Consider the following three situations:

1. In the operations department of an injection molding business, the manager notes a significant uptick in the costs of electricity due to a recent weather event. This pushes the fixed costs for manufacturing up 12%. The plant manager calls the manager in to discuss this expense and the plans for it because they are triggering a larger financial alarm.

2. A teenager breaks up with the first serious girlfriend. In the teenager’s mind, they have been dating forever and to be “dumped” preoccupies the mind incessantly. They had a favorite path in the local park. Recently, the city invests in upgrades in the park – and there is a communications campaign to celebrate the upgrades and to get people in the community to the park. Everywhere the teenager turns, there are reminders of the girlfriend.

3. The Deputy Police Chief of a mid-sized municipality, upon completion of an investigation into a check kiting fraud in the public works department, recommends the employee be prosecuted. The city manager and the personnel director disagree with the recommendation, noting the theft is not worth the cost of bringing charges.

What if anything do these very different situations have to do with each other? My proposition is they tie with a very central concept of accounting and financial risk: Materiality.

When I first took an interest in white collar crime, an important question came to me from the world of accounting and law enforcement: “Why do they do it?” While exploring this in the context of municipal government, I discovered I had a question for the accounting profession: “Just what do you mean by materiality?” (My B4G partner and friend, CPA Vic Hartman, explains the concept as determining whether the receiver of financial information is affected in decision-making based on the information received.)

The Fraudster’s Mind: Out-thinking the Financial Materiality Controls

Because a central part of my work with leaders is advising municipalities, I took particular interest in bringing the understanding of fraud into the thinking of the city leadership. In a workshop, an experienced fraud investigating accountant noted a particular scam she had seen through the years. One cynical set of fraudsters would discover the limits of financial materiality, defraud up to that limit, and then move on and work multiple communities. These clever criminals, knowing it was more expensive to prosecute then it was to recover the money, had quite a gold vein to mine. They knew the limits of financial materiality would protect them.

What struck all of us listening to this experienced CPA, was that the type of person she described was a criminal. And what struck me was that psychologically, their actions still had materiality. They MATTERED! An easy way to remember, I thought, was “Their actions matter to reality.” And they certainly matter in relating to the personality and character of the person and the victims. They had psychological materiality.”

Not financially material, BUT still a crime, so it is:

PSYCHOLOGICALLY MATERIAL

Therefore, I believe it makes sense to bring this dynamic into the awareness of the accounting world. To work with definition of a familiar term with the profession in such a way that perhaps we could raise their awareness and prevent more frauds. Could we find a way to track and prevent these scoundrels from being hired? Maybe not, but we certainly now had new language to drive home the importance of understanding the mind of the fraudster. In particular, the fact that they know what they are doing (there is no mental illness), they still broke the law, and as in many cases of fraud, the accounting rules are being used against the profession.

The Bottom Line on Psychological Materiality: The Mind MATTERS

The individual that moves from community to community, stealing while knowing the financial materiality limits, is even more of a predator than the typical fraudster whose thefts are more expensive.

Let’s close the logic here. Please go back and reread the introductory cases and consider what is discussed here regarding financial and psychological materiality and risk.

In this new light of financial and psychological materiality you will note that the first case is financially material, the second case is psychologically material, and the final case is only psychologically material.

Remember:
Although each crime may not be financially material to the organization, the actions are psychologically material to the larger community.

BEHAVIORAL FORENSICS GROUP^TM LLC 

The Behavioral Forensics Group^TM LLC is a team of professionals with vast experience in detecting fraud, understanding why it occurs, and in recommending steps to mitigate fraud incidence within the corporate workplace, particularly within higher-level (and therefore more costly to the enterprise) executives.  The fields of investigation, organizational psychiatry, accounting and behavioral forensics, and law enforcement are represented within the Behavioral Forensics Group^TM LLC.  Acting in synergy to help organizations prevent, find, and/or reduce fraud, B4G^TM is a premier, pioneering practice in this field.

We are blogging at: http://www.bringingfreudtofraud.com

(Daven Morrison with Jack Bigelow, Vic Hartman and Joe Koletar) Last month we spent a weekend with the National Association of Certified Valuators and Analysts (NACVA) in San Diego. In our inaugural Behavioral Forensics Group seminar our team had the delightful opportunity to share our concepts and experience with seasoned fraud investigators.  Invited by NACVA to provide education to their professionals who explore and track down concerns of fraud as they evaluate organizations.

The participants were curious about our shared experience in the human side of fraud and risk. They were not novices but rather seasoned veterans who were searching for new aspects of interviews, motivations and understanding. The participants were especially curious about our shared experience in the dimension of fraud that is often overlooked—the way in which the human mind works within fraudsters when they make that decision to commit white collar crime and justify it to themselves. Our impression was their appetites were satiated. The feedback was very positive and evidenced a need for even more training in this crucial area.

After an introduction facilitated by technology in which our founder Sridhar Ramamoorti was able to join the class by Skype from literally half way round the world, Jack Bigelow set the stage for the participants and for the presenters. His synthesized concepts and targeted quotes from the team and our text helped create an environment directed to learning, dialogue and to deeper thinking.

Joe Koletar then framed the fundamentals of fraud and the classic assumptions that reassure but misdirect auditors and financial minds. Bringing his experience as a former Chairman of the Board of Regents of ACFE, and his multiple decades with the FBI, Joe started the program off with a bang. Participants were intrigued with the questions he framed and the insights offered related to fraud prevention and where to look to find the evidence for financial crimes.

Not to be outdone, nor outgunned, Victor “Vic” Hartman, also of the FBI described the current fraud threat picture from a behavioral forensics perspective and with his knowledge as an attorney.  He expanded on the concepts of the fraud triangle and fraud tree to provide strategic solutions for professionals advising those in charge of corporate governance.  This was followed by session on interviewing basics for professionals including both legal and behavioral concepts.

Daven Morrison began the second day with a perspective on fraud that began and ended with the framework of an organizational psychiatrist. Exploring the role of emotions in the manipulations of the dark triad: narcissism, Machiavellianism and psychopathy participants were alarmed. Walking through a model of core motivations, a model which highlights the “reversal” of rule following and rule breaking the cases shared were explored in depth. Vic concluded this second day with an exercise on professional biases.

As the cases were explored in depth with the experts from the FBI and Jack Bigelow offering his perspective from the highest levels of Arthur Andersen with the students appreciated and shared the many light-bulbs of insights the dialogue revealed. Both current cases and older cases were examined and all had intriguing applications for the theory and the experience of the group.

The Behavioral Forensics Group is looking forward to presenting a two-day session in Las Vegas in June, 2018.

The Behavioral Forensics Group^TM LLC is a team of professionals with vast experience in detecting fraud, understanding why it occurs, and in recommending steps to mitigate fraud incidence within the corporate workplace, particularly within higher-level (and therefore more costly to the enterprise) executives.  The fields of investigation, organizational psychiatry, accounting and behavioral forensics, and law enforcement are represented within the Behavioral Forensics Group^TM LLC.  Acting in synergy to help organizations prevent, find, and/or reduce fraud, B4G^TM is a premier, pioneering practice in this field.

We are blogging at: http://www.bringingfreudtofraud.com

How can we distinguish them?

Sniffing out the Bad Apples, Bushels and Crops

From the first conversations of a team dedicated to understanding the human side of fraud  we collectively came to realize that there were multiple problems in the conceptualization of fraud that needed to be tackled. This team was first assembled at the Institute of Fraud Prevention of West Virginia by Dr. Sridhar Ramamoorti. Nearly simultaneously, Daven Morrison assembled his colleague Sridhar and the Group for the Advancement of Psychiatry (GAP): a group of top organizational and occupational psychiatrists. In addition to welcoming Dr. Ramamoorti’s ideas for exploration, Bethany McLean (most interesting to us as the author of “Is Enron Overpriced?”  – an article that brought down two well known organizations) was invited as well. It was with this group of psychiatrists, a business journalist, and a Governance Partner of an Accounting firm in White Plaines where we recognized how “deaf” the ears of senior leaders are to considering fraud – despite the odds that it could happen again.

One of the most pernicious aspects of fraud is how it can creep up on people. They buy into a corporate culture, and stop asking the bigger questions of right and wrong.

Bethany McLean

Author of: Shaky Ground,The Devils are all Here Now, and The Smartest Guys in the Room

Of the factors leading to missing larger organizational dynamics that reinforce fraud, perhaps most alarmingly is the actual legal definition of fraud that limits it to “one person”[1]. The law profession itself thus limits how fraud is framed. Clearly the Enron case included multiple guilty parties, and there are others exposed in the headlines everyday: from Madoff to FIFA, to Volkswagen and salmonella poisoned peanut butter – entire systems of people participate in fraud. It moves from a bad apple to a rotten bushel to a sour crop in our model. In fact, as described by Vic Hartman a new member of our team, when it includes the regulators and the quality inspectors (as it did with the S&P scandal) it becomes a bigger stinky mess: a “Rigged Farmer’s Market”.

So, in the media we have fairly clear evidence of a larger systemic problem beyond the “rogue greedy trader” that characterizes many public relations messaging of larger organizations caught up in fraud and the resulting embarrassment, but, is there evidence beyond this? What if the criminals themselves were to talk? Would they provide insight?

Pamela Murphy Ph.D. actually did interview criminals and her research does help provide understanding to these larger organizational dynamics.

Using lessons learned from sociology and criminology integrated with the fact that many major frauds are too complex to be executed by a single person, Dr. Murphy’s hypothesis is recruiting to a larger group must be occurring. In addition she wanted to test and see if the organizational culture would reflect how this happens. She found three types of interpersonal bonds (in decreasing order of incidence):

1. Self-serving bonds – “we will do this for our own needs”
2. Organizational-Serving bonds – “we will do this to make organizational goals”
3. Relationship first bonds – “we will do this because we care more about each other than the rules or the organizational needs = Do this because you love me”.

In parallel to this work, the prisoners were surveyed with an instrument designed to assess the ethical focus of the culture. Designed to tease out whether the culture was ethical or “instrumental” (complete the task by any means possible, disregarding ethics) her team found 39% noted an instrument culture. It may be that this number is actually higher assuming the criminals may already have a distorted view of what is ethical.

The notion of the lone gunman is safer for organizations.

Pamela Murphy, PhD; CPA CFE

What are the implications?

The research of Dr. Murphy and her team provides a light into mechanisms for the larger group dynamics that the actual fraud cases implicate are occurring.  We think that the prisoners’ motivations fit into the eight motivations we describe in our book,  A.B.C.s of Behavioral Forensics . In the research on motivations around these reversals, there is always one superior motivation. So we suspect the interviews are exposing what are the primary motivations. These basic motivations constantly reverse through out our lives between eight options. These options are each at the end of one binary choice. Specifically, Apter’s theory simplifies human motivation to four axes:

1)   Importance of Rules: do the rules matter enough to follow, or do I rebel?

2)   Others’ Fit/Purpose: Is this for my mastery or do I accept help from others

3)   What Outcomes: Is this about the journey (and play) or are we getting a task done?

4)   Who Benefits: Will this benefit me or others?

In work with fraud investigators (in internal risk departments of organizations as well as law enforcement) these factors of motivation are well received. The investigators have to interview people and these interviews can be awkward, lacking a place to start.  Thus, the interviewers appreciate the four axes as a way to organize motivations and get into the mind of the fraudster.  Bottom line: the model provides new trails to follow to help understand motivations beyond “greed” of the person who commits fraud.

And to the research of Dr. Murphy and her team, it is clear it also helps us understand those who commit fraud as part of a colluding group.

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.

Daven’s 7 Internet Safety Rules

7 Rules to stay safe from predatory tactics and fraud on the internet

As a father of social media savvy children and an author on the behavioral forensics of fraud, considering how people harm each other on the internet has been top of mind for me for several years.  From recent insights following presentations to the FBI as well as spooky hacks that have included major corporations such as SONY, people’s capacity to harm via the internet is as incredible as its ability to do good.

Perhaps the most terrifying for everyday people was the recent hacking of a Jeep while driving on the highway. Even though the hack was done with the driver’s knowledge, it came within moments of killing the driver and other drivers on the road as he was driving down the St. Louis interstate.

As Leonardo DaVinci observed: “simplicity is the ultimate sophistication”. So, in a humble attempt to make the complex simple, without oversimplifying, here are “Daven’s 7 Rules” to keep in mind relative to the dangers of the internet and those who want to harm – share with your friends and loved ones! Keep Daven’s 7 in mind as you actively and passively become more immersed into the web.

Daven’s 7 Rules for Internet Safety

An Organizational Psychiatrist’s cautions for being vigilant on the Web

1. Tell your kids: If you can see the internet, then the internet can see you.
2. The internet of things is good, powerful and dangerous: Beware taking the internet into the world: If things can see you and the internet sees things: the internet can see you.
3. You in hi-res = high risk. The increasingly complex, high resolution picture of you on the net means there are more details about on you. This has implicit dangers:  The more things see you, the more complex a picture can be made of you.
4. The more things see you the more they know what you think is important: you are what you value, and the internet knows it. These “things” can be quite personal: news sites, Google questions, your location, your calls, your texts, what you purchase: they are a laundry list of what you value. And, as many data points are also self-broadcast, they provide points and methods to access what is most personally valuable to you. Facebook knows this and sells your information to marketers. These details about you, arranged in the form of a profile, is available to not only those who want to persuade you (to sell you things or get you to join some cause) but they can also be used to play on your emotional triggers.   These are opportunities to seduce you or to extort from you. Be careful what is exposed on the web as beyond guileless marketers there are those who want to malignantly deceive. As a reminder, and as google directions say: “Take a u-turn when legal”.
5. Remember your elders. Overtime, a human brain ages and decelerates. Simultaneously, the  internet follows Moore’s law and accelerates: this is a bad combination for all of us especially our parents and grandparents. As our brains age (and in the minds of predators, as we acquire wealth) they are less efficient at distinguishing camouflaged threats. Meanwhile technology’s capacity to mimic reality grows. The internet will grow stronger at deception while each of our skills at detecting grows weaker.
6. Beware an emotional Siren song on the net.  The lurkers want you to get excited about easy money or getting something valuable for cheap. “Are you excited?” Excitement is a basic emotion, or affect, and this emotion is consistently refined to find easy targets and manipulate them over the internet. “Gullibility=Manipulability.”
7. Legend of the internet trolls. Trolls are unhappy people and likely are hurting.  They are unable to see the pain in others and if they did they would likely stop – we are hard-wired to stop hurting when we see pain. Yet, so much fraud and other mischief is done without seeing the other person. These are victimless crimes in the mind of the perpetrator but not painless crimes for the victim.  In the end, there is great promise on the web, but  also, the internet bodes long term danger for human kind. In the lack of human contact people can’t see hurt, and so their brains sense no hurt, and  so there is the potential to hurt more than they may intend. And psychopaths hurt despite seeing pain in others.

When Values Rot in the Bad Apple:

Understanding the changing of the fraudster’s mind from sweet to sour

(by Daven Morrison, with Ken Cramer*) One of the most perplexing questions in fraud prevention is how to halt the theft before it starts.   In parallel to the challenge of helping individuals and organizations not fall victim to a fraudster, another equally perplexing challenge is how to stop a nearly invisible fraudster who steals inside an organization:  silently and secretly—without detection.

For the typical fraudster who steals enough money to be financially material and is subsequently both discovered and prosecuted, a Certified Fraud Examiner is often involved. The Association of Certified Fraud Examiners (ACFE) compiles the work of the examiners and these case compilations begin to provide illumination into the trends of fraudsters.  What the ACFE study (among others) demonstrates is the average fraudster is not a “professional” criminal.  They have not committed other felonies and are not living a life of crime.  They are average people succinctly summarized as “soccer moms” and “hockey dads” by fellow blogger, Joe Koletar.  How does one stop them?  Understanding the components of one’s decision to commit fraud lies at the heart of the problem.

In our book, The ABC’s of Behavioral Forensics, we propose that these average people are reversing or switching between their motivations.  They are not ill (mentally or physically), because they commit only fraud, and do so while keeping “everything together.”  The point at which the fraudster crosses the line is as unique to them as his/her fingerprint — it’s part of the individual fraudster’s life story — but it would be instructive if one had a theory or model of how the mind switches from obeying the law to breaking it.  Fortunately there is one:  the empirically studied Theory of Reversals.

This theory begins with a foundation that a person’s mind is always in some motivational state, but that the motivation moves back and forth between four sets of opposing continuums.  Obeying rules vs. defying (or rebelling against) them is one such continuum.  Here is an example, in the form of a joke, of switching between disobeying rules and conforming:

            A visitor to Harvard is lost. He finds himself in the middle of the campus and is disoriented as to where he needs to be. He is anxious to get to his appointment on time. He sees a student and decides to ask for help . . .

Visitor: “Can you tell me where this path leads to?”

The student is silent. She stops but doesn’t look up. Visitor (louder): “Ahem, Can you tell me where this path leads to?”

 The silence persists. The visitor is becoming angry and he clears his throat again, only louder.

“CAN YOU TELL ME WH_”

“Please do not raise your voice at me. I can hear you fine.” The student replies. Then she continues: “The issue at hand is, we are educated here at Harvard to not respond to a comment that ends in a preposition. (She pauses) I am waiting for you to finish.”

“Ok, I will.” Says the visitor.

He then calmly continues: “Can you tell me where this path leads to jerkface!”.

There are times when the rules of grammar are essential and there are times when they are not. Being able to switch back and forth appropriately is an important social skill.

This summer in their biennial International Conference, the Reversal Theorists from around the world met, and I had the honor to present our ideas on Fraud and Reversal Theory. The conference was fascinating. Invited in as a colleague, I was part of discussions of presentations with topics ranging from violent felonious assault in sports to poor health compliance to college pre-party drinking as well as the factors of unprotected sex.  Many of the topics included the same perplexing problem of individuals breaking rules despite awareness of high risk to themselves.

In investigating fraud, greed is assumed to be the motivation. Reversal theory offers a refined method to consider human motivations. As we turn our attention formally to the behavioral forensics of fraud, it is clear that the motivations are more complex than “greed”. In fact, the all too common explanation of greed obstructs our understanding of the fraudster’s motivations. Perpetrators do not see themselves as greedy when they act, and thus the concept of greed as a motivation doesn’t provide any advantage towards understanding how they see themselves.

So what was the feedback on fraud? Generally the response was very positive with encouragement to develop a method to formally assess the actual motivations of fraudsters using the model of Reversal Theory. This goal lies between now and the 18^th Reversal Theory conference in London 2017.

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.

Financial War Profiteering

Why you should care when “Rain Man” takes the fall for the Multi-billion dollar LIBOR fraud

We live in a society in which the elites have maybe more power than they’ve ever had and a greater share of the wealth than they ever had in a very long time, but its not clear they have much in a sense of an obligation to society.

Michael Lewis  – Author: Liar’s Poker

Brief But Spectacular – the PBS Newshour

(by Daven Morrison) This week a financial insider involved in the LIBOR case was sentenced to 14 years in prison for illegal manipulation of the financial markets. For those who are not familiar with this case of fraud – you are not alone, of all the frauds I mention in lectures, LIBOR is the least well-known and the most confusing.

LIBOR is an acronym for London InterBank Offered Rate, which for non-interest rate wonks (which is likely close to 99% of the world) is the heart of interest rates around the world. This set number determines interest rates that tie to mortgages, commercial loans, inter-bank loans and loans between nations.  It is a number that is expected to be as trustworthy as the standard length of a meter, the temperature gauge of a thermometer or the weight of a kilogram. In other words if LIBOR is inaccurate than everything else that depends on LIBOR  is off – in other words the entire financial marketplace.

The amounts are stunning. By manipulating the rate, select banks were able to conceal their relative ill-health, as well as make unnatural profits to their advantage. This has ties to the average American. One estimate has noted roughly $6 billion in added interest rate payments US counties and municipalities (government) have had to pay, This is an additional 150% more than the $4 billion already paid[1]. Other estimates have put the cost of LIBOR in excess of $100 trillion. This problem is not new to myself and my coauthors. We were writing about this over two years ago in advance of the publication of A.B.C.s of Behavioral Forensics. In our text, LIBOR plays an important role in illustrating the problem of not only Bad Apples (individuals) but also Bad Crops (Industries). Our current thinking, since publishing “A.B.C.s,” is that LIBOR is an example of a Crazy Farmers’ Market (the whole system is rotten).

“This dwarfs by orders of magnitude any financial scam in the history of markets.[2]

Andrew Lo, MIT Professor of Finance

The individuals tied to LIBOR are elite. One does not graduate from a community college in the Midwest and then decide to get a job reporting and defining LIBOR. Therefore, to make an impact on the market, as was done around the crisis, and to move such large amounts of money is trusted to a select few. These are an informed and well-connected group of elite money managers in an insular profession. Therefore, to make these changes in a manner that is manipulative and intended for financial advantage likely requires some well coordinated tasks among special individuals.

(Because of my work experience as a Wall Street advisor) I know how much b-s  there is and I know how often people even in the financial world act like they know what is going on when they don’t’.

Michael Lewis  – Liar’s Poker

Brief But Spectacular – the PBS Newshour

Thomas Alexander William Hayes was one. Who was he? A recent article about his sentence was published this month in the Wall Street Journal

“Mr. Hayes, a mildly autistic mathematician whose quirky personality earned him the nickname “Rain Man” among colleagues…”[3]

As in the movie, Rain Man, it is likely that he did not work alone. He would be relatively shy, likely mathematically brilliant and also relatively easy to manipulate. Individuals on the autistic spectrum are at a particular risk of bullying. Biologically wired to not be comfortable with affect (emotion), it would be straightforward to stare down someone with autistic traits, and quite difficult for that person to stand up to someone who takes an aggressive stance with him or her.  But that does not mean an autistic man would not understand what was going on.

“I was very, very, very open, very transparent” about his tactics as a trader, Mr. Hayes said on July 10, his voice quavering. “All my managers knew. I had no reason to think that it was wrong.”[4]

This case is particularly revealing about how justice is dealt in the modern era. It has overtones of a fraternity that cheats at all opportunities and at all costs while presenting a face of angelic “best and brightest”. But when caught, the fraternity turns on its weakest member to take the fall. As Tom Cruise’s character did in the original move, the “Rain man” is merely a tool to be manipulated for easy money.

“Everyone’s talking about honesty and dishonesty and what did you think and what was your state of mind, but you know what? At the time I didn’t think about any of it. I didn’t think about whether this was right or wrong. And people go to work every day on the train or on their bike or however they get there, and they go to work and they do a job. And they don’t sit and think, ‘Is doing my job honest or dishonest?’ They do their job.”[5]

This breaks the mold of the common thinking about fraud. Legal definitions of fraud define it as one person[6] when we know that is not always the case. In the case of LIBOR it is very likely not true that it is one “bad apple”. We think it is very likely a bad crop (the entire industry), and potentially even a bad Farmer’s Market. If Mr. Hayes is the only one who goes to prison, this would be a miscarriage of justice.

According to the Senior Editor of A.B.C.s of Behavioral Forensics, Sridhar Ramamoorti, there is evidence of serious problems in this case. According to Dr. Ramamoorti: “Obviously, it appears there is no ‘ethical sensitivity’ at all, and in a highly competitive environment, and a ‘whatever it takes’ mentality, ethics must be sacrificed in order to succeed and win.  After all, by definition, ‘a hyperactive trader’, if he is a predatory fraudster, it is his job to commit fraud not to think like a philosopher and ponder over whether his actions are ‘right or wrong!’ “

Given the fact that LIBOR is the universal metric used to set standards for interest rates around the globe, and given the fact that it more than doubled the cost to the local and national government of the U.S. to service loans illegally rigged, LIBOR is not a fraudulent scam to forgive and forget. It is a sign that yet again the scale of fraud can scale to incredulous sums. Truly mind-boggling.

And, the ABC model bears critical relevance as it exposes that we are all in trouble when it is not one predatory fraudster but an entire industry (banking) that turns predatory with sinister dispassion.

“Burn baby, burn!

Enron Energy traders upon learning that wildfires would raise the cost of electricity to impoverishing rates to Californians and lead Enron to daily profits in the millions

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”, 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.

(By Vic Hartman)

In a previous post, we considered the recent Standard & Poor’s settlement with the federal government concerning charges the company had knowingly misrepresented the risk level in securities backed by mortgages (RMBs, or Residential Mortgage-Backed Securities and CDOs, or Collateralized Debt Obligations).  The Department of Justice accused S&P of illegally putting business interests above investor interests.  Relying on terminology from the book, “A.B.C.s of Behavioral Forensics,” we raised the question of whether the S&P issues were limited to a bad Crop (the company) or were symptomatic of a bad Farmer’s Market (the entire mortgage service industry)?

The mortgage service industry and its stakeholders consist of at least seven elements, each with its own mission and each with its own perceived risks and incentives:

What all this means is that Wall Street uses complex financial instruments that distribute the trust and risk involved with mortgages around the world with investors who now own the mortgages as part of their mutual funds and retirement nest eggs.  These investors may not even be aware of this ownership.  And, everyone trusts that the risk has been accurately and impartially judged by the rating agency.  That is the trust betrayed by S&P.  But every element of this industry structure, operating in the cultural ecosystem of the mortgage industry, passed impaired financial instruments (in farm terminology, manure) on to the next level.  Note that no one in this Farmer’s Market has meaningful incentive to assure the accuracy of the information on which risk level is assessed.  Some are accountable, but no one has the motivation (other than to comply with federal law).  This is The Farmer’s Market.  I call it a crazy market full of “ninja” loans…subprime mortgage contracts without anything as a foundation—no income, no jobs, no assets.  Produce without nutritional value.

We now know what happened.  In the “crazy market,” even S&P, a credit rating agency acting as a public guardian in this game, had been compromised! Loss of independence of a public guardian—as we saw earlier in the case of Arthur Andersen and Enron—is a lethal and frequently, catastrophic risk for the markets.  It’s as if the protector transmogrified into the predator!   The Market products? A harvest of loss, distrust, bitterness among those suffering from the collapse of a structure missing the foundation timbers of trust. And ultimately, shame.  Every element in the chart above had something to gain.  But when federal authorities put Fannie Mae and Freddie Mac into a taxpayer-bailout conservatorship, every taxpayer had something to lose.

I invite my bringingfreudtofraud colleagues to bring their Freudian insights into a deeper view of what was involved in this Faustian bargain—an exchange of accountability for profit.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of ABCs 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.

A – The sole bad apple.

B – The bad group, or bushel.

C – The bad crop, or corrupt organization.

Is it possible financial regulators may have followed our lead, and even expanded it?

The Wall Street Journal of February 2, 2015 carries the following front-page article:“As Regulators Focus on Culture, Wall Street Struggles to Define it,” by Emily Glazer and Christina Rexrode, page A-1.

The authors report that “culture” is now a buzzword used by regulators and financial institutions. They note senior regulators are increasingly expressing concern about organizational culture and excessive risk-taking, but seem to have problems as to how to measure and even define such terms.

The article advises that in October, NY Federal Reserve Chairman William Dudley told financial executives that regulators would consider dismembering financial institutions that failed to adequately address such issues. Glazer and Rexrode note that Mr. Dudley used the term, “culture” forty-four times in his remarks. She also reports he noted that such cultures seem to attract “risk takers.”

One is reminded of the quote by legendary Formula One driver Mario Andretti: “If you are under control you are just not going fast enough.”

As might be expected, consultants and even academics are flocking to the rescue, even going so far as to analyze word usage in internal communications. Some “remedies” propose renewed emphasis on an old, but valuable, mechanism – hotlines. In the view of those experienced in the field, hotlines are valuable, but often not used to their full potential. Others favor sampling employee engagement as the research shows an engaged employee is more prone to a positive relationship to the organization and thus to ethical behavior. Multiplied over all the employees of an organization this does a great deal to mitigate fraud risk.

According to the Association of Certified Fraud Examiners (ACFE), hotlines have, generally, a long and successful track record. The more current approaches may have yet to prove their effectiveness in a complex, profit-driven, and changing industry.

Our book was the result of two years of research, discussion, and collaboration by professionals in the fields of financial regulation, organizational psychiatry, and corporate investigations. Our goal was to meet a challenge presented by Joseph T. Wells, the founder of ACFE. Speaking at a conference of fraud researchers he expressed his frustration that after twenty-five years of investigation by fraud professionals, the “automatic” answer for high-level misconduct is simple greed.

He believes the profession could do better to explain the actions of Madoff and others (i.e., let’s bring Freud to Fraud!) The issue is both simple and challenging and thoughtfully and comprehensively explored in our text – why do those already wealthy decide to cheat? What internal forces drive them?

Since publication, we have presented our concepts to a variety of professionals and experts in the field who deal with these problems on a regular basis. One such program was a comprehensive workshop on fraud with risk officers from International Banks, The Federal Reserve Bank, The SEC, and the IMF. At a break following Dr. Daven Morrison’s description of risk factors for fraud in which a specific vulnerability was mentioned (“flexibility of thought”), an experienced banker approached Daven to note that those who are more “rigid” and thus more likely to stick with the rules (rather than figure out a way around them), have been completely eliminated from the profession: “They are not there anymore”.

The financial services profession had effectively eliminated the “psycho-diversity” required to minimize fraud. There were many other examples of what and how cultures can shift at that conference and at others our team have presented to over the last several years.

Mr. Stephen O’Brien adds (in the online WSJ comments section), “When done right, changing the culture of a firm will take years, and for large firms, probably closer to 10 than five years…..Judging by the article, the present efforts are doomed to failure as they are looking at practices, not beliefs and values [that constitute an organization’s culture].  The managements and consultants are treating the symptoms of a disease, not the cause.”

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of ABCs 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 is for those of you who manage the finances – the purse strings – of an organization. Read on to see if this post goes where you think it might . . .

(By Daven Morrison) The New England Patriots are currently awaiting their punishment for breaking the rules. They removed air from the footballs they used in the NFC championship game and the presumption is they did it for a competitive advantage. Most who comment on this story note that the devious scheming did not make a difference as the game was an easy victory for the Patriots. Their conclusion is: A leopard doesn’t change its spots (New England has bent and broken the rules before under their current coach) and they will get a minor punishment that fits the otherwise ignorable infraction.

Chapter closed.

But for those who rooted for their opponents, The Indianapolis Colts, that conclusion rings hollow. If there had been an unfair advantage this would have started in the initial plays of the game. The Patriot’s quarterback Brady would have gained confidence (as would his team) seeing progress and this would reinforce success as the team began well pulling out to an early lead. Meanwhile, on the other sideline, Andrew Luck and his team would be taking a turn for the worse as passes are dropped or inaccurate. Confidence drops. Then panic sets in as scoring appears impossible, and will not be enough to catch up.

Seen in this light, the lopsided final score does not diminish the rule breaking. In fact it may justify serious and meaningful punishment for the cheating. In financial terms, the cheating was “material”. The reason it is “material” is because it had serious psychological weight. The psychological weight comes from the impact on the confidence of the psychology of both teams. One positive (Patriots), the other negative (Colts).

All of us have experienced a situation like the Colts find themselves in after the game – the winners cheated. On many levels this never feels fair.

We react viscerally when a situation is not just –

the sibling who gets preferential treatment,
the teacher who changes grades for a class pet,
the charmer who gets a warning and not a ticket for speeding,
the player who gets cut because she’s not the right ethnicity.
The reason we react viscerally is we are biologically wired for equality. We know, and are vigilant for, justice. And we know when there is injustice.

What does this visceral response look like? See for yourself: https://www.youtube.com/watch?v=meiU6TxysCg

This video of two monkeys being rewarded for completing a task is rapidly becoming a famous video clip in the behavioral sciences. One monkey gets a grape (sweeter and preferred) the other gets a cucumber (not sweet, not preferred) for completion of the same task. The result, as you can see, is obvious outrage. The game is rigged against her.

The task is the same and the monkeys know each other. Yet one monkey gets a sweeter reward. It is like our jobs. Seriously.

You will hear the audience laugh, when you watch it (it is under 3 minutes long). But take the time and watch it again. It is not funny the second time. See yourself, one of your ancestors, or perhaps a close friend who has been a victim when the fix is in.

Notice these aspects as you watch:

The agitation of the monkey who was treated unfairly
The calm of the monkey who takes advantage of the outcomes
The increased agitation with a repetition of the unfair rewards
So, at this point, you should now see the monkey and football connection. There are other lessons to take, for example, from the beloved teacher or coach, or parent who has sat us down and told us “life is not fair”. It is an important lesson to learn as we have all been victims of the prejudice of someone in power. But that does not mean we do not give up on our ideals.

In a football game, the context is framed to be fair. So, our response to cheating is strong and it is normal. The capuchin monkey research shows this response has a basis in our animal instincts. This anger is not something “airy-fairy” or “soft” that is drummed up or imagined; our value of justice is part of us. It therefore matters how we handle issues of justice in the workplace and beyond.

The Man who fights for his ideals is the man who is alive.

Cervantes, Author of Don Quixote

In our text The ABCs of Behavioral Forensics we refer to the capuchin study as a evidence demonstrating why individuals switch their motivations from following the rules to cheating. We believe, the workplace is a context that is framed to be fair. Thus, in a context of cheating or unfairness, there is a fertile ground for resentment and retaliation. We note this has ties to Financial Fraud in our text, but it likely has ties to workplace sabotage (hacking, stealing) and also violence.

So, if you are a leader, and you have “P&L” responsibility, then people are watching you. I strongly recommend you reflect on these questions, as they relate to how your employees see you and leadership:

How does your organization “rig the game”?
How do employees show their agitation around injustice?
What risks do you take in ignoring their agitation/concerns?
Perceived injustice is one of many perception problems for the C-suite to manage. They should not feel they have to manage it alone. They ought to also consider: How well does middle management help in correcting misunderstandings? And relatedly, what perception of injustice does middle management have?

The workplace is not a football game. There are many different contexts at work, and some aspects are simply not fair. Performance reviews (formal and informal) are the most natural and frequent places for all levels of management to make these repairs. These conversations are essential requirements of work. Good listeners will uncover resentments. That is the beginning step of a repair.

These emotional responses of employees may seem trivial, “soft stuff”, but misunderstandings about perceived injustice is real. Those who ignore them miss the lessons learned by the NFL, a large successful organization, with Ray Rice and domestic violence, as well as lessons learned at Andersen and AIG in the recent past.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of ABCs 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.