Fraud Newsbrief – December 2018

A handful of fraud stories grabbed headlines in top-tier media outlets over the past month. In brief:

HP/Autonomy – British technology entrepreneur and investor Mike Lynch now faces 14 counts of conspiracy and fraud charges in the U.S. The charges relate to the $11 billion sale of Lynch’s software firm to HP in 2011.

TESCO – The collapse of Britain’s Serious Fraud Office £250m case against two former TESCO executives cast an unfavorable light on UK authorities’ ability to hold big corporations to account.

Theranos – The Theranos case continues to gain prominence beyond financial markets, largely due to the media coverage of Bad Blood: Secrets and Lies in a Silicon Valley Startup, an investigative account by the Pulitzer-winning reporter who broke the story in 2015. HBO has adapted the story into a feature film expected make its official debut at the Sundance Film Festival in Park City, Utah in 2019.

Pentagon – Arguably the most startling and strangely amusing fraud story over the past month comes from the Pentagon, which was dragged kicking and screaming into its first formal audit. The results are in. The startling part is the scale of what The Nation characterizes as “massive accounting fraud” but the Washington Post euphemizes as “bureaucratic noncompliance”. The amusing part is the nonchalant comment to the media by Deputy Defense Secretary Patrick Shanahan: “We failed the audit, but we never expected to pass it. It was an audit on a $2.7 trillion organization, so the fact that we did the audit is substantial.”

These are all richly instructive cases with clear implications for senior management teams, boards of directors, investors, auditors, journalists, regulators, voters, not to mention corporate PR and investor relations departments. But, as I wrote in my opinion piece in The Fiscal Times in 2014, we should remain mindful of our “collective tendency to react to specific cases of fraud with an obsessional and myopic sensationalism that obscures the broader context of causes and consequences.”

I also briefly touched on the psychological underpinnings of this tendency: “…every case of fraud constitutes an injustice in which wealth destruction represents only one of many tangible insults added to the deeper injury of desecrated trust. The victims of fraud observe the perpetrators with a level of morbid fascination usually reserved for high-speed collisions and public executions. In this anguished mindset, people often choose not to grasp the full meaning of the moment.”

Fraud inflicts trauma, which activates psychological defense mechanisms, as mounting evidence threatens prefabricated narratives. It can take years to process the experience, or it can take just a few moments, but the metabolism invariably depends on the fraud survivor’s ability get past denial and other forms of willful ignorance.

The shock obscures not only the details of each fraud, but also its systemic dimensions, the epidemiology of the phenomenon. And, as long as most top-tier media coverage of accounting fraud — and fraud in general — fixates on individual high-profile cases, it will continue to lend credence to the “a-few-bad-apples” theory of fraud risk.

Focusing on capital markets, I developed this argument more fully in the TFT byline, citing academic research including estimates that, in any given year, 14.5% of public companies employ accounting practices that materially distort asset values, costing investors an average of 22% of the enterprise value in the fraud-committing firms. I haven’t reviewed more recent data, but, as Maria Konnikova writes in The Confidence Game: “The whirlwind advance of technology heralds a new golden age of the grift. Cons thrive in times of transition and fast change.”

Fraud Hidden in Plain Sight

Having worked as a communications adviser to organizations affected by fraud, I’ve often found myself answering some version of the question “What should we say?” But a more useful question is often “What should we see?” Nothing shields the perpetrators of fraud as effectively as the tendency of their victims to see no evil.

Theranos had enough governance red flags to decorate a Christmas tree, but the victims of the scam chose not to see. And, as the GQ review of Bad Blood points out, throughout the story, “a number of figures easily uncover pieces of Theranos’s sham. But in nearly every case, the skeptic is overruled by someone who is intoxicated by the company’s potential. That’s how Theranos raised $1.4 billion in capital.” When they don’t see what matters, the companies affected by fraud typically don’t do much better in their decisions about what to say or do.

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