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4.02 AVERAGE
4.02 AVERAGE
Very interesting book on financial fraud. The author identifies four different fraud types: long firms, counterfeiting, control fraud, and market crime. Each type is illustrated with stories of famous fraud cases.
The name "long firm" comes from "gelang", meaning fraudulent, and "firm" (like the Italian "firma") referring to a signature. So it refers to the crime of signing a fraudulent bill of goods. An example given for this type of fraud is from the Kray brothers in London in the 1960s. They set up companies, made larger and larger orders on credit, and once the order was big enough they shut down the company without paying for the last order. A similar type of fraud, exit fraud, has happened in online drug markets (like Silk Road), where you take money for orders that you don’t intend to deliver (and then you exit the market). Another example was the Salad Oil King in New Jersey, that used tanks of seawater, that supposedly contained vegetable oil, as collateral in a “warehouse lending” scheme. The author also emphasizes that it can sometimes be hard to tell the difference between a fraud and a badly run company.
Next, there is a chapter called The Snowball Effect, the brings up the tendency of many frauds to get bigger and bigger in order to avoid being found out. The typical example is the original Ponzi scheme by Charles Ponzi. In 1920 he discovered an arbitrage opportunity of sending International Reply Coupons (IRC, for mail) to Italy and back to the US. To exploit this mispricing, he needed money, and he promised people a 50% return in 90 days, which was too high. The money poured in, but he didn’t actually use it to buy IRCs, since he got so much money from people who wanted in on it. Since he promised such great returns in such a short time, he had to keep growing the scam in order to avoid getting found out. The author goes on to describe other pyramid schemes, like the Pigeon King (breeding pigeons), Bernard Madoff, and Bayou Capital.
Counterfeiting. Examples include the 1925 case of Portuguese banknotes that were supposed to be for Angola (at one tenth of the value), but were instead used in Portugal. These notes were printed the same way as the official notes, but since they were not approved by the central bank, they were still forgeries. A more modern example is that of the Canadian mining company Bre-X that faked samples from an Indonesian mine to show that there was gold there. Another example is counterfeit drugs, and stressing benefits of a certain drug while suppressing reports of its side effects (Vioxx from Merck).
In the chapter Cooked Books, the author gives examples of ways dishonest accounting can inflate the value of a company: fake sales, swapping similar assets at inflated prices, up-front recognition of revenue (an Enron specialty), delayed recognition of cost, completely fake assets, and unreported debt (Enron used this with “off-balance sheet vehicles”). There is also a good discussion here about how the vast majority of auditor are honest, but how fraudsters that happen to find dishonest ones take advantage of that. The author (himself a former securities analyst) also explains how hard it is for analysts to spot fraud, in part because frauds are so rare.
Control fraud. The story of Nick Leeson in Singapore bankrupting Baring Brothers by unauthorized trades in index arbitrage of the Nikkei index starts this chapter. One problem here is that traders share in the upside of the profits they generate, but aren’t affected by losses. This gives them an incentive to take huge risks. The other problem was that Nick Leeson both did the trades (front office) and the record keeping of them (back office), so he could hide his losses. It all fell apart when the Kobe earthquake led to a large overnight drop in the Nikkei index. Another example covered is the Savings and Loans crisis of the 1980s.
The chapter ends with the example of the British Payment Protection Insurance (PPI) mis-selling scandal. The author uses the term “criminogenic” (having the tendency to incentivize criminal behavior) to describe the setup. Banks were selling people insurance that they often did not or could not use, and at inflated prices. This made a lot of money for the banks, but it is hard to draw the line between incentivizing the wrong behavior for the sales staff, and outright fraud. Even though the author doesn’t make the comparison, this reminds me of the reckless housing loans that triggered the financial crisis of 2008.
In the chapter The Economics of Fraud, the author observes that to understand how to manage something is also knowing how to defraud it. For complex tasks, as a manager you can’t check everything that is done. Instead, you have to find representative parts to control. But because you can’t check everything, there can also be fraud slipping through. Frauds often use weaknesses in the control system.
The chapter Cold Cases gives examples of fraud throughout history: the Bible, the Icelandic sagas (inheritance fraud), and Victorian England. One fascinating indication of how lax the laws were is the estimate that up to one-sixth of all stock market flotations between 1866 and 1883 were frauds. But, as the author mentions several times, trying to stamp out all fraud will also limit growth.
Examples of Market Crimes are insider trading, cartels, and toxic waste dumping. The chapter on Defrauding the Government covers tax avoidance, for example carousel trades, and money laundering.
There were many interesting stories about fraud in the book. However, to me it was not always clear which category of fraud they belonged to. The order of the chapters was also a bit weird – for example, The Economics of Fraud comes before all types of fraud have been discussed. It would have been better to have it last I think.
In addition to the good stories, I also like the author’s sense of humor. For example, in a footnote he writes: the phrase “corporate drone” is meaningless. Drones don’t do the work in beehives. Worker bees do. A “corporate drone” would be someone whose only purpose was to fertilize the corporate queen, and I can’t think of a single company that’s managed that way. Another example is when he quotes: I respond to incentives / You game the system / He is a crook.
The name "long firm" comes from "gelang", meaning fraudulent, and "firm" (like the Italian "firma") referring to a signature. So it refers to the crime of signing a fraudulent bill of goods. An example given for this type of fraud is from the Kray brothers in London in the 1960s. They set up companies, made larger and larger orders on credit, and once the order was big enough they shut down the company without paying for the last order. A similar type of fraud, exit fraud, has happened in online drug markets (like Silk Road), where you take money for orders that you don’t intend to deliver (and then you exit the market). Another example was the Salad Oil King in New Jersey, that used tanks of seawater, that supposedly contained vegetable oil, as collateral in a “warehouse lending” scheme. The author also emphasizes that it can sometimes be hard to tell the difference between a fraud and a badly run company.
Next, there is a chapter called The Snowball Effect, the brings up the tendency of many frauds to get bigger and bigger in order to avoid being found out. The typical example is the original Ponzi scheme by Charles Ponzi. In 1920 he discovered an arbitrage opportunity of sending International Reply Coupons (IRC, for mail) to Italy and back to the US. To exploit this mispricing, he needed money, and he promised people a 50% return in 90 days, which was too high. The money poured in, but he didn’t actually use it to buy IRCs, since he got so much money from people who wanted in on it. Since he promised such great returns in such a short time, he had to keep growing the scam in order to avoid getting found out. The author goes on to describe other pyramid schemes, like the Pigeon King (breeding pigeons), Bernard Madoff, and Bayou Capital.
Counterfeiting. Examples include the 1925 case of Portuguese banknotes that were supposed to be for Angola (at one tenth of the value), but were instead used in Portugal. These notes were printed the same way as the official notes, but since they were not approved by the central bank, they were still forgeries. A more modern example is that of the Canadian mining company Bre-X that faked samples from an Indonesian mine to show that there was gold there. Another example is counterfeit drugs, and stressing benefits of a certain drug while suppressing reports of its side effects (Vioxx from Merck).
In the chapter Cooked Books, the author gives examples of ways dishonest accounting can inflate the value of a company: fake sales, swapping similar assets at inflated prices, up-front recognition of revenue (an Enron specialty), delayed recognition of cost, completely fake assets, and unreported debt (Enron used this with “off-balance sheet vehicles”). There is also a good discussion here about how the vast majority of auditor are honest, but how fraudsters that happen to find dishonest ones take advantage of that. The author (himself a former securities analyst) also explains how hard it is for analysts to spot fraud, in part because frauds are so rare.
Control fraud. The story of Nick Leeson in Singapore bankrupting Baring Brothers by unauthorized trades in index arbitrage of the Nikkei index starts this chapter. One problem here is that traders share in the upside of the profits they generate, but aren’t affected by losses. This gives them an incentive to take huge risks. The other problem was that Nick Leeson both did the trades (front office) and the record keeping of them (back office), so he could hide his losses. It all fell apart when the Kobe earthquake led to a large overnight drop in the Nikkei index. Another example covered is the Savings and Loans crisis of the 1980s.
The chapter ends with the example of the British Payment Protection Insurance (PPI) mis-selling scandal. The author uses the term “criminogenic” (having the tendency to incentivize criminal behavior) to describe the setup. Banks were selling people insurance that they often did not or could not use, and at inflated prices. This made a lot of money for the banks, but it is hard to draw the line between incentivizing the wrong behavior for the sales staff, and outright fraud. Even though the author doesn’t make the comparison, this reminds me of the reckless housing loans that triggered the financial crisis of 2008.
In the chapter The Economics of Fraud, the author observes that to understand how to manage something is also knowing how to defraud it. For complex tasks, as a manager you can’t check everything that is done. Instead, you have to find representative parts to control. But because you can’t check everything, there can also be fraud slipping through. Frauds often use weaknesses in the control system.
The chapter Cold Cases gives examples of fraud throughout history: the Bible, the Icelandic sagas (inheritance fraud), and Victorian England. One fascinating indication of how lax the laws were is the estimate that up to one-sixth of all stock market flotations between 1866 and 1883 were frauds. But, as the author mentions several times, trying to stamp out all fraud will also limit growth.
Examples of Market Crimes are insider trading, cartels, and toxic waste dumping. The chapter on Defrauding the Government covers tax avoidance, for example carousel trades, and money laundering.
There were many interesting stories about fraud in the book. However, to me it was not always clear which category of fraud they belonged to. The order of the chapters was also a bit weird – for example, The Economics of Fraud comes before all types of fraud have been discussed. It would have been better to have it last I think.
In addition to the good stories, I also like the author’s sense of humor. For example, in a footnote he writes: the phrase “corporate drone” is meaningless. Drones don’t do the work in beehives. Worker bees do. A “corporate drone” would be someone whose only purpose was to fertilize the corporate queen, and I can’t think of a single company that’s managed that way. Another example is when he quotes: I respond to incentives / You game the system / He is a crook.
informative
medium-paced
Not necessarily written for casual fraud connoisseur; be prepared to do more research if you're not already a little versed in economic terms and processes.
informative
medium-paced
funny
informative
medium-paced
Really excellent book, already bought a second copy for a gift.
While the descriptions of different frauds were entertaining, it is the parts of the book that talk about how certain systems are susceptible that makes it stellar. Some really strong insight here that have had me thinking in entirely new ways about the subject - excellent!
While the descriptions of different frauds were entertaining, it is the parts of the book that talk about how certain systems are susceptible that makes it stellar. Some really strong insight here that have had me thinking in entirely new ways about the subject - excellent!
I thought this book might be on the dry, technical side, but it had me laughing out loud at some of the escapades. Apparently the most important attribute needed for committing financial fraud is balls of steel. This book is a riot. Highly recommended.
I bought this book to defraud my friends and have some great tips thanks Dan
Zips along at a fair old pace and never quite delivers on the promise of an analysis of how the economy works, but more than worth it for the descriptions of various frauds, the humourous writing style (not a given in this subject) and the footnotes. If you liked "Bad Blood" but want more variety, this is a good choice.
I work in the world of financial institution risk. Davies gives the reader a good primer on the most common financial scams/frauds, cases, and explainations of what happened. The book isn't dry, which can be a trapping of this genre.
funny
informative
fast-paced