WEBVTT - Why Understanding Financial Fraud Is The Secret To Understanding Business 0:00:09.920 --> 0:00:14.120 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.200 --> 0:00:19.200 I'm Joe Wisenthal and I'm Tracy. Allowit, Tracy, I think 0:00:19.440 --> 0:00:23.560 you're really gonna like today's episode. Oh okay, what is it? 0:00:23.800 --> 0:00:26.400 I mean? I guess I would hope that you like 0:00:26.520 --> 0:00:29.040 all of the episodes. But I feel like this is 0:00:29.040 --> 0:00:31.560 a topic that, just from what I know about you 0:00:31.640 --> 0:00:35.479 really animate too. But we are going to be talking 0:00:35.520 --> 0:00:40.559 about fraud and financial fraud. Fraud. Wait. Should I take 0:00:40.600 --> 0:00:43.080 that as like a personal slight that you think I'm 0:00:43.080 --> 0:00:46.080 really interested in financial fraud? No, it's not a slight. 0:00:46.240 --> 0:00:49.560 I just feel like that you have a mind that 0:00:49.920 --> 0:00:55.040 likes to figure out frauds and leans towards fraud. Yeah, exactly, 0:00:55.080 --> 0:00:58.880 and figures them out and understands how they happen and 0:00:58.920 --> 0:01:02.960 the conditions it allow frauds to take place, and how 0:01:03.000 --> 0:01:05.880 people missed everything. I feel like that's a youth thing. 0:01:05.920 --> 0:01:09.520 Am I wrong? No, you're right. Uh, you actually nailed 0:01:09.520 --> 0:01:11.680 it on the head in um what you just said. 0:01:11.760 --> 0:01:15.399 It's the fact that people miss these things when they're happening, 0:01:15.520 --> 0:01:18.479 and then as they unfold, you kind of go back 0:01:18.480 --> 0:01:21.280 and you see all the warning signs and you think, 0:01:21.440 --> 0:01:24.640 how could people not have seen this coming. That's what 0:01:24.720 --> 0:01:27.920 fascinates me the most. It's it's people missing out on 0:01:28.040 --> 0:01:32.199 something that is quite clear in hindsight. Yeah, it's pretty 0:01:32.200 --> 0:01:35.760 incredible when we have these stories about big financial frauds, 0:01:35.760 --> 0:01:40.399 how egregious they seem always in retrospect, and how they're 0:01:40.400 --> 0:01:43.800 just always seemed to be numerous red flags that anyone 0:01:43.880 --> 0:01:46.080 with half a brain should have been able to pick 0:01:46.160 --> 0:01:50.000 up on. And yet somehow we have this suer delusion 0:01:50.080 --> 0:01:52.920 where nobody sees it, or maybe people who saw it 0:01:53.240 --> 0:01:56.400 decided that it wasn't worth pointing it out, and then 0:01:56.520 --> 0:01:59.920 we have to relearn human history and human behavior all 0:02:00.000 --> 0:02:03.240 over again for the next time. Yeah, exactly. And there's 0:02:03.280 --> 0:02:06.880 an example that springs immediately to mind, probably one of 0:02:06.920 --> 0:02:12.040 the most famous recent financial frauds, Bernie made Off and 0:02:12.080 --> 0:02:16.120 you remember, um, after he got arrested, people started circulating 0:02:16.400 --> 0:02:20.160 charts that showed the historical performance of the fund that 0:02:20.240 --> 0:02:23.960 we're coming from, uh, the made Off funds marketing materials, 0:02:23.960 --> 0:02:27.760 and they were just a straight, smooth line pointing upwards. 0:02:27.800 --> 0:02:31.400 And of course, in hindsight, everyone thought that was deeply, 0:02:31.480 --> 0:02:35.120 deeply suspicious. But at the time, people some of them anyway, 0:02:35.440 --> 0:02:39.200 seemed more than happy to just accept that as fact. Yes, 0:02:39.360 --> 0:02:42.080 it's it's perfect example, because it's one of these things 0:02:42.080 --> 0:02:44.760 that in hindsight, as you say, it's like, oh, of 0:02:44.800 --> 0:02:47.760 course that could never have been realistic. Where was everyone 0:02:47.800 --> 0:02:51.400 at the time saying how impossible it was. It's a 0:02:51.480 --> 0:02:55.040 perfect example of how something happens and the exact same 0:02:55.080 --> 0:02:58.320 fact goes from being oh, this is very impressive to oh, 0:02:58.360 --> 0:03:03.080 this is obviously a scamp. Yeah. How quickly things change. Yeah, 0:03:03.120 --> 0:03:07.600 So maybe we could avoid frauds in the future, or 0:03:07.720 --> 0:03:12.160 spot them quicker if we really studied the patterns and 0:03:12.320 --> 0:03:17.400 instituted some good practices about the weak spots in our 0:03:17.440 --> 0:03:21.800 behavior and in organizational behavior that fraudsters like to exploit. 0:03:22.480 --> 0:03:24.919 I think that would make a lot of sense. So 0:03:24.960 --> 0:03:27.600 maybe we'll start on that road with our guest today. 0:03:28.160 --> 0:03:31.200 His name is Dan Davies, and he is the author 0:03:31.320 --> 0:03:34.839 of a new book called Lying for Money, How Legendary 0:03:34.920 --> 0:03:39.320 Frauds Reveal the Workings of our World. And it is 0:03:39.360 --> 0:03:43.280 a fascinating book, and it looks at lots of frauds 0:03:43.280 --> 0:03:47.280 and historical patterns and how they come about. And uh, 0:03:47.360 --> 0:03:59.440 Dan joined us. Now, Dan, thank you very much for 0:03:59.520 --> 0:04:02.880 joining us, Thanks very much for having me Dan. Before 0:04:02.960 --> 0:04:06.840 we get into the frauds and the patterns of fraudsters 0:04:06.960 --> 0:04:08.440 and why we miss them and all this stuff that 0:04:08.480 --> 0:04:12.400 we're talking about, let's just talk about your career. I 0:04:12.760 --> 0:04:15.040 kind of think of you as someone who just knows 0:04:15.200 --> 0:04:20.560 about everything, and you, uh, you can talk about political referendums, 0:04:20.600 --> 0:04:23.480 and you can talk about technical things, and tell us 0:04:23.520 --> 0:04:27.920 a little bit about your career background and why you 0:04:28.040 --> 0:04:30.920 wanted to write a book on this topic. Sure, well, 0:04:31.080 --> 0:04:35.640 I was basically acquisi analyst for fifteen years. I started 0:04:35.640 --> 0:04:38.480 out at the Bank of England as a regulatory economist 0:04:38.520 --> 0:04:41.720 and I used to be in the office next door 0:04:41.760 --> 0:04:44.880 to the guy who was the elite supervisor of Barings 0:04:44.880 --> 0:04:48.080 Bank at the time of the Nick Leason crisis, which 0:04:48.200 --> 0:04:50.799 was kind of an interesting set of office traffics watch. 0:04:51.680 --> 0:04:54.400 Then I was lucky enough, over the course of about 0:04:54.480 --> 0:04:58.200 fifteen years in equity analysis to have a succession of 0:04:58.279 --> 0:05:03.080 busses who allow old me to mess around looking at 0:05:03.240 --> 0:05:08.040 quirky things rather than doing something about the usually disgraceful 0:05:08.120 --> 0:05:11.159 quality of my own ex forecasts. And so, you know, 0:05:11.240 --> 0:05:13.240 you pick up a little bit of everything because I 0:05:13.279 --> 0:05:17.760 was covering the financial sector, and financials are relevant to 0:05:18.000 --> 0:05:19.960 more or less anything you want to get interested in, 0:05:20.600 --> 0:05:23.960 which was something that I took full advantage of. Then 0:05:24.000 --> 0:05:26.480 about four or five years ago, I kind of felt 0:05:26.480 --> 0:05:28.480 that I had had as much fun as it was 0:05:28.520 --> 0:05:32.440 possible to have out of equity analysis, so I quit 0:05:32.839 --> 0:05:38.800 and well started writing articles for newspapers and websites and 0:05:38.880 --> 0:05:42.440 eventually started writing this book. And you know, frauds. It's 0:05:42.480 --> 0:05:46.880 just really interesting because it's like where the system breaks down. 0:05:47.440 --> 0:05:49.760 You know, you can study the economics all the time, 0:05:49.880 --> 0:05:53.640 but if you're only studying successful companies and economies, then 0:05:53.680 --> 0:05:56.239 it's like trying to learn about medicine by only studying 0:05:56.279 --> 0:06:00.840 healthy people. Where you really see how the structure works 0:06:01.360 --> 0:06:04.240 is in cases like bankruptcies and frauds and all these 0:06:04.320 --> 0:06:07.320 nasty things that people don't like to think about, where 0:06:07.360 --> 0:06:10.240 the whole system breaks down and where key assumptions turn 0:06:10.279 --> 0:06:13.440 out not to be true. I like that description. You're 0:06:13.480 --> 0:06:17.160 sort of probing the system for its weak spots. So 0:06:17.320 --> 0:06:19.400 I'm just going to jump right into it because, as 0:06:19.680 --> 0:06:22.320 Joe has already said, this is a topic that is 0:06:22.360 --> 0:06:26.039 dear to my heart. So what's your favorite example of 0:06:26.080 --> 0:06:29.600 fraud that you chronicle in your book. Oh, it kind 0:06:29.640 --> 0:06:33.160 of changes every day, because the thing is that obviously 0:06:33.160 --> 0:06:35.120 every day I'll come up with a new one that 0:06:35.160 --> 0:06:37.760 I wish i'd put in the book but didn't, or 0:06:37.839 --> 0:06:40.320 someone asks whether they're favorites in there, and I'm just 0:06:40.360 --> 0:06:42.480 like to do half of my favorites aren't in there. 0:06:42.960 --> 0:06:46.120 But I think the classic one is the Great salad 0:06:46.160 --> 0:06:49.600 oil scam. It's just such a beauty. Yeah. I mean, 0:06:49.640 --> 0:06:54.080 it's just basically oil floats on water. And because of 0:06:54.120 --> 0:06:58.920 this fact, it is surprisingly difficult to tell the difference 0:06:59.520 --> 0:07:03.600 between a tank full of valuable soybean oil and a 0:07:03.600 --> 0:07:07.000 tank that is basically full of seawater with a few 0:07:07.000 --> 0:07:10.400 gallons of soybean oil floating on top. And there was 0:07:10.440 --> 0:07:13.480 a guy called Tino de Angelis who was the salad 0:07:13.520 --> 0:07:18.200 oil king and really knew more about soybean markets than 0:07:18.400 --> 0:07:21.280 anyone else in the world at that time. But he 0:07:21.520 --> 0:07:25.040 was an absolute crook, and one of the ways that 0:07:25.120 --> 0:07:29.160 he managed to extract fraugil in cash from his company, 0:07:29.200 --> 0:07:34.400 American Crude Vegetable Oils, was to borrow money collateralized against 0:07:34.400 --> 0:07:39.360 the soybean oil in his tanks, but to have vastly 0:07:39.440 --> 0:07:42.640 more warehouse receipts, as the kind of short term ones 0:07:42.680 --> 0:07:47.800 were called outstanding, than there was soybean oil cartalized against them. 0:07:47.840 --> 0:07:50.040 He was a hell of a character. But what he 0:07:50.120 --> 0:07:53.520 used to do was let the lenders come out take 0:07:53.520 --> 0:07:56.120 a dip sample into one of his tanks, and it 0:07:56.240 --> 0:07:59.080 either had oil floating on water, or there was a 0:07:59.160 --> 0:08:02.320 length of pipe welded into its full of soybean oil 0:08:02.360 --> 0:08:04.600 and the rest of the tank was empty, or they 0:08:04.640 --> 0:08:07.360 even had a plumbing system to pump it around so 0:08:07.440 --> 0:08:11.120 that the same soybean oil could appear in different tanks. 0:08:11.200 --> 0:08:13.200 In the end, he was claiming to have more in 0:08:13.240 --> 0:08:16.200 his one tank form than the USA produced in an 0:08:16.320 --> 0:08:23.280 entire year. Now, obviously there's a scientific lesson here that okay, 0:08:23.400 --> 0:08:27.080 oil floats on water, and just for various technical reasons, 0:08:27.200 --> 0:08:30.880 it's difficult to verify that a big tanker is actually 0:08:30.920 --> 0:08:34.679 filled with the soybean oil that the owner claims it is. 0:08:35.440 --> 0:08:38.520 What is the sort of human lesson though? So what 0:08:38.679 --> 0:08:44.120 did he exploit with regards to human systems that allowed 0:08:44.200 --> 0:08:49.000 him to perpetrate this highly profitable scam. Well, yeah, that's it. 0:08:49.000 --> 0:08:51.280 It is all about the human systems. Because at the 0:08:51.360 --> 0:08:54.200 end of the day, if it hadn't been that, he'd 0:08:54.240 --> 0:08:56.240 have thought of something else. That was just the kind 0:08:56.240 --> 0:08:59.800 of guy he was. At the time, American Express was 0:08:59.840 --> 0:09:03.320 an independent financial institution rather than just a credit card brand, 0:09:03.760 --> 0:09:07.480 and it had a brand new corporate lending business, and 0:09:07.640 --> 0:09:10.280 it had a set of targets whereby every one of 0:09:10.320 --> 0:09:14.200 its divisions had to make at least a million dollars 0:09:14.200 --> 0:09:16.880 worth of profit every quarter, back in the days when 0:09:16.880 --> 0:09:19.240 that was a lot of money. And so there were 0:09:19.280 --> 0:09:23.600 people out there looking to gain market share rapidly, and 0:09:23.640 --> 0:09:26.800 if you're looking to gain market share rapidly, you tend 0:09:26.960 --> 0:09:29.320 to not be choosing off about the kind of customers 0:09:29.400 --> 0:09:32.760 that you take on. Now, everyone wanted to believe him 0:09:32.800 --> 0:09:36.240 he was a larger than life character. He actually used 0:09:36.280 --> 0:09:41.400 to allow rumors to circulate that, you know, D'Angelis was 0:09:41.520 --> 0:09:44.760 in the mafia because he felt like, you know, he wasn't, 0:09:45.080 --> 0:09:47.760 but he felt like if people believed that, then they 0:09:47.760 --> 0:09:49.959 would think that he had extra sources of cash flows 0:09:49.960 --> 0:09:54.160 and paid back his loans. And so, really, the thing 0:09:54.200 --> 0:09:56.079 that I keep on coming back to in these things 0:09:56.360 --> 0:10:01.719 is it's surprisingly difficult to challenge someone who's really determined 0:10:02.400 --> 0:10:05.960 to be a big time fraudster. If you've got someone 0:10:06.000 --> 0:10:11.600 who's really got into running a dishonest business, then actually 0:10:12.080 --> 0:10:14.800 they're going to design their scam around all the controls 0:10:14.840 --> 0:10:18.000 that you have, and they're going to look like a 0:10:18.080 --> 0:10:21.400 really successful operator. And you know, as we know from 0:10:21.840 --> 0:10:24.959 the dot com era, from all sorts of examples from 0:10:24.960 --> 0:10:28.880 the very recent past, if something's a success story, it's 0:10:29.080 --> 0:10:34.840 very psychologically, sociologically, and institutionally difficult to be the person 0:10:35.000 --> 0:10:36.920 who stands up to that guy. You know, It's the 0:10:36.920 --> 0:10:40.280 whole Emperor's New Clothes phenomenon. So I'm curious from the 0:10:40.400 --> 0:10:45.479 fraudsters perspective. I mean, there's clearly a lot of intellectual 0:10:45.880 --> 0:10:48.720 ingenuity that goes into a scam like the one that 0:10:48.800 --> 0:10:52.760 you just described. Why do you think they sort of 0:10:52.880 --> 0:10:57.640 channel their creative energies towards fraud and scamming people rather 0:10:57.720 --> 0:11:01.960 than actually working within the system to create a legitimate business. 0:11:03.000 --> 0:11:06.960 It's very weird, actually, Tracy. I mean, I'm not sure 0:11:06.360 --> 0:11:10.760 I understand why these people do this. I think the 0:11:11.120 --> 0:11:14.040 classic model is what they call the fraud triangle, Like 0:11:14.240 --> 0:11:18.480 you have the murder triangle of means, motive and opportunity 0:11:18.720 --> 0:11:21.720 for fraud. What it seems to be is that you 0:11:21.800 --> 0:11:25.840 have an opportunity which is a deficient control or a 0:11:25.840 --> 0:11:30.280 way around the existing control systems. You have a mead, 0:11:31.000 --> 0:11:33.439 which is just someone you know. As I say in 0:11:33.480 --> 0:11:36.160 the book, bankers in the end steal for the same 0:11:36.200 --> 0:11:38.640 reason that heroin addicts do. They've been put in a 0:11:38.679 --> 0:11:40.880 position where they have to get hold of more money 0:11:40.880 --> 0:11:43.240 than they can get hold of immediately by honest means. 0:11:44.120 --> 0:11:48.520 And then you have what Kressy called a rationalization, because 0:11:48.559 --> 0:11:52.720 the interesting thing about these fraudsters is in general, they 0:11:52.760 --> 0:11:57.120 don't regard themselves as deviance individuals in the way that 0:11:57.360 --> 0:12:02.440 other criminals basically do. Are read about two dozen autobiographies 0:12:02.440 --> 0:12:05.240 of people who had been convicted of famous frauds, and 0:12:05.320 --> 0:12:08.760 the absolute constant refrain through all of them is that 0:12:08.840 --> 0:12:12.360 it wasn't really my fault. They always find some way 0:12:12.440 --> 0:12:16.679 of distancing themselves and putting a psychological barrier between their 0:12:16.720 --> 0:12:20.760 self image as basically an honest and successful business person 0:12:21.200 --> 0:12:24.280 and the reality of what they're doing. So even to 0:12:24.320 --> 0:12:27.600 you know, the Angelus, who was clearly stealing money from 0:12:27.640 --> 0:12:32.800 his company, kept on rationalizing it that all he was 0:12:32.880 --> 0:12:37.439 doing was borrowing money in order to finance later transactions. 0:12:37.760 --> 0:12:40.800 There's usually some fantasy that there's going to be a 0:12:40.800 --> 0:12:42.920 big score at the end of it which will allow 0:12:43.000 --> 0:12:46.240 them to pay everything back and make everything right as 0:12:46.240 --> 0:12:49.000 if the fraud had never happened, and then we only 0:12:49.000 --> 0:12:53.160 find out about them when they collapse. One thing that 0:12:53.240 --> 0:12:56.600 interests me is how many nick Leason's there are out 0:12:56.640 --> 0:12:59.480 there who actually did happen to have a good day 0:12:59.480 --> 0:13:01.319 on the market and managed to make cool of the 0:13:01.440 --> 0:13:04.840 hitting account's balance. Daniel said something that I thought was 0:13:04.960 --> 0:13:08.360 very funny when you said that this character, you know, de' 0:13:08.440 --> 0:13:12.560 angelis like to have the rumor out there that he 0:13:12.800 --> 0:13:16.160 was linked to the mafia even though he wasn't, because 0:13:16.160 --> 0:13:19.480 it put the idea in prospective business partners had that 0:13:20.000 --> 0:13:22.680 maybe had actually made him more credit worthy because he 0:13:22.720 --> 0:13:25.520 had other sources of income coming in. It kind of 0:13:25.559 --> 0:13:30.120 reminded me of with made Off. Weren't there people who 0:13:30.360 --> 0:13:34.559 suspected something was amiss, but that they thought it was 0:13:34.600 --> 0:13:36.800 something else, so they thought, oh, maybe he's doing some 0:13:36.920 --> 0:13:41.400 sort of insider trading or doing something else that sort 0:13:41.400 --> 0:13:44.480 of scam me with the uh, you know, market maker 0:13:44.559 --> 0:13:48.319 side of his company. And although you'd think that should 0:13:48.360 --> 0:13:50.960 be a red flag to anyone that actually made them 0:13:50.960 --> 0:13:54.920 more confident that he would have the money to keep 0:13:54.960 --> 0:13:57.800 supporting his fund. Yeah. Yeah, yeah, quite a lot of 0:13:57.800 --> 0:14:01.439 people thought exactly. Thus, also with some Israel that you 0:14:01.600 --> 0:14:05.440 capital and some Israel actually wasn't inside its radiator as 0:14:05.440 --> 0:14:10.640 well as a conci scheme operator. But yeah, people thoughts, well, 0:14:10.760 --> 0:14:13.880 he's a crook, but he's not necessarily going to scam me, 0:14:14.760 --> 0:14:18.000 which turns out usually to be quite about way to 0:14:18.360 --> 0:14:24.640 run your relationships. So how can organizations, I mean, you've 0:14:24.640 --> 0:14:30.160 identified a couple of obvious weaknesses or blind spots that 0:14:30.240 --> 0:14:33.960 happened when organizations they set out a specific target for 0:14:34.160 --> 0:14:38.040 making money or market share that causes them to drop 0:14:38.080 --> 0:14:41.520 their guard. They think, well, I'm I'm okay getting into 0:14:41.560 --> 0:14:43.840 business with the scammer because I'm not the one being 0:14:44.080 --> 0:14:49.920 scammed here. What are some practices that companies can actually 0:14:50.000 --> 0:14:53.120 implement to sort of guard against these sort of obvious 0:14:53.400 --> 0:14:56.840 human failures. Well, I'm going to give two answers to that, 0:14:56.880 --> 0:14:59.680 I mean, directly answering the question. I think it comes 0:14:59.680 --> 0:15:03.920 back to the fraud triangle. You want to avoid creating 0:15:03.920 --> 0:15:08.840 a need so you don't want to create situations in 0:15:08.880 --> 0:15:12.680 which you're setting unrealistic targets for your staff, because if 0:15:12.720 --> 0:15:15.360 you're setting on realistic targets, then you're putting them in 0:15:15.360 --> 0:15:19.520 a position where they can't do things legitimately, and that's 0:15:19.520 --> 0:15:23.720 where you're getting what they call criminergenic in sensuves so 0:15:23.840 --> 0:15:29.160 in sense of structurally making people more likely to commit crimes. 0:15:30.080 --> 0:15:34.920 You can then look at the opportunity side of the triangle, 0:15:35.400 --> 0:15:38.120 and an opportunity to commit fraud is just a weakness 0:15:38.120 --> 0:15:41.840 in controls. As we say in the book, every time 0:15:41.960 --> 0:15:44.800 you decide what you're going to check up on, you 0:15:44.840 --> 0:15:47.520 are also deciding what you're not going to check up on. 0:15:48.000 --> 0:15:50.200 And that's how the fraud gets into the system, because 0:15:50.240 --> 0:15:54.000 you simply can't check up on everything. And so, you know, 0:15:54.160 --> 0:15:58.800 for catching the bulk of frauds, it's really you know, 0:15:58.920 --> 0:16:02.680 a like a return except it's say fraud return trade off, 0:16:03.040 --> 0:16:06.320 where you start beefing up the controls until you think 0:16:06.360 --> 0:16:09.800 that the marginal value of the frauds you're preventing is 0:16:09.840 --> 0:16:14.360 equal to the marginal cost of doing so. Having said that, 0:16:14.360 --> 0:16:18.320 that's a really difficult thing to investigate because the definition 0:16:18.320 --> 0:16:21.200 of a fraud is it's something that happens outside your 0:16:21.240 --> 0:16:26.440 normal manufacturements information systems, so you can really badly get 0:16:26.480 --> 0:16:29.320 that optimization calculation wrong. In the classic example of that 0:16:29.360 --> 0:16:34.920 is Medicare, where in the end, credible people like non 0:16:34.960 --> 0:16:40.960 politically say that in the nighties, between twenty and a 0:16:41.040 --> 0:16:45.840 third of all payments made under the Medicare system were fraudulent, 0:16:46.680 --> 0:16:49.880 which was probably hundreds of billions of dollars, probably the 0:16:49.880 --> 0:16:52.640 biggest fraud until the financial sector took the title back. 0:16:53.480 --> 0:16:56.400 And what was going on there is that it was 0:16:56.600 --> 0:17:00.800 absolutely assumed that the main cost problem in Medicare was 0:17:00.960 --> 0:17:04.040 over treatments, and that the main driver of over treatment 0:17:04.359 --> 0:17:07.439 was defensive medicine from doctors who are scared of getting sued, 0:17:08.400 --> 0:17:12.320 and so they had systems that were meant to catch 0:17:12.720 --> 0:17:18.919 unusual treatments but minimize otherwise the cost per claim processed. 0:17:19.359 --> 0:17:21.560 And so what they built was a system that couldn't 0:17:22.000 --> 0:17:26.919 detect four thousand identical hip replacements coming in from a 0:17:26.960 --> 0:17:30.240 clinic in Florida that just simply didn't exist because it 0:17:30.280 --> 0:17:33.480 was a paper creation of some fraudsters. So you can 0:17:33.560 --> 0:17:37.639 think about things like that. On the other hand, the 0:17:37.680 --> 0:17:40.000 second answer I'd give is almost to turn around the 0:17:40.080 --> 0:17:44.120 question and say, are you sure that minimizing your exposure 0:17:44.160 --> 0:17:45.960 to fraud risk is actually what you want to do, 0:17:46.920 --> 0:17:50.080 because you know, the question is do you want to 0:17:50.280 --> 0:17:52.920 make yourself bulletproof against fraud or do you want to 0:17:52.960 --> 0:17:58.320 get rich? And actually, it turns out, as far as 0:17:58.320 --> 0:18:02.600 I can sell, the optimum level of fraud is certainly 0:18:02.640 --> 0:18:05.800 not zero, and it could be very high. We could 0:18:05.800 --> 0:18:09.040 look in Silicon Valley and take a look at the 0:18:09.040 --> 0:18:13.520 Frans case and Elizabeth Holmes and say, well, this is 0:18:13.520 --> 0:18:18.160 pretty easy. You avoid a thranos by really checking out 0:18:18.520 --> 0:18:23.520 all your tech demos and then not doing any business 0:18:23.560 --> 0:18:27.159 at all with people who fake their demos, which is 0:18:27.200 --> 0:18:30.920 a great way of avoiding frauds. Unfortunately, it also means 0:18:30.960 --> 0:18:35.880 that you miss investing in Oracle because Larry Ellison totally 0:18:35.880 --> 0:18:40.600 fake demos at crucial elite stages. It means you probably 0:18:40.720 --> 0:18:43.840 miss investing in Apple around the time of the iPhone 0:18:44.240 --> 0:18:48.399 because some of those demos there were definite differences between 0:18:48.400 --> 0:18:50.119 what was happening on the big screen and what was 0:18:50.160 --> 0:18:54.880 being sent from the device. In general, a system that's 0:18:54.880 --> 0:18:58.320 set up to eliminate fraud risk is going to eliminate 0:18:58.560 --> 0:19:01.880 so much legit some business that I kind of find 0:19:01.920 --> 0:19:04.920 myself wondering if what you should be looking for is 0:19:04.960 --> 0:19:07.280 almost a rule of thumb to stop you trusting too 0:19:07.280 --> 0:19:10.920 little rather than trusting too much. H Um. I want 0:19:10.960 --> 0:19:13.240 to press you on this point because it's a really 0:19:13.280 --> 0:19:16.520 interesting one. And you know, if you read another very 0:19:16.520 --> 0:19:19.840 good book, Bad Blood, about the Sarin Nos case, one 0:19:19.840 --> 0:19:22.320 thing that comes out is that Elizabeth Holmes was sort 0:19:22.359 --> 0:19:26.480 of pursuing strategies that she thought had been pursued by 0:19:26.560 --> 0:19:30.159 Apple and Microsoft before, so sort of a fake it 0:19:30.200 --> 0:19:33.440 till you make it approach. How many of the frauds 0:19:33.480 --> 0:19:38.520 that you look at actually start out as legitimate business activities, 0:19:38.560 --> 0:19:42.840 maybe even promising business activities, and then encounter some trouble 0:19:43.000 --> 0:19:47.480 and then turn into actual frauds. I think it's about 0:19:47.600 --> 0:19:50.520 fifty fifty between that sort of thing of being a 0:19:50.560 --> 0:19:54.120 legitimate business that drifts and something that was clearly set 0:19:54.240 --> 0:19:56.600 up as a fraud from day one. I mean, the 0:19:56.720 --> 0:19:59.960 interesting thing about the whole Soranus and the fake it's 0:20:00.080 --> 0:20:03.639 or you make it model is that it's a history 0:20:03.640 --> 0:20:08.719 of that comes from mining fraud. Gold miners always thought 0:20:09.200 --> 0:20:12.200 that there was a great big load just a few 0:20:12.280 --> 0:20:16.440 feet away for digging rock, and that all they needed 0:20:16.960 --> 0:20:19.280 was a little bit more investors cash in order to 0:20:20.520 --> 0:20:24.359 achieve it. And that's how gold miners started getting into 0:20:24.359 --> 0:20:28.600 the habit of faking essay results, which is a tradition 0:20:28.640 --> 0:20:30.639 that goes way back to the first days of the 0:20:30.680 --> 0:20:35.800 Californian gold Rush. And you get these things which start 0:20:35.840 --> 0:20:41.000 out as having an honest intention, but then when you 0:20:41.080 --> 0:20:44.000 realize that you can do that, there's some people who 0:20:44.000 --> 0:20:47.720 realize that actually faking it until you make it is 0:20:47.760 --> 0:20:51.119 one business model, but it's in many ways cheaper to 0:20:51.240 --> 0:20:55.359 just start straight out by faking it. Dan, what is 0:20:55.560 --> 0:21:00.119 the oldest type of pride? The very earliest one I 0:21:00.240 --> 0:21:07.240 found as public procurement fraud. There is a public procurement 0:21:07.280 --> 0:21:11.040 fraud in the Bible, and it's a case of skimming 0:21:11.119 --> 0:21:16.160 profits of a maintenance contract in the Book of Kings 0:21:16.240 --> 0:21:22.919 for anyone who's counting. And that's really because governments developed 0:21:23.200 --> 0:21:26.880 earlier in the history of civilization than corporations did. And 0:21:27.160 --> 0:21:31.040 what is actually quite interesting is that modern commercial fraud, 0:21:31.480 --> 0:21:36.240 as opposed to just generally stealing by lying, is surprisingly modern. 0:21:36.560 --> 0:21:39.960 You don't find that many of them before about eighteen hundred, 0:21:40.320 --> 0:21:42.080 and the reason for that is that you don't find 0:21:42.160 --> 0:21:47.240 that many recognizably capitalist enterprises before eighteen hundred. Actually, I 0:21:47.320 --> 0:21:50.440 tell a lie because I've got my ancient history wrong. 0:21:51.119 --> 0:21:53.919 The ancient Greeks had a loss of shipping fraud, and 0:21:54.000 --> 0:21:56.720 that would presumably have predated the ev answer of the 0:21:56.720 --> 0:22:01.240 Book of Kings. Getting a ship, pretending to load it 0:22:01.280 --> 0:22:05.280 with a valuable cargo, scuppering it or hiding it, and 0:22:05.320 --> 0:22:08.440 then telling your investors that they've lost their money. That's 0:22:08.480 --> 0:22:11.840 probably the oldest form of fraud. Um. I have what 0:22:12.080 --> 0:22:14.720 might be a strange question, but I'm going to ask 0:22:14.720 --> 0:22:18.200 it anyway. Do you think as the world grows more 0:22:18.240 --> 0:22:23.560 complex and as we get more regulation, more supervisors, you know, 0:22:23.840 --> 0:22:29.520 big supervisory departments situated within companies, whether they're financial or 0:22:29.560 --> 0:22:33.199 something else, do you think that makes the potential to 0:22:33.240 --> 0:22:37.880 have frauds more likely or less likely? So, for instance, 0:22:39.080 --> 0:22:41.479 the fact that we have insurers is what allows us 0:22:41.520 --> 0:22:46.640 to have insurance frauds. Right, So do the opportunities expand 0:22:46.840 --> 0:22:49.720 as we have more regulation and more supervision or do 0:22:49.760 --> 0:22:55.080 they shrink. I think it's an arms race basically, so 0:22:55.359 --> 0:22:59.720 locally they could be growing or shrinking. Globally, I think 0:22:59.720 --> 0:23:04.080 they probably stay at a reasonably stable long term proportion 0:23:04.119 --> 0:23:07.720 of the economy. I'm writing some more at the moments 0:23:07.720 --> 0:23:09.720 because there's a U S edition of the book coming out, 0:23:10.520 --> 0:23:13.560 and looking back through the book, I realized that it's 0:23:13.600 --> 0:23:16.399 time after time that I'm talking about something that happened 0:23:16.400 --> 0:23:19.240 in the a C. S or nineties and saying, of course, 0:23:19.320 --> 0:23:21.520 you couldn't get away with this today because they changed 0:23:21.560 --> 0:23:24.760 the rules. And it makes me worry that I'm portraying 0:23:24.800 --> 0:23:27.919 this view of an almost whig version of history of fraud, 0:23:28.480 --> 0:23:31.240 that all these bad people did bad things in the past, 0:23:31.400 --> 0:23:33.800 but we got wise to them and we've shot that 0:23:34.880 --> 0:23:39.040 particular loophole, and so that couldn't happen anymore. And then 0:23:39.080 --> 0:23:42.880 you get something coming along like sub primal libel. So 0:23:43.600 --> 0:23:48.880 what you get is technology and algorithms, I think are 0:23:49.080 --> 0:23:55.600 very good at detecting the general run of fraud, and 0:23:55.640 --> 0:24:01.160 you might actually even see genuine structural declines in just 0:24:01.760 --> 0:24:06.200 simple credit card skimming, check kiting and fairly straightforward small 0:24:06.200 --> 0:24:10.960 time stuff like that. But the nature of the really 0:24:11.040 --> 0:24:16.160 big frauds is that they're designed around the systems. They're 0:24:16.200 --> 0:24:19.560 designed around the guy who sets the algorithms in place, 0:24:19.960 --> 0:24:24.679 and you have the whole company controlled by a either 0:24:24.760 --> 0:24:28.200 by a fraudster or by a system of incentives that's 0:24:28.200 --> 0:24:30.160 so bad that it might as well be a fraudster. 0:24:30.880 --> 0:24:34.320 And the thing is that the amount of loss and 0:24:34.400 --> 0:24:38.639 the amount of damage is just totally driven by the 0:24:38.760 --> 0:24:42.560 very big frauds. If we consider something like payment protection 0:24:42.560 --> 0:24:47.320 insurance in the UK, or libor or forex, every single 0:24:47.440 --> 0:24:50.200 small time fraudster in the USA could work for five 0:24:50.280 --> 0:24:52.840 years and not get to be the tenth part of 0:24:52.840 --> 0:24:56.720 what the size of one of the really big financial scandals. 0:24:56.760 --> 0:25:01.280 Someone like you know, d'angelus, the salad oil king, if 0:25:01.359 --> 0:25:05.280 he were in his prime today, is he still alive? 0:25:05.800 --> 0:25:09.199 He is still alive. Yes, he was arrested for another 0:25:09.200 --> 0:25:13.600 fraud in the nine hasn't done anything since. That's if 0:25:13.640 --> 0:25:16.560 you were in his prime today. Coming up with the 0:25:16.680 --> 0:25:21.400 skills that enabled him to identify the selled oil opportunity, 0:25:21.400 --> 0:25:26.440 in your view, lend themselves to spotting opportunities for fraud today. 0:25:27.200 --> 0:25:33.000