emotions, culture, and the other factors mentioned by Joe above. That’s when the accidents occur. Former Fed Chairman Alan Greenspan appears to realize this in writing about the recent economic crisis in the U.S.:

• “I’ve always considered myself more of a mathematician than a psychologist. It all fell apart, in the sense that not a single major forecaster of note or institution caught it.”

• “The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely.”

(From Alexandra Wolfe, in What Went Wrong?, Wall Street Journal, October 18, 2013)

The result: A financial disaster of epic magnitude.

We invite your comments.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of A.B.C.s of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D. These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud. Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.