Jul 1, 2018

From bubble to bitcoin, it’s a fraudster’s wonderland

If there is business, there will be frauds. I was reminded of this recently, when a senior manager at one of our companies admitted to falsifying invoices. He stole the money to cover his losses trading cryptocurrencies. This was a minor affair; the stuff that hits the news is much grander and more dramatic.

From the earliest era of finance to Silicon Valley today, swindlers have been forever devising cons to rip off investors and companies. The 18th century South Sea Bubble almost bankrupted Britain; the collapse of “Match King” Ivar Kreuger, and the demise of Clarence Hatry’s empire, helped trigger the Wall Street crash of 1929; the insider dealing scandal of Ivan Boesky and the subsequent fall of Mike Milken and Drexel Burnham contributed to Black Monday in 1987. The financial crisis of 2008 was hastened by bent mortgages issued by crooked bankers and sold to dupes who thought the value of their homes would only ever rise.

Fraud is eternal because there is an endless supply of potential victims, who let their greed, gullibility and ignorance cloud their judgment. Similarly, there will always be immoral operators keen to exploit such credulity. Passing new laws never stops fraud; determined criminals will find ways round them. Sophisticated forensic accounting usually only discovers the deceit after the fact — even in the age of digital records and ever more detailed regulations.

In fact, safeguards against fraud can actually make people more complacent. As the 19th century philosopher Herbert Spencer wrote: “The ultimate result of shielding men from the effects of folly is to fill the world with fools.” This was surely the case with the Bernie Madoff scandal; the signs of duplicity were obvious, but no one wanted to believe it.

There is excellent literature on fraud, and I shall be putting up a list of my favourite volumes on my website lukejohnson.org. To that canon should be added two new books. First is Bad Blood: Secrets and Lies in a Silicon Valley Startup, written by the journalist John Carreyrou. It tells the dark tale of Theranos, the medical venture that claimed to have amazing new technology to analyse blood. It was the creation of Elizabeth Holmes, a well-connected Stanford University dropout. She got backing from high-profile investors such as Oracle’s Larry Ellison and even Rupert Murdoch, chairman of the publisher of this newspaper. Ironically, it was our sister publication, The Wall Street Journal, that uncovered alleged larceny; last month, Holmes and her lover Ramesh “Sunny” Balwani were charged with various counts of wire fraud. If convicted, each faces a maximum 20 years in prison.

Many fraudsters do not set out to cheat investors and customers, but they over-promise and cannot deliver — so they lie, and the cover-ups and fiddles grow until the fraudster is overwhelmed. Few swindlers are truly evil. Robert Maxwell fell into that category — looting Mirror staff pensions was wickedness in a different league to misleading institutional investors. I met him a few times, and he was very menacing.

Robert Vesco, who fled to Cuba after embezzling from the investment fund IOS, was also a genuine villain. It is surprising that no one has yet made a movie about his career as a financier and fugitive; it is an extraordinary tale.

The other new book worth reading is Ultimate Folly, a biography of Whitaker Wright — “The World’s Most Shameless Swindler” — by Henry Macrory. Wright was a share promoter in the late 19th century, specialising in mining ventures. He had a spectacular rise and fall, eventually committing suicide at the Royal Courts of Justice after having been found guilty of fraud and sentenced to “seven years’ penal servitude”.

In frothy times and during bull markets, the “bezzle” (the amount of money illegally siphoned from the system) grows, as John Kenneth Galbraith highlighted in his book The Great Crash 1929. Investors now are so desperate for returns, and liquidity is so plentiful, that they are embracing much riskier assets — where the danger of corruption is inevitably higher. Easy money — in every sense — attracts con artists, who come up with all sorts of unscrupulous schemes.

I believe that cryptocurrencies are a fraudsters’ paradise. I agree with the description of bitcoin by the general manager of the Bank for International Settlements: “A combination of a bubble, a Ponzi scheme and an environmental disaster”. Any bitcoin investor unaware of the fool in the market is the fool in the market.