We keep reading about scams in the financial world, though fraudulent practices are pervasive in every walk of economic life. Scams in resource allocation and frauds in banks and companies are making headlines in India especially, so a lot of what one reads in Dan Davies’ book Lying for Money would not be very novel.
The author presents a view of the various kinds of frauds that have been committed across the world that can actually be a guide on how to cheat in the white-collared world. He is careful, however, to warn the reader that people rarely manage not to get caught and, therefore, one should not try out such means, howsoever tempting they may be.
The LIBOR scandal is well known where respectable bankers gave low quotations in the polling process as the idea was to trick the market into believing that the banks were strong. If they had provided the right rates, which were actually higher, then the prevalent fear psychosis would have taken over, given the deep suspicions that were harboured against banks post the financial crisis. Barclays was the big name that was involved in this fraud.
Starting from this example, Davies goes across various kinds of frauds that have been perpetrated, right from raising money for central banks of countries that never existed to the more well-known cases of Ponzi or Madoff. His belief is that fraudsters play on the weaknesses in the system of checks and balances and the audit processes that are meant to supplement the environment of trust. And it is hard to catch these people because crooked businessmen employ the services of crooked auditors, accountants, lawyers and even bankers so that there is a strong circle of fraudulent parties in the ring, which is hard to dislodge.
Based on the series of episodes of fraud perpetrated in the commercial world, the author brings the characterisation of them to four groups. The first is what he calls a ‘long firm’, which runs up a lot of credit from the vendors with the intention of never paying them. Dealers often have to sell on credit or else they will not be able to manage inventory. These long firms look honest and prima facie one can never find out that there is no intent to repay.
The second kind of fraud is plain ‘counterfeiting’, where false documents or claims are made that go beyond making counterfeit goods. This can hold for products as well as people. To become a long firm, one may present fraudulent documents to gain trust and the rest becomes easy for the fraudster.
Third is what he calls a ‘control fraud’ wherein the classic principal-agent problem is leveraged as the owner may not be able to control what goes on in the company. This happened in the financial crisis where incorrect decisions were taken, the boards misled and high bonuses earned by the management. Nick Lesson was another example of how systems were dodged or misused to earn large salaries and bonuses. When the bubble bursts, the company’s name gets tarnished, and even collapses, but the perpetrator(s) could just get away with it, or even if found, cannot compensate for the losses. That was what happened to Barings Bank. The same becomes a distributed control fraud when there is a mechanism that is set in place where high risks are taken and fake profits reported.
The last kind of fraud comes under— what are termed as—market frauds where the victim is the market. Cartels best exemplify this phenomenon. Another example put forward is of toxic dumping, which several companies do and which never gets detected because of the strong chains built to ensure that any nit is not reported by the authorities.
Given the trend of a large number of frauds involving some of the best names in the field of accounting, there are some interesting insights provided by Davies. As all firms seek business, it is easy for companies to force the accounting and auditing firms to agree to what they would like to show. The author believes that all auditors are honest and competent. But they need to have a spine, which is never revealed as the fees are more important and a persistent and overbearing CEO can have his or her way.
One can also get very good stock market valuation by making incorrect projections based on numbers that have been cooked up by the accountants. By rigging the due diligence process, one can continue to keep bringing out deceitful statements. Stock market experts can be paid to move up the price and tempt investors to buy into these stocks. Here, he takes us through various kinds of accounting frauds, which include fake sales, incorrect recognition of revenues, delayed recognition of costs, fake assets, and unreported debt. Several conglomerates have multiple subsidiaries that are floated, especially as special-purpose vehicles or what Enron had called ‘off-balance sheet vehicles’, where the idea is to conceal the true debt of the entity. Even when revelations are complete, they would normally go into the fine print in notes to the accounts, which very few would ultimately see.
He argues that there is a fraud triangle, which can be found in every such episode. The need to commit fraud is always linked with earning more than one can by honest means. This can work, provided there is opportunity, which involves complete understanding of the system to spot the loopholes for exploitation. Last, there has to be rationalisation of the deed—often corporate frauds are rationalised as being done for a temporary period, which then gets institutionalised.
And finally, cheating the government is something all of us are familiar with, which happens through both tax avoidance, as well as tax management. This is where almost all companies hire the best heads to ensure that tax payments are not always commensurate with growth in profits.
This is a very interesting book and for those who work in the corporate world, it will be easier to identify with various techniques that are used on real-time basis to cheat the system. It would be hard to come across companies where these practices are absent, as it does appear that the crux of doing business is to make money by any means—and if it cannot be found out, “‘tis even better”.
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