Book Review on Business Fraud

Why They Do It: Inside the Mind of the White-Collar Criminal, Eugene Soltes (2016). Soltes wrote, called, and emailed various white-collar criminals to get their insights on why. He also described economics, criminal justice,and some psychology that could be relevant. The most interesting guys (they were all male) were Andy Fastow of Enron infamy, Dennis Kozlowski of Tyco, and Bernie Madoff who pulled off the biggest Ponzi scheme. The amazing thing was how little they accepted blame for their actions, usually based on their perception that what they were doing was typical and others were doing far worse. Major forces found for fraud were pressure, opportunity, and rationalization--the fraud triangle.

The first half of the book is background on miscellaneous aspects of financial and accounting fraud, basically asking why successful professional people break the law. This was relatively disappointing; the analysis was incomplete and missing key elements. The biggest missing component was behavioral economics, probably the area that has the best explanations of why people behave as hey do, especially relevant for this cast of characters. (See for example various books by Dan Ariely such as The (Honest) Truth About Dishonesty or my Accounting Fraud book, second edition, Chapter 1). Note that bits and pieces have useful information, so skimming over this material is useful.

Part III of the book is the useful part, where he talks to the crooks. Many are obscure; that is, they didn't make the front page of the newspapers when they were caught. On the other hand, some big names did talk to him. The story of Enron is well known, but the part Soltes adds Fastow's perspective. Fastow was the special purpose entity specialist, creating separate legal entities to mainly hide liabilities, claim undeserved revenues, and hide losses. Fastow also did his own self dealing, which made him, in my opinion, the biggest crook of the lot. Great Fastow quote: "We were finding ways to get around the rules but going through a complex process to find the loopholes to allow us to do it. ... I cheated fair and square." He also claimed to be brilliant and innovative--apparently for cheating.

Another key point about Enron is their use of lobbying and other forms of political pressure for multiple purposes, like getting contracts from foreign governments. This is generally true of most big businesses, but some are more aggressive than others.

The big catch was Madoff and the last chapter is devoted to Bernie. Madoff started out as a broker of over-the-counter securities and became an important leader at NASDAQ. He was aggressive (e.g., using naked shorts, making markets) and innovative, diverting trading away from the NYSE. He also started an investment advisory service in the 1980s for individuals and institutions. Apparently, his arbitrage strategies did not work that well and the 1987 market collapse may have been the point of moving from a failing strategy to a Ponzi scheme. He collected money from investors,claimed relatively high and consistent returns and invested in Treasuries. Because hedge funds are essentially not regulated, he did not have to file with the SEC or issue reports to investors. Even this scheme failed with the subprime meltdown of 2008. He confessed to the FBI and sentenced to 150 years in jail. He claimed that his behavior was deceitful but not unusual; that is, within the norms of Wall Street.

What's the answer? Why did Bernie do it: "I really have not been able to figure out how I let myself do this." The book doesn't answer the question, but provides additional clues on white-collar crime.