Friday, 13 March 2009

Tha anatomy of a fraud

Most, if not all, corporate frauds start small. Probably not even as a clear cut fraud. It then builds momentum, becomes a monster, and gets out of hand. Two recent cases lead me to muse on how, and why, frauds start.

Bernard Madoff pleaded guilty yesterday and was taken in handcuffs to jail. He will spend the rest of his life in a cell. Three months ago, in India, Ramalinga Raju the Chairman of Satyam Computers owned up to a massive accounting fraud and has been in jail since then. He too faces a long prison sentence.

Madoff said yesterday, that "he felt compelled to deliver at all costs". He said that "he had started the scheme in the 90s when financial markets were struggling amidst a US recession" . "He had hoped to end the scheme in short order, but it spun out of control."

Ramalinga Raju in his now famous letter said "what started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years" and that "it was like riding a tiger, not knowing how to get off without being eaten".

People, who commit fraud and get caught, of course try to say the right things. Even discounting for this, I think there is some truth, and learnings, in both their statements. Two cases, by themselves, cannot be the basis of any generalisations. But I will still speculate on a few hypotheses.

What is the motive for a fraud. In most cases, its of course, to get rich quick. But increasingly there is an added motive - to look big and successful in the public eye. Both Madoff and Raju wanted to be seen as giants and when they couldn't perform as giants, they committed fraud to maintain that image.

Frauds seem to start small. After all, inflating profits by $ 100,000 cannot be a real crime, can it ? Or deliver a quarter's return by the Ponzi scheme cannot be all that criminal surely ? Taking a temporary small "loan" from the company for 15 days to settle a personal debt isn't all that serious. This is where the critical point is, I believe. I think you are eventually doomed if you cross it, thinking its only a small step and that you'll only do it once. Its only a matter of time before it will catch up with you, even if you rectified the original misdemeanour.

A third ingredient in the mix, I believe, is overconfidence. A belief that one can get away with it. After all, am I not so big and competent and that I won't be caught and I can anyway clear things up well before there is any danger of getting caught. A giant sized ego is another cause for white collar crime.

There is no such thing as a small fraud. It will grow in size. Once the fraud starts to become big and gather momentum, a whole series of forces seem to come into play. It keeps multiplying, although the incremental addition to the fraud seems small by itself. The capacity of the fraudster to delude himself that it can still be corrected and he won't be caught, seems to rise exponentially. There seems to be no way out, other than to get deeper and deeper into the mess. I believe in the development of a fraud, there comes a point of no return. Before this point, some people do turn back. But once this is crossed, there is a only a one way ticket.

What could be some lessons for ordinary mortals like me.
  • Ethical dilemmas occur for all people in the corporate world; not only to the likes of Madoff and Raju.
  • The smaller dilemmas are more difficult to deal with than the larger dilemma. If I was faced with the possibility of inflating profits by $100 m, the answer is easy - no way. If I was faced with the choice of inflating profits by $100 K, that's a little more tempting.
  • May I have the strength to never cross the first line and being human, if I sometimes do, may I have the strength to come quickly running back.
  • Let expectations not completely take over me. Expectations might be from the boss, from headquarters, from the market, whatever. May I have the strength never to let this be an excuse for crossing the line.
  • Keep the ego firmly in check. Yes, of course, I want to be seen as a great guy - who doesn't ? But I ask for the strength to accept being seen a shade below what I truly am, rather than a shade above.
  • When faced with a possible temptation, may I have the courage to seek a counsellor.
I suggest an ethical "test" to guide when faced with such a situation
  • If I add three zeroes to the amount in question, would I still do it ?
  • Can I live with it if my mother/wife/daughter knew what I had done ?
  • What if it came on the TV tomorrow ? Play in my mind what I would say in front of the camera.
Give me the strength to take a rap on the knuckles now, and look silly, rather than commit an improper act and try to look good.


Sidharth Mehta said...

What a wonderfully written blog. Well done.

Ramesh said...

Many thanks Sidharth for your kind comment.

Syed Aleem said...

In this real world, everyone including your family would like to see you succeed. Very rarely you are accepted "as you are" which includes the families as well. So Man/Woman tries hard to achieve their best but when they fail, they resort to other means just to prove themselves. One has to be content with what he can achieve, otherwise he is sure to regret in his life.

Ramesh said...

Well said Aleem. Absolutely true.

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