With the long bank holiday I managed to finish reading the book “Lying for Money” by Dan Davies. This is one of the best books I have read on fraud.
It covers the history of fraud through the ages including most of the great cases and the most recent big ones. Fraud is still rampant despite many of the obvious ways it can be executed blocked by better laws in the last 100 years. For example, the FCA announced last week that three individuals have been convicted and sentenced to a combined 24 years for an “all-or-nothing” investment fraud. Punters were persuaded via cold calling to invest in binary options via a sophisticated online platform that appeared to show their funds being traded, however, this was manipulated to show trading activity when there was none.
His Honour Judge Hehir, remarked that ‘[BMG] was no more than a money-making machine, which operated to transfer as much of its unfortunate customers’ money into [the defendants’] pockets as possible’. ‘All 3 defendants were a loose confederation of criminally minded associates’ and ‘equally responsible’. He stated that they lived a lavish lifestyle from the money and often misery of the victims, including large cash withdrawals, expensive foreign travel, cosmetic dentistry, online gambling, property purchases, a wedding reception and partying in nightclubs. Binary options have subsequently been banned for retail investors.
There is a particularly good chapter under the heading “Cooked Books” on stock market fraud. These paragraphs are from it: “There are many reasons one might want a crooked set of books — to present an image of financial soundness to the victim of a long firm, for example, or to pretend that a sum of money has been spent honestly rather than embezzled. But the most common one is that you want to show your crooked accounts to investors so that they give you money. For this reason, any discussion of accounting fraud needs to be put in the context of stock market fraud, because one is usually the point of the other. With that in mind, here’s how one steals money by lying to the stock market.
A public financial market provides the same service to liars that it provides to honest businesses — it converts stories into cash. If you own a profitable enterprise in an economy with functioning stock markets, you hold a form of ‘Supermoney as the fund manager and auditor George Goodman noted in a book of that name. Super how? Not only does the business provide a steady stream of income; the stock market offers a way to acquire and spend years of future profits before you make them”.
If a company is trading on a prospective p/e of 30 then it is multiplying its future profits by 30 in terms of market capitalisation.
This book should be essential reading for all investors and for all auditors as it covers the most common types of frauds. Does the book help you to spot frauds? Perhaps in that there are often warning signs. Such as high growth rates and consistently better financial performance than similar competitors (Madoff investment funds or Patisserie Valerie).
But here is one warning in the book: “Small investors in the stock market legitimately expect that they ’re going to have a chance to make a profit; if, instead, they’re systematically going to be filled up with the duds, then they are going to find something else to do with their savings and/or gambling money. And even in the modern world of huge fund managers and high-frequency robot traders, retail investors are more important than you might think.
Retail investors have one hugely attractive property when considered by a professional – they’re dumb money. Not only are they unlikely to have private information, a lot of the rime they haven’t taken care to consider all the public information. When the party on the other side of the trade is a small investor (or a lot of orders from small investors all over the country, ‘bundled’ by a retail stockbroker), you can be reasonably sure that you’re not taking too big a risk that the person selling stock to you knows something about it that you don’t.
This makes retail orders very valuable to the market. One of the reasons why stock brokerage commissions are so cheap these days is that retail brokers have actually realised how valuable they are. They charge a quite substantial fee to players like the high-frequency traders for the privilege of dealing against their order flow, and they rebate some of this fee to their customers. But the retail orders would eventually dry up if the customers lost too much or felt that they weren’t being given a fair chance. And without a steady flow of ‘dumb money’ lubricating the wheels, the professionals would find it a lot harder to trade, as they’d always suspect each other’s motives for buying or selling”
The book is an easy read and does not get too bogged down in the technicalities of fraud (even the complexities of VAT carousel fraud). Most frauds are quite simple in essence – lying about assets, revenues or profits.
Altogether a highly recommended book of 300 pages.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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