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Posts Tagged ‘fraud

“The opposite of knowledge is not ignorance, but deceit and fraud”*…

In follow-on to our last look at corporate fraud, a provocative piece by Byrne Hobart

This paper has been getting some attention lately for its eye-catching estimates: 11% of publicly traded companies are committing securities fraud every year, with an annual cost of over $700bn…

[There follows an illuminating discussion of lessons that can be drawn for the follow-on to Arthur Andersen’s collapse after the implosion of Enron, the rules/regulations developed then to prevent similar public company frauds, and a consideration of whether corporate fraud has waned– at least among publicly-traded companies– and is perhaps a little less wide-spread than the paper argues…]

But since fraud is a human problem, and not purely a matter of better accounting standards, it’s not likely to have just gone away. But if the rate of accounting problems among big publicly-traded companies is lower than the 11% number cited in the paper, the question isn’t “why did it disappear?” but rather “where did it go?” And we can take our list of trends against fraud and invert them:

• Sarbanes-Oxley does apply to private companies, but only on the penalty side, not the disclosure side. But accounting frauds in private companies are often less visible; many investments go to zero, anyway, and it’s less embarrassing for everyone involved not to say why.

• There are no short-sellers in private markets. There have been efforts here, but they don’t work out because the market doesn’t clear (“everyone wanted to short Theranos, Dropbox and WeWork”). The closest you can get to shorting is to pass on a round and then brag about it later. Big deal: I didn’t invest in FTX, either.

• There’s less data available on private companies, though the rise of alternative data tools means it’s easier to get decent proxies.

• Startups are not expected to return capital. It’s a bad sign if they do. They’re often valued either based on strategic considerations or starting with a multiple of sales—a dollar of sales is much easier to fake than a dollar of earnings or cash flow, so the incentive to do so is strong.

• The idea market in startups is liquid when it comes to successes, but it would be pretty tacky for a VC to write a long blog post explaining why they passed on a live deal. (That memo may exist internally, but to the extent that it’s shared it’s in the form of a quick summary over Twitter DM or Signal.)

JPMorgan Chase’s writedown of their fintech acquisition Frank is a great case study in all of these forces. The NYT has a good story digging into the details: Frank’s founder is a serial exaggerator whose self-promotion veered into fraud (once again, if the rate of continuous improvement in public perception to be maintained exceeds what the fundamentals can deliver, compound interest works its ruthless magic). The company was valued at a high multiple of what turned out to be a flexible metric, total email addresses captured. And there were alternative datasets that could have pointed to problems: given the likely number of student aid applicants in the US, Frank’s numbers implied that it had reached near-dominant market share in the category with little marketing. Meanwhile, its monthly site traffic was not enough to have acquired that sizable a customer list over Frank’s entire existence. So it could have been caught, if the buyer had been looking for fraud. But one paradox of frauds and cheats in general is that lying is less than half the work—most of the effort is in appearing not to need to lie. The more impressive a company looks, the more embarrassing the basic due diligence questions are.

A down market and a series of high-profile failures might give private markets the same kind of natural experiment that Arthur Andersen’s failure did for public markets. Due diligence checklists will get longer and more thorough, and new funding rounds will feel more like a cross-examination and less like a party. One reason for a high base rate of fraud is that at least some of it stems from inattention rather than malice—the Arthur Andersen study finds that most of the frauds were fairly minor, and could be more the result of poor internal metrics than of intent to mislead. But either way, standards will get higher, and private companies will need to step up their efforts accordingly…

Has the primary locus of corporate fraud moved from public to private companies? “Where Fraud Lives and Why,” from @ByrneHobart.

[Image above: source]

* Jean Baudrillard


As we do due diligence, we might recall that it was on this date in 2016 that the Centers for Medicare and Medicaid Services (CMS) sent a letter to Theranos after an inspection of its Newark, California, lab. The investigation, which took place in the fall of 2015, had found that the facility did not “comply with certificate requirements and performance standards” and caused “immediate jeopardy to patient health and safety.” This followed on three exposes on Theranos in the Wall Street Journal (in October [here and here] and December of 2015) and a critical FDA report. Things unraveled from there: in March, 2018, Thearnos, CEO Elizabeth Holmes, and President Sunny Balwani were charged by the FCC with fraud. Three month later, a federal grand jury indicted both Holmes and Balwani on two counts of conspiracy and nine counts of wire fraud, finding that the pair had “engaged in a multi-million dollar scheme to defraud investors, and a separate scheme to defraud doctors and patients.” Theranos closed in 2018. Holmes was convicted and sentenced to 11 years in prison for her crimes (a sentence she is appealing); Balwani, to 13 years.

Theranos was a private company, funded by investors including Henry Kissinger, Betsy DeVos, Carlos Slim, and Rupert Murdoch.

Elizabeth Holmes found guilty (source)

“Things gained through unjust fraud are never secure”*…

Mischief is cyclical—it is bred in good times and uncovered in bad times…

The bad news just keeps coming. Ten months after America’s stock market peaked, its big technology companies have suffered another rout. Hopes that the Federal Reserve might change course have been dashed; interest rates are set to rise by more than previously thought. The bond market is screaming recession. Could things get any worse? The answer is yes. Stock market booms of the sort that crested in January tend to engender fraud. Bad times like those that lie ahead reveal it.

“There is an inverse relationship between interest rates and dishonesty,” says Carson Block, a short-seller. Quite so. A decade of ultra-low borrowing costs has encouraged companies to load up on cheap debt. And debt can hide a lot of misdeeds. They are uncovered when credit dries up. The global financial crisis of 2007-09 exposed fraud and negligence in mortgage lending. The stockmarket bust of the early 2000s unmasked the deceptions of the dotcom bonanza and the book-cooking at Enron, Worldcom and Global Crossing. Those with longer memories in Britain will recall the Polly Peck and Maxwell scandals at the end of the go-go 1980s.

The next downturn seems likely to uncover a similar wave of corporate fraud…

The archetypal sin revealed by recession is accounting fraud. The big scandals play out like tragic dramas: when the plot twist arrives, it seems both surprising and inevitable. No simple formula exists to sort the number-fiddlers from the rest. But the field can be narrowed by searching within the “fraud triangle” of financial pressure, opportunity and rationalization…

As Warren Buffett has noted, “you don’t find out who’s been swimming naked until the tide goes out.” Read on for more from @TheEconomist, “A sleuth’s guide to the coming wave of corporate fraud” (a gift article: no paywall).

* Sophocles


As we contemplate criminality, we might recall that it was on this date in 1997 that MCI and Worldcom announced what was then the largest merger in history, valued at $37 Billion, creating the second largest telecom company in the U.S. (after ATT).

Worldcom, the acquirer, completed the deal in 1998, then continued to grow via acquisition. MCI Worldcom (as then it was) filed for bankruptcy in 2002 (the Dot Com Bust) after an accounting scandal (as referenced above), in which several executives, including CEO Bernard Ebbers, were convicted of a scheme to inflate the company’s assets… which were ultimately acquired by Verizon.

Written by (Roughly) Daily

November 10, 2022 at 1:00 am

“There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning”*…

In the past few decades, the Gini coefficient—a standard measure of income distribution across population segments—increased within most high-income economies. The United States remains the most unequal high-income economy in the world. The disparity reflects a surge in incomes for the richest population segments, along with sluggish or even falling incomes for the poorest, especially during bad economic times.

At the same time, the middle class is shrinking. The percent of Americans in the middle class has dropped since the 1970s, from 61 percent in 1971 to 51 percent in 2019. Some have moved up the income ladder, but an increasing number are also moving down. The middle class has also shrunk considerably in countries like Germany, Canada, and Sweden, but other advanced economies have generally experienced more modest declines.

From the introduction to the Petersen Institute for International Economics report “How to Fix Economic Inequality?

Founded by Pete Petersen (Lehman Brothers Chair, Nixon’s Secretary of Commerce, and co-founder, with Trump supporter Stephen Scharzman, of investment giant Blackstone), and overseen by trustees who include Larry Summers, Alan Greenspan, and George Schultz, PIIE is hardly a “progressive” think tank. But they are worried: quite apart from its obvious humanitarian toll, inequality at the scales that have emerged is highly unlikely to be sustainable (even at the human cost that we’ve so far been willing to pay). Put more bluntly, it is ever more likely to torpedo the domestic (and large hunks of the global) economy and indeed to threaten the stability of democratic society.

Other sources suggest that they have very good reason for concern:

• Even as the stock market hits new highs, 26 million Americans are suffering food insecurity (See also: “The boom in US GDP does not match what’s happening to Americans’ wallets.”

• The distribution of assets in the US (and other developed economies, but most egregiously in the U.S.) is even more skewed than income: see data in the PIIE report and “The Asset Economy.”

• And lest we think that this issue is confined to the U.S., social democracies throughout the developed world are feeling the same pressures (albeit mostly less dramatically).

FWIW, your correspondent doesn’t have terrifically strong confidence in the remedies mooted in the PIIE report. Even as the authors recognize that the issues are deeply structural, they confine themselves to recommending (what seem to your correspondent) relatively timid and incremental steps– which, even if taken (and most require legislative or regulatory action) are more likely to slow the polarization underway than to reverse it.

But they are worth contemplating, if only to provoke us to more fundamental measures (e.g., here). And in any case, it’s telling– and one can only hope, encouraging– that determined champions of the very neoliberal economics that have gotten us here recognize, at least, that unless we change course, we’re speeding into a dead end.

* Warren Buffett


As we agree that fair’s fair, we might recall that it was on this date in 2001 that Enron, once #7 in the Fortune 500, declared bankruptcy. Six months earlier, it’s stock had traded as high as $90; it closed November 30th at 26 cents, wiping out billions in wealth (a appreciable part of it disappearing from employees’ pension plans). At the time, Enron had $63.4 billion in assets, earning it the honor of being the nation’s largest bankruptcy to that date. (It would be surpassed by the WorldCom bankruptcy a year later.)

Jeff Skilling, Enron’s CEO served 11 years in prison on several counts of fraud; Andy Fastow, Enron’s CFO, would served about 5 years. Chairman Ken Lay was also found guilty, but died before his sentencing. Enron’s accounting firm, Arthur Andersen (at the time a leader among the “Big 5”), which at least “missed” the egregious fraudulent practices in their audits of Enron, was effectively forced to dissolve after the scandal.

Published a year before the scandal broke


Written by (Roughly) Daily

December 2, 2020 at 1:01 am

“Results aside, the ability to have complete faith in another human being is one of the finest qualities a person can possess”*…



Downtown San Francisco ablaze after the 1906 earthquake, from the slope of Nob Hill


Amadeo Peter Giannini was born in San Jose, California in 1870. The son of Italian immigrants had an outsized personality and unlimited faith in the American dream.

Giannini began by selling fruits and vegetables from a horse-drawn wagon. But he was made for bigger things. At age 34, he launched a small bank in the Italian neighborhood of North Beach, San Francisco. At the time, big banks lent only to large businesses, handled deposits of the wealthy, and frowned on aggressive advertising.

The novice financier knocked on doors and buttonholed people on the street. He persuaded “unbanked” immigrants that gold and silver coins were safer in vaults than under mattresses. Moreover, the money would earn interest at his “Bank of Italy.”

bankof italy

On the morning of April 18, 1906, a massive earthquake hit San Francisco. The ensuing fires burned down the large banks. Their superheated metal vaults could not be opened for weeks—lest the cash and paper records catch fire when oxygen rushed in.

As flames threatened his one-room bank, Giannini spirited $80,000 in coins out of town. He hid the precious metal under crates of oranges and steered his wagons past gangs of thugs and looters in the streets.

As other banks struggled to recover, Giannini made headlines by setting up a makeshift bank on a North Beach wharf. He extended loans to beleaguered residents “on a handshake” and helped revive the city.


The innovative bank welcomed small borrowers who might otherwise have to use high-cost loan sharks. Most banks at the time regarded people with modest incomes as credit risks not worth the paperwork. But experience had taught Giannini otherwise: that working class people were no less likely to pay their debts than the wealthy.

Seeking more customers, the former produce salesman returned to his old haunts—the fertile valleys of California. He “walked in rows beside farmers engaged in plowing” to explain how bank branches make credit cheaper and more reliable. Town by town, he built the first statewide branching system in the nation.

On November 1, 1930, the Bank of Italy in San Francisco changed its name to Bank of America. The bank today has the same national bank charter number as Giannini’s old bank— #13044.

When A.P. Giannini died in 1949, the former single-teller office in North Beach claimed more than 500 branches and $6 billion in assets. It was then the largest bank in the world…

How a humane response to a community tragedy launched what became the biggest bank in the world: “Bank of America: The Humble Beginnings of a Large Bank.”

* Haruki Murakami, The Wind-Up Bird Chronicle


As we learn from our elders, we might recall that it was on this date in 2006 that the first news stories based on the Panama Papers were published.  A cache of 11.5 million leaked documents that detailed financial and attorney–client information for more than 214,488 offshore entities, all from Panamanian law firm and corporate service provider Mossack Fonseca, the Panama Papers chronicled tax evasion, money laundering and fraud involving 12 current or former world leaders; 128 other public officials and politicians; and hundreds of celebrities, businessmen, and other wealthy individuals from over 200 countries.


An online chat between Süddeutsche Zeitung reporter Bastian Obermayer and anonymous source John Doe



“When I consider Life, ’tis all a cheat”*…




Sarah Howe’s early life is mostly a mystery. There are no surviving photographs or sketches of her, so it’s impossible to know what she looked like. She may, at one point, have been married, but by 1877 she was single and working as a fortune-teller in Boston. It was a time of boom and invention in the United States. The country was rebuilding after the Civil War, industrial development was starting to take off, and immigration and urbanization were both increasing steadily. Money was flowing freely (to white people anyway), and men and women alike were putting that money into the nation’s burgeoning banks. In 1876, Alexander Graham Bell invented the telephone, and in 1879 Thomas Edison created the lightbulb. In between those innovations, Sarah Howe opened the Ladies’ Deposit Company, a bank run by women, for women.

The company’s mission was simple: help white women gain access to the booming world of banking. The bank only accepted deposits from so-called “unprotected females,” women who did not have a husband or guardian handling their money. These women were largely overlooked by banks who saw them — and their smaller pots of money — as a waste of time. In return for their investment, Howe promised incredible results: an 8 percent interest rate…

All told, the Ladies Deposit would gather at least $250,000 from 800 women — although historians think far more women were involved. Some estimate that Howe collected more like $500,000, the equivalent of about $13 million today…

Then, in 1880, it all came crashing down. On September 25, 1880, the Boston Daily Advertiser began a series of stories that exposed Howe’s bank as a fraud. Her 8 percent returns were too good to be true. Howe was operating what we now know as a Ponzi scheme — 40 years before Ponzi would try his hand at it…

Rose Eveleth on the fascinating story of a 19th-century scammer, and what she can teach us about women, lying, and economic boom-and-bust cycles: “The No. 1 Ladies’ Defrauding Agency.”

* John Dryden, Aureng-Zebe


As we remind ourselves that what’s too good to be true usually isn’t, we might recall that it was on this date in 1946 that FBI agents arrested Chicago gangster George “Bugs” Moran in Kentucky.

During the Prohibition era, Moran was one of the biggest organized crime figures in America, and has been credited with popularizing the drive-by shooting. He was a rival to Al Capone, who gunned down seven members of Moran’s gang in the 1929 Saint Valentine’s Day massacre.

Unlike Capone, Moran wasn’t a clever crime boss. By 1946 he had been reduced to common crimes like bank heists. He was basically penniless. The FBI found him renting an upstairs apartment from a law-abiding couple in Henderson, Ky.  [source]

220px-Bugs_Moran source


Written by (Roughly) Daily

July 6, 2019 at 1:01 am

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