The main pillar of capitalism is reliable financial information
The main pillar of our capitalist free market economic system, which is a cornerstone of our democracy, is the integrity of financial information. Without reliable financial information, capitalism cannot survive. The integrity of financial information can only be achieved through building blocks such as sound internal controls and independently verifiable financial information. The well educated, skilled, and experienced certified internal auditor or certified public accountant is the first line of defense for the capitalist system.
Why our economy imploded
We created artificial wealth, then we borrowed against it, and finally we spent it. When the artificial wealth disappeared, we had an implosion. Lax regulations, failed public company audits, and an unskeptical public create a perfect breeding ground for criminals to artificially inflate asset values and generate artificial wealth.
Do not trust, just verify. Verify, verify, and verify.
White-collar criminals use a combination of charm and deceit to achieve their objectives.
White-collar criminals consider your humanity, ethics, morality, and good intentions as weaknesses to be exploited in the execution of their crimes.
White-collar criminals measure their effectiveness by the comfort level of their victims.
White-collar criminals build a wall of false integrity around them to gain the trust of their victims.
White-collar crime can be more brutal than violent crime, since white collar crime imposes a collective harm on society.
No criminal finds morality and stops committing crime simply because another criminal went to jail.
On August 17, 2009, I testified before the New Jersey State Assembly Republican Policy Committee as an expert witness during their hearings on political corruption and white collar crime and advised them that:
White collar crime is more brutal than violent crime. The actions of one or a few corrupt public officials and corrupt businessmen affect the livelihoods of thousands of people. Treat them with the same disdain as we do treat serial killers because white collar criminals are economic predators. We are serial economic predators.
Simply said, white-collar criminals continue committing their crimes until they are caught.
Understanding White Collar Criminal Behavior
According to various studies conducted by the Association of Certified Examiners, approximately 95% of white collar criminals have no previous criminal record. In fact, the higher the monetary value of the economic crime, the less likely it is that the perpetrator will have a previous criminal record.
White collar criminals know that people live on the hope of a better financial future. The white collar criminal’s job is to feed people’s hope with their spin and lies.
Initially, the white collar criminals attempt to build a wall of false integrity around them to gain the trust of their victims. They showcase their good deeds, such as giving money to charity and helping the poor and needy, in order to help build a public perception of integrity. For example, as the criminal CFO of Crazy Eddie, I walked old ladies across the street and gave huge sums of money to charity, while having no empathy whatsoever for the victims of my crimes.
White collar criminals measure their effectiveness by the comfort level of their victims. Those false perceptions of integrity that criminals build around themselves help to mask their criminal intents by increasing the comfort level of their victims, and corroding skepticism of the criminal’s actions.
The white collar criminal always has the initiative to commit their crimes. They have no respect for society and their victims. White collar criminals consider your humanity as a weakness to be exploited in the execution of their crimes. By your humanity, I mean your ethics, your morals, and our great laws that create the presumption of innocence until proven guilty. Your trust, your morality, your ethics, and our great legal system limit your behavior, while giving white collar criminals freedom to commit their crimes and obstruct justice.
Trust is a professional hazard that will destroy the careers of journalists, Wall Street analysts, auditors, and criminal investigators. For example, during the cold war, President Regan used to say about his dealings with the Soviets, “Trust, but verify.” The inclination to initially trust and later verify, gives white collar criminals a major advantage over their victims. While you initially trust white collar criminals, they work on ways to solidify your trust before you verify.
The white collar criminal hopes that you will never verify. Even if you do verify, your skepticism of the criminal’s deceptive answers may be corroded your comfort level. In other words, you will accept the criminal’s deceptive answers as factual.
In any case, as the criminal CFO of Crazy Eddie, I found that most journalists, Wall Street analysts, investors, and auditors did not know how to ask proper questions, who to ask the proper questions to, how to handle my deceptive answers, and how to ask appropriate follow up questions.
No criminal finds morality and stops committing crime simply because another criminal went to jail
Many people mistakenly believe that strong punishment such as long prison sentences are a deterrent to crime. Recently, many white collar criminals have received very stiff sentences, which I firmly support. However, strong punishment is not a material deterrent to crime, but rather a society's policy for dealing with the consequences of those found guilty of it. Criminals don’t plan on going to prison just like entrepreneurs don’t plan on business failure.
Apologies are irrelevant
As a society, we place too much emphasis on contriteness and apologies. While that is an admirable trait, apologies do not undo any harm on victims of white collar crime. Apologies make society feel good but accomplish little beyond that. Therefore, I feel that apologies are irrelevant and serve only to humanize white collar criminals at the expense of dehumanized victims.
Sources of information on white collar crime
Every source has an agenda. To government investigators, it’s known as the XXX principle (and I am not talking about pornography).
1. Ex-lovers: Divorced spouses, former girlfriends and boyfriends.
2. Ex-business associates: Former customers and employees
3. Ex-employees: Fired employees, laid off employees, and employee who quit working for the entity.
While such sources can provide useful information, investigators and the media are cautioned that such sources usually have an ax to grind and are looking to promote their particular personal agendas. They may have known about the crime during the execution of it, but did not report it. Worst yet, they may have participated in the crime and are trying cover up their own wrongdoing by blaming some people and protecting other co-conspirators.
Investigators and journalists should never trust a source or fall in love with the information that sources provide you. Criminals know that investigators and journalists have limited time and resources to check the accuracy of their information. Therefore, cross checking information and independently verifying information from a source is essential for any investigator or journalist.
Common elements of all white collar crime – the fraud triangle
Criminologists believe that all white collar crime have three common elements: incentive, opportunity, and rationalization (known as the fraud triangle).
Incentive
All white collar criminals require an incentive to commit their crimes. However, many people erroneously believe that personal financial benefit is the primary incentive for economic crimes.
While personal financial benefit can be one of many motivations to commit white collar crimes, in many cases it is not the primary reason that white collar criminals commit their crimes. As a result, many white collar criminals are overlooked as possible suspects because people do not associate a personal financial benefit to their actions.
The primary reason that many white collar criminals commit their crimes is for ego, stature, and loyalty. Personal financial benefit is not always a primary incentive for white collar criminals to commit their crimes.
Opportunity
All white collar criminals require an opportunity to commit their crimes. Unfortunately, our society creates that opportunity.
Society’s belief in the presumption of innocence until proven guilty, trust and then verify, and giving people the benefit of the doubt limits society’s behavior while providing the white collar criminal with the freedom of action to take advantage of society and commit their crimes.
In addition, lack of internal controls, lack of effective oversight, lack of freedom of the press or speech to question irregularities, and a general lack of professional skepticism creates a fertile opportunity for white collar criminals to commit their crimes.
Rationalization
Many criminologists erroneously believe that white collar criminals have to rationalize their crimes with some sense of perceived entitlement. I disagree. Most white collar criminals are highly intelligent, have no previous criminal records, and know right from wrong.
How to find red flags for possible fraud in plain sight
In order to find fraud, you have to spot "patterns of inconsistencies" in a company's public disclosures found in SEC filings, earnings conference calls, media interviews, trade journals, and other forums. In an interview with Fortune Magazine published on December 17, 2007, I listed the following rules:
INVESTOR BEWARE
Sam E.'s five rules for spotting potential fraud in public companies.
Study SEC filings yourself.
External auditors, audit committees, and Wall Street analysts cannot protect you from most fraud. Analysts often do not ask the important questions and are too quick to accept management's representations.
Read the footnotes first.
Tiny things can be huge. In the Crazy Eddie fraud, the change of a single word (from "purchase discounts and trade allowances are recognized when received" to "recognized when earned") allowed Sam E. to inflate the company's earnings in fiscal year 1987 by about $20 million.
Watch for inconsistencies.
If the CEO tells the press, "We are profitable," make sure the figures in the 10-Q back up the statement.
Always crosscheck disclosures.
Compare Management Discussion & Analysis in the current report with MD&A sections in past 10-Qs. Look for any changes in disclosure language.
Sound like too much work?
If you don't have the time or expertise to do the above, don't buy individual stocks. Stick with index funds.
