By Prabhakar Kaza
Fraud is never accidental. Much as most fraudsters have tried to convince the Press and the Judiciary, it is invariably pre-meditated. Above all, fraudsters know that it is their intention to abuse the system and begin with the self-belief that they would never be caught and if caught, they would be exonerated, ie they would be let off for want of sufficient evidence. No fraudster in history has said that he was sorry for the victims and proposed to reimburse him for his wrongful gains.
Wonder if any of you read about the Scotsman, Gregory McGregor (who has been called by a 21st Century Financial Analyst as “The founding Father of Securities Fraud”) and his Poyals Con which is the most bizarre confidence trick in History. In the 1820s he drew up an imaginary country Poyals in Central America and sold Sovereign Bonds/Land certificates in London. In short, the Poyaisian scheme failed due to general instability in South America as well as the fact that a few investors ventured to visit the Americas and returned disillusioned.
Black Monday (19th October 1987) is the name associated with a sudden global Stock market crash. It sparked fears of extended economic instability and a return of the Great Depression (1929-33). It also altered implied volatility patterns that arise in pricing financial options. This is being mentioned to indicate that every Stock Market crash is not the result of Financial Crimes, as this was found by analysts that it was caused by general mindset of the investors, a “gut feeling” of an impending crash, brought on by “ too much indebtedness”.
Insider Trading: Surely all the readers know that it is a financial crime to use personal/non-public material information for stock market transactions. History records that William Duer, Assistant Secretary of the Treasury in the times of Alexander Hamilton in 1789 was the first to be caught taking advantage of his access to confidential information in order to speculate on stocks and bonds. In the 1980s quite a few leading traders like Ivan Boesky, Robert Freeman were convicted. American Retail Businesswoman Martha Stewart in 2001 was arrested for selling stocks as a loss-minimization measure benefiting from the knowledge of time of FDA announcements. The reader will vastly benefit from seeing the movie “Wall Street” and how Gordon Gekko(called by some as Corporate Psychopath)’s philosophy “Greed is Good” contributed to the Crash.
1980 also saw Barry Minkow who as a teenager, claiming that his company was the General Motors of carpet-cleaning created, out of thin air, a multi-million dollar corporation, by manufacturing more than 20,000 phoney documents and sales receipts. Through this forgery and theft, he took his company ZZZZ Best to public in 1986 eventually reaching a market capitalization of more than USD 200 million on the Stock market.
One Rogue trader can bring a Bank down! Nick Leeson, English derivatives trader in Singapore brought down UK’s oldest Merchant Bank—Barings, in 1995, by his fraudulent, unauthorized and speculative “arbitrage” trades. He used to hide the losses in Error accounts 8888 (accounts used to correct mistakes made in trading). The laid-back attitude of the Senior management in London, the unquestioning trust that they placed in a trader 6,765 miles away and the ease with which they remitted millions as margin money without assessing the risks involved, contributed to the downfall of the Bank. The lack of oversight in the 233-year old bank, coupled with the Kobe Earthquake of 1995 (The Bank’s trading position heavily leaned on Japan) compounded to the disorganization in the institution. The unauthorized investments, primarily Futures Contracts collapsed the Bank with a Billion Pound loss and the Bank was eventually bought by ING bank for £1.
At one point of time Enron was the Seventh largest company in terms of Revenue in USA. Keeping debt off its books and recording fictitious revenues, thanks to some Shell companies, fooling analysts and investors, the company imploded and brought the phrase “Cook the Books ” a household term once again. WorldCom, Bernie Madoff and Wirecard who fall under the same category have brought the Auditing world under scrutiny. Boiler Room Frauds: Boiler room is a manipulative operation in which salespeople apply high-pressure tactics to persuade investors to purchase securities, some speculative and fraudulent. The sales people lure unwitting customers into making investments in several manipulative schemes and in the Stock Market in particular, making the investors subscribe to IPOs in worthless companies which have no real value. They do this by creating a hype about the company/products/its forecasts and making outrageously false promises.
Hollywood in “The Wolf of Wall Street” amply makes the tactics clear how the tactician pressurises for an immediate decision, guarantees win, promises huge returns and advises the prospective investor how the call has been tailored to his needs. The employees are invariably offshore and carry fancy designations, supposedly carrying insider and personal knowledge.
This social engineering operation has been made famous in India by Jamtara series on Netflix.
Global Financial Crisis of 2007-08: The most serious financial crisis since the Great Depression. The US political intention of Housing for all ended up in predatory lending to clients by Banks/Building societies with poor or no credit-rating, NINJA Loans (No Income No Job and no Assets) extended to borrowers with little or no attempt by the lender to verify the applicant’s ability to repay and ignoring the normal verification process of evidence of stable income stream or sufficient collateral.
These loans were bundled and sold by all high-street Corporate and Merchant bankers, after getting them rated AAA by Credit-Rating agencies as high-yielding bonds, knowing well that they were junk bonds. The Global Financial Crisis led to the collapse of Lehman Brothers and Bear Stearns with the majority of the Global banks kept afloat by generous hand-outs by the Governments (The economies had to be kept from going under by Quantitative Easing).
The loan default-rates coupled with fall of property values led to the collapse of the Stock market. The Global Financial Crisis had the complicity of the Lenders, Traders, Realty valuers, Rating Companies and of course the customers and last but not the least the Government. Everyone knew what was happening and nobody wanted to stop the Financial Mela! Cost to the world of this reckless lending spree was bizarre and the upper estimate (including loss of output) is $25 trillion. It led to the bailout of banks the world over and reduction in Real Estate prices, cost of borrowing and above all standard of Living.
1. Too Big to Fail
2. The Big Short
3.The Shifts and The Shocks
Financial Crime goes Hi-Tech: Dubbed by London media, as the Hound of Hounslow, Narinder Sarao, the “flash crash trader”, triggered $1 trillion stock market crash in USA in 2010 in less than an hour.
Sarao has Asperger’s syndrome and saw beating the markets “like winning a Video game”. He remotely traded on Chicago Mercantile Index and every time an order was placed to buy or sell,“ High frequency traders”—not all human but computers running algorithms-would make their own trades milliseconds before those orders could be executed.
Once he had created artificial demand, his bespoke software took advantage of this by placing thousands of orders before quickly canceling or changing them. He is estimated to have made in all $40m. He pleaded guilty to Electronic fraud and “Spoofing”.
Back home in India we have had the famous case of Harshad Mehta who took advantage of the delay in posting transactions. Exploiting several loopholes in the banking system, the group siphoned off funds from Inter-bank transactions and bought shares at a premium triggering a rise in the BSE Sensex. He engaged in massive stock manipulation financed by worthless Bank Receipts(BRs). The 1992 Indian securities scam is valued at INR 10,000 Crores.
Ketan Parekh had written his name in history as a famous market manipulator who rigged prices of chosen securities (K-10 Stocks) using large sums of money borrowed from banks. Ketan would buy stakes in less known small market cap companies and jack up their prices through circular trading with other traders and collude with other companies and institutional investors.
In conclusion Financial Criminals are very intelligent players who exploit the weaknesses in the people, procedures and systems. They are always one step ahead of the Regulators, always knocking on the boundaries of Compliance and Supervision. As Thomas J.Donohue, CEO of the United States Chamber of Commerce said “Sound regulation and enforcement are needed to ensure that our capital markets remain accessible, competitive, and free of bad actors”
“History repeats itself”. In order not to repeat history we need to have a more comprehensive, assured and demonstrable approach to Financial Crime.
(Prabhakar Kaza is the former general manager, State Bank of India and now CEO/Director of Hamilton Reserve Bank Lt)