(By Victor Hartman)More than 25 years ago, I was sitting in an FBI Academy classroom soon to become a newly minted FBI Agent. I heard a presentation on the legendary but notorious Charles Ponzi. I thought to myself, how stupid for someone to get caught up in such a “transparent” scheme and certainly this is the kind of history that doesn’t get repeated. Over the next 25 years as an FBI Agent specializing in white-collar crime, it was much to my surprise to find these schemes are very common. Inherent in its structure and operation lie the seeds of its own destruction: Every Ponzi scheme eventually collapses, leaving many victims out of large sums of money and its perpetrators with lengthy prison sentences. Two interesting and related questions arise from the aftermath of a Ponzi scheme.
• What motivates someone to do this? and,
• Why would anyone participate?

Ponzi schemes have these general characteristics:
• The Ponzi operator is charismatic and/or has apparent credentials;
• the rate of return is significantly above market rates,
• the investment is described as no or low risk, and
• the investment concept is either hard to understand or not disclosed.

Why would anyone start a Ponzi scheme? Ponzi schemes get started in one of two basic ways and depends on whether the operator was an accidental fraudster or a predatory fraudster. In my experience, the accidental fraudster often starts the scheme with the intent of raising funds for a legitimate investment or business. Then two things occur. One, the charisma of the operator overtakes him. He learns his sales pitch is so convincing, that he can easily raise millions of dollars. Two, the underlying business concept is flawed:  He now has to continue paying out hefty returns.  To pay out the promised high returns, more money is required, as the scheme is all about using recent investors as the bait to satisfy the early investors whose money has been exhausted (a 25% return allows the investor’s money to last no more than four years).  Now, the operator is faced with a difficult choice: admit failure to his captive audience, or continue to raise funds with no ability to produce a legitimate profit. If the operator chooses to continue with what is now a Ponzi Scheme, everyone’s fate is now sealed – – the Ponzi scheme will grow until the supply of new investors is exhausted. The resulting collapse is a horror story for everyone involved.

The second and less common motivation is that of a predatory fraudster. This individual’s intent is to steal every investor’s money right from the beginning. By definition, when this is their mens rea, many of these individuals may be considered psychopaths (As the APA puts it, they suffer from “anti-social personality disorder”). They are simply lying, cheating, and stealing for the purpose to taking another’s wealth for their own. This makes some logical sense because bad guys will plan and do bad things; what is perplexing is understanding why they keep occurring and in particular why do they keep finding victims.  Occasionally, accidental fraudsters running Ponzi schemes abscond or simply “disappear,” only to come back later in a different persona, possibly as a predator.

Let’s now look at the victim’s psychology: How do so many individuals get taken in by this scheme? How do educated people, often financially savvy professionals, become victims of a Ponzi scheme? I have interviewed many victims of these schemes. What is most amazing is that to the bitter end, victims continue to believe in the scheme and will defend the Ponzi operator. They will blame law enforcement for shutting down the scheme by seizing whatever remaining funds were left. They continue to expect not only their deposited investment, but the accrued rate of return. There are two reasons for this. One, the Ponzi operator is very charismatic and convincing. Two, the victims’ collective judgment is clouded by the promised high rate of return, appearing to be confirmed in the early years.  What’s not recognized is the difference between a legitimate, profit-making enterprise providing a return ON capital versus the Ponzi scheme involving a return OF capital.

One thing to remember when making investments or advising others, if an investment is characterized as “risk free” and the promised rate of return is higher than the return on either gilt-edged certificate of deposit and/ or a U.S. treasury bill, it’s a Ponzi scheme.

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.

(By Jack Bigelow and Joe Koletar) A Wall Street Journal article by Maria Armental describes “The Curious Case of an ‘Oxford’ Man,” in which Steven Wessel is described by a U.S. Attorney as “…much less an investment banker than a serial liar.” According to the article, Wessel conducted a classic Ponzi operation. Investors were persuaded by assertions of spectacular returns to invest money that was used to provide spectacular returns to earlier investors. This April, Wessel told an investor he’d be getting back $249,000 for his $200,000 investment, when at the time, Wessel’s bank account had about four dollars in it!
The book, A.B.C.s of Behavioral Forensics (Wiley, 2013) examines the motivations of fraudsters—motivations that go much deeper than greed itself. The Armental article gives us some hints. Wessel is described as “a burly man with a hearty laugh,” given to boasting about his investment banking practice. He’s described as making assertions about Oxford degrees, and employment by former presidents Ronald Reagan and George H.W. Bush (none of which appears to be true). He set up a charity to help military families, chairing prestigious events to bring in funds for it. Amazingly, he succeeded—for a while—in obtaining investment moneys even though he had served time for bank fraud eight years ago! Why did he do it? And what could have motivated the more recent “investors” to unwittingly participate in this scheme?
Regular blog contributor Joe Koletar’s reaction: “This is a typical scam. A little BS goes a long way. All the charity stuff is just cover. The victims could have found out all about this guy by doing a public records data search. I have a friend who’s been doing this for 20 years. He can do a nationwide data search and turn it around in 24 hours for $200. Scams take two parties—the bad guy and a gullible victim”
Which underscores again the questions: “Why do the bad guys do Ponzi schemes and similar scams and why do the victims allow themselves to be so gullible, even to the point of not even researching backgrounds?” Two follow-on posts by Vic Hartman and Daven Morrison will tackle these questions.

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.

(By Jack Bigelow) I was scanning my emailed Washington Post Headlines when an article by Drew Harwell grabbed my attention. It was titled, “Tarnished by the Enron scandal, can this brand be saved?” Whoa! Having been a part of Andersen for more than 27 years, I knew that this was Big News. And it was: It told about a west coast tax firm, WTAS, formed by a group of former Andersen partners, which had become an “international tax giant” and was now changing its name to AndersenTax. The article described the change as a high-profile bet on this question: “Just how toxic can an international brand become – and still be saved?”

Toxic? Well, maybe. But thousands of alumni like me will tell you that the toxicity was neither the brand nor the “crop” of us comprising this formerly esteemed organization. The downfall of Andersen was to me the result of a perfect storm of factors that in the aggregate, began to converge three weeks after my retirement and doomed the organization. It was like watching an elegant vessel that I had helped to construct go to the bottom of the sea with many of my friends aboard.

Andersen was never accused of fraud in the Enron case. It was indicted and convicted (a conviction later overturned by the U.S. Supreme Court) of obstructing justice by destroying documents as the Enron investigation was starting. The book, A.B.C.s of Behavioral Forensics (Wiley, 2013), examines fraud cases from the viewpoint of what motivates individuals (bad apples), organizations (bad bushels) or cultures (bad crops) to commit or abet fraud. I’d like to apply the “crop” factor to the non-fraudulent downfall of Andersen. Andersen was a culture as much as it was an organization.

How can we tell when a good crop might be beginning to turn bad? For me, it was when it appeared that the luster of some of Andersen’s fundamental values was beginning to move to other values. Every professional firm struggles with tensions between its role as a public servant and its role as a business. When I started, the Andersen value structure emphasized its responsibility to the investing public. The business side was downplayed, inside and outside. (The term, “Marketing” was banned from the Andersen lexicon.) By the mid-1990s, I could see that the emphasis had switched to our performance as a business. (Andersen now had an official Marketing function.) Whether this change was justified by a competitive environment is a separate issue. But it was a change that I noticed and I found it troubling.
As I see it, this very fundamental shift in the value structure rippled down through the organization in many ways that contributed to the perfect storm. A book would be required for a complete analysis; here are just a few examples:

• To reduce costs, Andersen reduced the infrastructure in the primary office serving Enron—some of those released were those who routinely saw to the destruction of documents no longer needed. Now, old documents piled up and became a source of panic when the investigation started. (Note this, those of you who see infrastructure costs as overhead expense, rather than an investment to keep your organization out of trouble.)
• Rainmakers reigned and success (including promotion within the management structure) was measured by profitability more than the oft-proclaimed value of stewardship.
• Quality review controls were—according to some reports at the time—disregarded in the case of Enron, a highly prized client generating lots of extra billable work.
• Those expressing concern about these changes were viewed as being out of sync with the times. Others, I am sure, remained silent but concerned.
• The motto, “Think Straight-Talk Straight” morphed into “Helping our clients succeed.”
• Major partner meetings began to take on the appearance of rallies, (in one instance, a key leader walked on stage, leading a tiger to the tune of “Eye of the Tiger”).
I believe numerous outside factors were also at work in the perfect storm downfall of Andersen. One example: Enron leadership was very chummy with the White House at the time, and I suspect that the federal government’s zeal in prosecuting Andersen was not incoincidental with that relationship.
If I were to summarize the values shift that I saw, it would be a change from asking, in any situation, “What is the right way to do this?” to asking, “What’s the most cost-effective way to do this?” Indeed, the first approach is what attracted me to Andersen in the first place.
So, what happened with the crop? I suggest that the Andersen crop was still an excellent crop, but the values driving the standards of that crop did change. Standards influence behaviors and all the rippling changes from the heavy emphasis on business success ultimately tarnished the brand. Can the brand be restored? The partners of WTAS believe that the bloom can come back and reseed the once-pristine Andersen reputation. I, and, I am sure, many of my former Andersen family members certainly hope so.

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.

(By Jack Bigelow) Colleagues Daven Morrison and Joe Koletar have kicked off a discussion of lessons learned from the Richard Nixon resignation of 40 years ago (see their posts below).  Daven describes the behavior of deception (behavior exercised in spades throughout the sordid Watergate coverup leading to the President’s resignation as impeachment and trial were looming ).  Joe dives into some of the behavioral forensics in this case, noting that we all practice deception of one kind or another.

Which raises the question of when does deception descend into outright fraud?  And why do we allow ourselves to make choices that drive seemingly innocent deceptions (a la make-up, special effects, etc.) to illegal activities leading to criminal prosecution, potential impeachment, prison, fines, and the downfall of an administration?

My own musings suggest that fraud as we usually see it is a form of deception with the objective of illegal financial gain.  But not all gains are financial.  In the case of Nixon, the deception of covering up a crime committed was also a form of fraud.  In this case, the potential (and temporary) gain was the preservation of political power through re-election.  Post- election, the gain was preservation of political power and prestige through keeping the crime hidden from public view.  Power and prestige were both lost when the facts came out.  The whole Watergate episode is an example of deception run amok to the point of criminal behavior.

My conclusion then, up for discussion, is that deception crosses “the thin line” into fraud (for financial, power, prestigious, and other gains) at the instant that the behavior breaks the law.

But the question remains:  Why do people give themselves permission to allow that morphing to take place?  Some answers can be extracted from the book, A.B.C.s of Behavioral Forensics (Wiley, 2013). I invite my colleagues, the authors of that book, to offer their thoughts.

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.

(By Joe Koletar) My friend and colleague, Daven Morrison, recently posted a piece on deception (see below) and why it is quite common human behavior, to one degree or another.

We see deception in many areas of our lives. A child may “make up” an imaginary friend they can talk to and play with. Little girls may treat a doll as if it were their child. It is cute and correctly perceived as a normal part of “growing up.” 

Later in life women, and increasingly men, may use “make up” in an adult fashion. Women apply make up to enhance or change their appearance. I once dated a professional model who, by adjusting her hair and make-up, could look like two different people in the space of twenty-four hours. Hollywood can use make up and other devices to make an actor look younger, older, or achieve the physical characteristics of a monster. 

But, like many things, make up can go too far. Human Resources professionals routinely report that about thirty percent of resumes contain material misstatements – covering up gaps in employment, falsifying credentials, over-stating job achievements, or misstating reasons for leaving a prior employment. And employers are often complicit in dealing with these issues, when discovered. They may allow an employee to resign “for personal reasons,” because stating the truth would be “too messy.” 

Is it any wonder then that some people in the business world may overstate financial performance? We know all too well that it happens with some frequency, but the issue is why does it happen? Is it a form of arrested psychological development, or is it a calculated strategy that “it worked before; it can work again?”

In the case of Nixon, I’ve read reports that he served as a Navy officer in the Pacific.  When off-duty aboard a ship, there is little to do, except smoke, drink coffee, or gamble.  Nixon was an excellent poker player and came home after the war with about $7,000 in cash, a huge amount in 1945.  His specialty at poker was…….bluffing.  A form of classic deception.  And when Watergate hit, he tried his specialty one time too often. 

Such considerations have, to date, been little addressed in the financial literature. Those dealing with or interested in such behavior might benefit by better-informing themselves of the mental processes that may at work. For those experienced in the field an all-too-common scenario is encountered time and again. We pay immediate attention to failure and spend significant time and effort to determine its causes. At the same time, we rarely spend one-tenth as much effort looking at what caused apparent “success.” We learn about it when it is too late – think of Enron, et al. 

Does this mean the watchdogs – the accountants and regulators – are corrupt? No. In the vast majority of instances they are not. They just fell into the all-too-human trap of not looking closely enough behind the “make up.”

(By Daven Morrison) As the world turned and watched the World Cup, it was witness to an unpleasant and ugly foul: the biting of Giorgio Chellini of the Italian national team by Luis Suarez of Uruguay. Although the deed wasn’t seen by the referee (an important aspect of fraud to which we will return later) the players knew and the repercussions after the game were justifiably swift and severe.

Why?
The reason for the severe penalty to Suarez and his team (they lost the next game likely because of his absence) was because he was a repeat offender. As the Chicago Tribune noted:

This isn’t the first time Suarez has been accused of biting a player during a match. Suarez has been disciplined two previous times for biting opponents. He was banned seven games in 2010 after a biting incident while he was playing for Netherlands club team Ajax. Another biting incident landed him a 10-game suspension last year with Liverpool in the English Premier League.

What is the tie to fraud?
Predatory fraudsters are not novices. They have honed their craft like a magician and have come to know very well when the “referee”, i.e. the auditors, the regulators, the internal controls, are looking at their work. They, like Suarez, have settled into a pattern of behavior which the legal community calls “recidivism.”

Recidivism refers to the overall likelihood to be a repeat offender. In general, there’s an important distinction between psychiatry and the law. In the law, when making a judgment in court on a repeat offender, the previous offenses are not admissible. This is at the heart of justice, each case must stand on its own. In psychiatry, however, past behavior is prologue. If someone was a troubled child who frequently broke the law and had run-ins with the police, than it is more likely they will be seen as anti-social as adults. In fact, it is part of the definition of an Anti-Social Personality Disorder.

This professional divide between the law and mental health can put the managers in a bind. The law tells them to judge each case, but behavioral science tells them to beware the person who has broken the law in the past.

Why did Suarez bite?
Biting is a very primitive and hostile act towards another. Generally, it resolves itself in pre-school, but when a person uses biting it is because they are incapable of coping. Suarez bit with the intention to have Chellini respond and in order to provoke him. In the video, one can see that he’s over-reacting to Chellini’s response in order to draw a foul and earn a penalty kick. As we noted earlier, the referee didn’t witness the bite. Suarez was quite skillful: He recognized the context, a penalty box where a reaction would lead to a penalty kick, as well as the location of the referee and his ability to see him initiate the conflict. The referee was watching the play around the soccer ball.

Predatory fraudsters also learn this skill. They know when the watchers are watching and they know how an audit works. They can bide their time, shuffle accounts, and clean up their trail, all the while knowingly deceiving the financial oversight process.

What is the take home message?
In the end it didn’t work, but in the next few minutes, the Italians did concede a goal on a corner kick. It will be up to others to determine if it was because of the bite.
We recommend managers have a low threshold as the tendency to repeat is a strong one. The lesson from Suarez is the leopard does not change his spots and the sabre-toothed predator doesn’t change his bite.

(By Daven Morrison) In the 1960s in my hometown of Chicago, protestors chanted “the whole world is watching”. They brought attention to the fact that what had been done by the police relatively invisibly was now exposed to not only the local Chicago news but the entire world. What had been previously dismissed and hidden was now exposed. What had been covered up was no accessible for all to see.

Last week, the World Cup began with a defeat of Croatia by the host country Brazil. It was not their best game, yet Brazil won handily 3-1. It was what the world expected and did not surprise anyone. Unfortunately, this might not be the whole story. On television, the commentators felt passionately that two calls hurt the Croatians, one leading to a penalty kick, another calling back an easy goal. This would have made the final score 2-1 in favor of the Croatians. For this to happen would have to include the collaboration of the referee and his team of officials. It would likely mean others were also involved. Is that possible?
Is what we see real?
Unfortunately it is quite possible and has happened. In a recent long form article in the New York Times, investigations uncovered how easy it was to not only swap out referees who were paid off, but also to influence the teams that lost to be silent about it. In an opening match, with relatively superficial investigative techniques and fairly easily “turned” informants, it was discovered that a large part of the power behind the illegally fixed matches came from wealthy individuals. And in several situations these were not one person but rather they were coordinated by Asian betting syndicates.

The syndicates are able to move easily through this world because many nations are very poor and willing to look the other way for financial reward. This is also true of the referees, the ones who are expected to enforce the rules objectively and consistently. And to do so with both teams.

Yet worst of all, was the intimidation of those regulating the game. Overseers of the referees were clearly able to stave off some fixed matches, but in the end the powerful forces behind the money were most problematic. Although there is no evidence that the regulators were victims of bribes, it was clear that that they were influenced by blackmail – many felt for their personal safety or that of their families. Behind it all was the dark shadow of FIFA which investigated late, stalled some investigations and shut others down.
So what, it’s only a game!
For those of us who investigate the human dynamics of fraud, there are several important factors playing out on a world stage currently that remind us of the perennial challenges of halting fraud:

• When we are excited about an event we can miss cues that tip us off to fraud.
• Large amounts of money can be leveraged to corrupt many in a system in small amounts to the big picture, but large to the individuals.
• Money can mean more than greed for those who are desperate; it can mean affording the basics of health care or living (food, shelter).
• When police are hired by the criminals and the regulators are intimidated, all bets are off. Literally. Or they should be.