How to Avoid Being Asked to Commit Fraud

A recent article in The Economist discusses how to avoid being asked to commit fraud. It can be very uncomfortable if your manager asks you to alter the books or do anything that is unethical. Often there are not only repercussions for committing the fraud (i.e., fines or jail time), but also for not committing the fraud (21% of employees who reported unethical behavior at work said they experienced some form of punishment from their employer). If you refuse to commit a fraud, your manager may choose not to promote you or may even fire you.  Rather than refusing to commit a fraud, the best scenario for an employee would be to never be asked to commit a fraud. A study that was done by Dr. Sreedhari Desai (professor at the University of North Carolina at Chapel Hill) found one approach that dissuades managers from asking employees to engage in unethical behavior.

Tension Between Corporate and Government Whistleblowing Programs

Whistleblowing is considered the most effective method of detecting large corporate frauds. For example, Cynthia Cooper and Sharon Watkins are famous whistleblowers who spilled the beans on the frauds at WorldCom and Enron, respectively. Unfortunately, the corporate world, and society in general, hasn't always treated whistleblowers as heroes. In fact, many whistleblowers are blamed for the negative effects of fraud (such as job layoffs) when fraud comes to light. For example, Cynthia Cooper experienced this and speaks about being shunned by the people in her town after she brought WorldCom's massive fraud to light. Basically, society seems to perpetuate the Kindergarten stigma of being a "tattle tale" and, as a result, they shoot the messenger when it comes to reporting fraud.

Since Enron and WorldCom, many government regulations have been established to provide incentives to whistleblowers. The Sarbanes-Oxley Act requires internal whistleblowing programs at publicly traded companies while the False Claims Act and, more recently, the Dodd-Frank Bill provide incentives for whistleblowers to tell government officials about fraud. The False Claims Act applies to acts that defraud the Federal Government while the Dodd-Frank Bill applies to any public company who commits fraud and involves basically any fraud that is regulated by the federal government. As we've discussed before, the government incentives can lead to millions in rewards to an individual who blows the whistle if the government collects more than $1 million from the company.

The WSJ has an interesting article that talks more about the tension these regulations have led to. Basically, SOX has led public companies to have internal whistleblowing systems while Dodd-Frank leads whistleblowers to go outside the company to blow the whistle. Unfortunately, I'm not sure there are any easy answers since it seems both programs are important. The internal program is needed for smaller amounts (frauds that lead to less than $1 million in fines to the Federal Government don't apply to the Dodd-Frank Act) while it seems that whistleblowers of large frauds may not be treated fairly at a corporate level, especially if top management is involved.

I guess there are no simple and profitable solutions for preventing and detecting fraud in a business environment that is ethically bankrupt. In my opinion, as long as families fail to instill ethical values in the home, the forecast for this tension and cost is not looking good. If society continues to deteriorate because families fail to instill ethical values in the home, regulation will either cripple business or fraud will become more rampant.

Documentary of the Crazy Eddie Fraud

A documentary of the Crazy Eddie fraud has recently become available on YouTube (clips embedded at the end of this post).  Sam Antar, Crazy Eddie's former CFO described the motivation behind the fraud as follows (via White Collar Fraud):

New Stimulus idea: Promote fraud to create jobs!

This is the idea that a delegate from Russia seemed to espouse as he commented in a meeting yesterday.

I was asked by the Marriott School to speak to a small group of delegates from Russia who were interested in understanding fraud and corruption. As we talked about the effects of fraud and corruption on an economy, one of the delegates (a lawyer) kept smiling and commenting that unethical business conduct leads to job creation!

It's true that when people are unethical in business, you need to increase controls including people and systems to monitor, prevent and detect the conduct. However, this does not lead to economic gain overall. After several explanations of how corruption creates friction in an economy, I was amazed that he persisted in this thought. He continued to smile and espouse this job creation from unethical business conduct over and over again even though we tried to explain how corruption can cripple an economy.

I tried to explain how corruption in an economy has crippled many third world countries such as Haiti. I've been to Haiti and seen people who are willing to work hard for $3 a day but who can't find work because viable businesses can't survive there because the costs of bribes and corruption are so extreme. As a result 90% of the people are out of work.

The argument of this lawyer is about like saying we ought to promote violent crime so we can create more jobs for police officers, builders of jails, jail keepers, emergency room workers and so on!

I've tried to imagine what our economy would be like if people had a high standard of ethics. If people followed the golden rule to treat others how you want to be treated, the economy would be very different. I must agree with the Russian lawyer that many people would find their jobs were not in demand. This includes police officers, auditors, fraud examiners, virus detection software programmers, alarm system companies, lawyers, etc. The list goes on and on. Unfortunately, I think the future is only getting brighter for careers in these areas.

I believe that the drain on the economy from all the economic effort needed to protect us from being exploited and hurt by one another is tremendous. I also believe that the drain is getting bigger with time. I can only imagine that a high standard of living could be accomplished for all with much less work if we didn't need to spend so much energy protecting ourselves from one another.

Yes, it's true that unethical business conduct leads to job creation. In fact, it also leads to a lower standard of living for every economic input. So, if we now have to work 50 or 60 hours a week to have a reasonable standard of living, I believe the same standard of living would probably require about 10 hours a week of working in a society that lives the golden rule. If corruption increases, either we will need to work more or our standard of living will decrease in order to support all the jobs needed to protect ourselves from the corruption.

That's not the stimulus package I want to see!

Ethics and Ponzi schemes...

The NY Times published an interesting article that describes how many Madoff victims are upset because the trustee, Irving Picard, is not counting funds that were paper gains in Madoff's Ponzi scheme. This article does a good job illustrating how we often focus on how a decision affects us, personally, and ignore how it impacts others. When we fail to concern ourselves with how a decision affects others, we often behave in ways that are immoral or unethical. I try to help my students see how unethical behavior is selfish and takes from someone else. Here is a classic example from the NY Times article:

Put yourself, for a moment, in the shoes of a certain class of Madoff victim — what the trustee is calling “net winners.” These are the people who took out more money from their accounts than they put in. ... I’m talking about the Madoff investor who put in, say, $1 million and over a 15-year period withdrew $1.2 million.

On that person’s November 2008 statement — the last one before the fraud was exposed — she probably still had a very healthy balance, maybe $500,000 or more. It’s only natural that she views that balance as money that was hers — but that she has now sadly lost. To her, that money is real.

Now look at that same net winner from Mr. Picard’s point of view. In truth, that $500,000 doesn’t exist. After all, Mr. Madoff wasn’t really running an investment fund; he was running a Ponzi scheme. The steady returns, from which that $500,000 was supposedly generated, were fictitious.

“What they were getting was other people’s money,” said David J. Sheehan, a lawyer at Mr. Picard’s firm, Baker Hostetler. In other words, any money our hypothetical Madoff investor received came from the pockets of other Madoff investors, who were putting money into their accounts. That’s how Ponzi schemes work. And because that $500,000 never really existed, Mr. Picard has said he will not count it. He is going to count only how much actual money went into an account versus how much came out.

Perhaps if people would ask whether the latest "get rich quick" scheme that they are considering might be hurting another person, Ponzi schemes wouldn't be so prevalent in our society...